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Lessons from Islam about smart investing

Islam, which many Americans consider a threat, has a valuable and little-noticed lesson for Western investors. Following Muslims' Shariah law, the religion's investing style avoids highly indebted companies that burn brightly -- and risk fizzling out.

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With interest rates headed up in the U.S. and red flags abounding regarding the dangers of overleveraging, Shariah's risk aversion may once again pay off for investors. In recent years, amid debt-happy euphoria, the returns of Islamic-oriented investing in the West have waned.

In the U.S., the term Shariah connotes medieval behavior like stoning infidels, amputating petty criminals' hands and subjugating women. To Muslims, however, it is a moral code vital for civilization.

And Shariah investing? For the few Westerners who know something about it, this means a ban on gambling, tobacco and alcohol stocks. Less known is its avoidance of financial services shares, because banks and Wall Street firms traffic in debt instruments, and Islam forbids charging interest. Along with that is Shariah's prohibition on companies that are too reliant on bonds and loans.

Shariah investors, for instance, snubbed oil producers that went heavily into debt to take advantage of the shale boom. Good thinking. This year through early November, 36 drillers have filed for Chapter 11 bankruptcy protection as dwindling crude prices decimated revenues -- and the companies' ability to service the huge debt loads. Pipeline operator Kinder Morgan (KMI), groaning under almost $45 billion in borrowings, announced Tuesday it was slicing its quarterly dividend by 75 percent.

Globally, the Shariah-compliant sector has surged to $1.6 trillion in assets over the past three decades, according to the Global Islamic Financial Review, making it hard to ignore. While much of that is in the Muslim world, several American funds follow Islamic precepts.

Amana funds, the largest U.S.-based family of Islamic-oriented mutual funds, have posted mostly so-so performances since 2009, as corporations worldwide issued a plethora of bonds to take advantage of minuscule interest rates. "When risky, debt-fueled stuff does the best, Amana doesn't," said David Kathman, an analyst with research firm Morningstar.

Consider Amana Growth (AMAGX), the group's flagship, with $1.8 billion in assets. It averaged 7.62 percent annual returns over the past 10 years, beating the Standard & Poor's 500 by a half-percentage point, says Morningstar. Although that may not sound like a lot, compound it and the difference is appreciable.

In 2015 as of Thursday, however, the fund is down 1.78 percent, versus a 0.27 dip for the S&P 500. None of this is to say that Amana Growth is a stodgy blue-chip player: 42 percent of its holdings are in technology, and as the fund's name implies, it specializes in growth stocks. The fund's biggest holding is software maker Adobe Systems (ADBE), up 28 percent this year.

Over the past 12 months, investors have pulled $236 million out of Amana Growth. Analyst Kathman attributes that to the fund's trailing performance, not politically tinged developments like the rise of Islamic State, the terrorist massacres in Paris and San Bernardino, California, and Donald Trump's anti-Muslim fulminations. The vast bulk of Amana's investors are Muslim.

Shunning "sin stocks" isn't confined to Islamic funds. Various Christian faith-based funds also won't buy stocks involved with booze, cigarettes and gambling. Shariah adds pork producers to its taboo list.

Nevertheless, forbidding these investments likely has little affect on Shariah funds' returns. Shares in tobacco have done very well lately -- such as Diageo (DEO), which more than doubled since 2009 -- as have those in alcohol, like Altria (MO), whose price has tripled.

Offsetting that lost opportunity are casino stocks, now suffering traumas in Macau, the gaming mecca on China's coast. Owing to a Chinese government crackdown on gambling and the nation's economic slowdown, Las Vegas Sands (LSV) is down by half since early 2014.

Nevertheless, these developments pale when compared with the rollicking ride financial stocks took. Shariah investors sidestepped their 2007-2009 collapse, when the iShares U.S. Financials (IYF) exchange-traded fund slid 75 percent. In 2008, Amana Growth lost 29 percent, but the then-finance-heavy S&P 500 was off 37 percent. (While financial stocks recovered later, they have been flat this year.)

Unfortunately, widespread unease about Islam in the U.S. obscures the virtues of Shariah funds. Calls for preventing Muslims from entering the U.S. are just part of the trend. Seven states have barred courts from using Shariah law. As Usmat Hayat, a director at the CFA Institute, wrote in a blog post earlier this year: "Shariah, after all, is a particularly freighted term in the U.S., where it carries negative political connotations." And that's a shame.

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