This article first appeared in Forum, The Edge Malaysia Weekly on November 18, 2024 - November 24, 2024

When discussing quantitative investments, names like Renaissance Technologies, Citadel and Millennium often dominate the conversation. However, this Western-centric view may overlook innovative developments closer to home, particularly in the realm of Islamic finance.

Recent advancements in the Malaysian financial sector highlight a growing trend: the application of cutting-edge quantitative techniques to Islamic investing. This intersection of traditional principles and modern technology is addressing a significant gap in the market.

Islamic asset management has seen limited innovation over the past two decades. Shariah-compliant investment products account for less than 1% of the world’s financial assets, leaving Islamic investors with few options beyond concentrated, actively managed funds or broad market Islamic indices.

However, the industry is now at a turning point. The explosion of data — with approximately 2.5 quintillion bytes generated daily worldwide — has rendered traditional methods inadequate for handling super massive, unstructured datasets. This challenge presents an opportunity for innovation in shariah-compliant investment solutions.

The traditional approach to Islamic screening involves an advisory board conducting both quantitative and qualitative screening. This labour-intensive process typically results in a limited investment universe, often based on exclusionary approaches starting with standard indices. The constraints can lead to crowding in the same names, potentially overlooking less popular but viable multibillion dollar investment opportunities.

Islamic funds should leverage artificial intelligence (AI) to modernise the screening process. For example, a recent new fund by Kenanga Investment Bank Bhd (KL:KENANGA) developed systems that automate the weekly quantitative screening, processing and updating of financial statement data for more frequent and comprehensive analysis. Additional machine learning algorithms enhance qualitative analysis by sifting through vast amounts of textual data from diverse and live sources like textual corporate filings, news and press releases, packaging the information in a human consumable form for the shariah board. Furthermore, the system provides an additional layer of validation by cross-referencing investments against holdings in other shariah-compliant funds and analysing the composition of their respective shariah advisory boards.

An interesting side effect of this approach is that funds employing these methods often achieve higher environmental, social, and governance scores than traditional indices. This alignment is not coincidental; the principles of responsible investing have roots in ethical behaviour and stewardship that trace back millennia.

Research suggests that well-governed, responsible firms also tend to be more environmentally conscious. While not explicitly climate-focused, these new quantitative shariah-compliant products show promise in meeting broader socially responsible investment criteria.

As the financial industry continues to evolve, the integration of advanced quantitative techniques with Islamic finance principles represents a significant opportunity. It offers the potential to expand the universe of shariah-compliant investments, provide more diverse options for Islamic investors, and contribute to the broader field of responsible investing.

These developments signal an exciting convergence of tradition and innovation in the financial sector. As quantitative techniques merge with Islamic finance principles, a new era of data-driven approaches is dawning. And importantly, it is an approach that will continue to benefit from additional research and development in the field of AI. This convergence offers expanded investment options for Islamic investors and contributes to the broader field of responsible investing. For Malaysia and beyond, it signals an exciting fusion of tradition and innovation in finance, honouring religious principles while harnessing the power of modern technology.

Ben Charoenwong is an associate professor of Finance at INSEAD Singapore, where he teaches investments and asset management, and hedge funds. His research focuses on financial regulation and financial technology.

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