A Robo-Advisory Framework for Islamic and ESG Compliance – A Benchmark Study on the S&P 500 Stock Index

The last decade has brought a revolution in the financial sector, enabling more individuals and institutions to access the stock market. Islamic finance has similarly gained considerable interest from the growing Muslim population that is looking for Shariah-compliant investment options. Furthermore, a growing number of investors are looking for investment options that are environmentally sustainable and adhere to ethical values. While there are various Shariah advisory services, these services differ widely in their assessments of whether a company is Shariah-compliant. Given the cost of these services, it is typically only available for large institutional investors. The objective of this article is to address the challenges of providing individualized Shariah-compliant investment services automatically while providing a comparison with Environmental, Social and Governance (ESG) compliance to assist both investors who are seeking Shariah and ESG compliant investments. Hence, the study presents a new unsupervised learning framework for the determination of Shariah compliance and evaluates it with ESG compliance. The framework first filters the companies based on whether they have any exclusionary activities and then performs a clustering approach in order to classify them into compliant and non-compliant stocks. The framework was evaluated on the S&P 500 stock index and delivered acceptable and reasonable classifications. This Robo-Shariah advisor framework allows automatized real-time Shariah compliance evaluation based on a data-driven approach. The practical implication of this new framework is the enablement of objective, data-driven Shariah-compliant investment recommendations that can be easily integrated with Shariah expert information. The social implication is the empowerment of retail investors in being able to easily set up their own Shariah-compliant portfolio.