Author: Aakash Rastogi, Symbiosis Law School Nagpur
Introduction
Shariah Compliant Investing is an investment product that adheres to Islamic Law – this is regarded as a socially responsible investment, specifically a requirement for using funds subject to Islamic principles. The Islamic banking institutions agree on sharing profit or loss with the business as charging interest is prohibited. Like other socially responsible investments, Shariah-compliant social investment funds include the return on investment and social impacts created for beneficiaries. Following the Shariah-compliant paradigm, and within that framework for socially responsible investment, those funds need to be Shariah-compliant (Islamic law), so the overall management would need to fall within the core principles of the Islamic Faith.
Principal Differences to Conventional Funds:
The primary difference to conventional funds is in the investment process since it is part of the Shariah-compliant investment fund, so either the Shariah committee as part of funds governance to ensure compatibility with Shariah or are involved as part of fund management, or acceptable Shariah screening criteria if the fund was established from the pathway of traditional investment funds. As a result, the organization determines the initial investment and the entire portfolio holding period until it is finally disposed of. Constraints will be placed on the fund regarding the activities of the investee companies or the types of assets the fund may invest into, for example.
•Closing adjustments and later investors
•Default of payment
•Financial ratios
•Use of swaps and derivatives
•Prohibited interest
•Requirement to purify any haram (forbidden) income
•Carry and use of inter-company debt
Forms of Shariah-Compliant Investment Funds:
Shariah-compliant investment funds can take many forms, which can include:
An investment policy for a Shariah-compliant fund must be developed to ensure that the fund’s investments do not violate Shariah principles. Some investments are considered haram (forbidden) products. These haram investments include companies or assets involved:
The creation, sale, refining, or distribution of alcoholic beverages or other alcoholic products
Gambling, casinos, lotteries and related games
The creation, sale, distribution, or slaughtering of pork and products based on pork
Banks, financial institutions, or insurance companies non-Islamic in nature
Companies involve pornography and other forms of obscenity.
Several investments could be considered in a ”grey area,” and although they are not called out as haram, they are typically discouraged considering Shariah compliance. These investments include:
Assets involving tobacco and tobacco-related products
Companies or assets involved in the entertainment business (film, video, theater, cinema)
Companies using leverage may be allowed on a non-Shariah compliant basis, although exceptions to this principle are being developed
Companies or assets involved in the creation of weapons
Mandatory rules governing Islamic finance impact strategy selection and asset allocation with Shariah-compliant investing regardless of asset class.
Riba (Interest):
Under Shariah law, money is merely a means of exchange. Money doesn’t have inherent value and cannot ethically be used to make more money or “earn more money.” Interest is, thus, prohibited in all transactions because one party benefits at the expense of another party.
Gharar (Unreasonable uncertainty):
Uncertain transactions are prohibited as uncertainty created without information could lead to undesirable states. Futures are a great example in which the traded assets may not even exist on the delivery day.
Halal (Permissible):
Halal transactions are permissible transactions. Conversely, Haram (impermissible) transactions involving prohibited actions in Islam. Examples could be trading alcohol, pork, or gambling.
Mudarabah (Profit and loss sharing principle):
All investment stakeholders must shoulder a proportionate risk and split rewards accordingly. Depositors must be involved in the agreement, and all risks and rewards are calculated proportionally to realized profit or loss.
The asset-backing principle:
Financial transactions must involve the exchange of tangible and identifiable underlying assets. Traded assets must demonstrate clear benefit and value to their owners. Conversely, transactions backed by demonstrably harmful assets are banned.
Sukuk:
Sukuk is an Islamic financial certificate that conforms to Sharia, and its approach is based on a bond structure in banking. When a sukuk is issued, the issuer essentially sells investors an interest or participation certificate. Since Shariah prohibits standard interest-paying bond structures, the money is instead used to buy an asset that investors at least partially own as a group of other investors so that each has direct ownership. In other words, the issuer must enter a legal obligation to buy back the bond later in time for par value.
The Islamic conception of interest is forbidden under its root: “riba.” Due to this, typical debt instruments are inappropriate for making investments or funding in an entity. To solve this problem, sukuk was formulated to practically spread the benefits of that asset by correlating returns and cash flows generated through debt financing with such an underlying asset. It allows investors to bypass Sharia law’s limitations yet still benefit from funding with debt. by the nature of sukuk as a structure, financing could be mobilized only for identified assets.
Types:
Ijara (lease) Sukuk:
Ijara is a contract wherein one party rents out another party to purchase and lease a specific item (such as land, buildings, or machines) the client needs. The rental terms, including the upfront rental price, are outlined in the agreement between the lessor (the owner of the asset) and the lessee (the beneficiary). The lessor still owns the asset. Ijara Sukuk are securities linked to a lease contract and denote asset ownership. Lease rentals are the investors’ source of income under the contract. Ijara Sukuk can be traded on the secondary Sukuk market at a price determined by the supply and demand for the instrument.
Murabaha (profit margin sales plus cost) Sukuk:
A Murabaha is a sales contract wherein goods are sold for a sum that comprises the purchase price plus a profit margin that has been mutually agreed upon. You have the option of paying in full or in installments. An equal-value certificate known as a Murabaha Sukuk is given out to finance the acquisition of goods through Murabaha, giving the holders of the certificate ownership of the Murabaha commodity. Using the money from the Sukuk, the commodities are purchased from a Supplier/Vendor and subsequently sold to the Sukuk Originating Entity at cost plus a reasonable profit to be paid later. In a legitimate sales agreement, the seller must reveal to the buyer the amount of money they will make from the sale upfront.
Shariah-Compliant Mutual Funds
Various mutual funds have been developed that abide by the principles of socially responsible investing. Shariah-compliant mutual funds are socially responsible investments that are consistent with Shariah law and the ethical values of Islam. To be a Shariah-compliant mutual fund, several stipulations must be adhered to:
Debt-to-Asset Ratio – The fund must not invest in companies with total debt over 25% of their assets.
Interest-free Income – While it is difficult to find companies with entirely interest-free income, those companies whose interest income is no greater than 3% of the company’s total revenue may be invested.
Prohibitions- The fund may not invest in companies that conduct financial services, such as banking and insurance, and/or conduct business in producing alcohol, pork, tobacco, gambling, adult entertainment, or similar business.
Examples of Shariah-Compliant Mutual Funds
In 2010, S&P provided the first Shariah indices in India, which consisted of:
a. S&P CNX 500 Shariah
b. S&P CNX Nifty Shariah
Compliant Mutual Funds available in India:
Tata Ethical Fund This fund is appropriate for investors seeking diversification with equity holdings that would not include banks and finance firms. This fund is aimed at those investors who are looking for long-term capital appreciation and investments in Shariah-compliant equities and related instruments.
Taurus Mutual Fund
This fund is appropriate for investors seeking equity holdings that would not include banks and finance firms. This fund is oriented toward investors seeking long-term capital appreciation catering to Shariah law.
Nippon India ETF Shariah BeEs
The Nippon India ETF Shariah BeEs seeks to determine returns that nearly mirror the Nifty50 Shariah Index as it invests across a range of securities
The primary attributes of Shariah-compliant mutual funds include several attributes that separate these evolving investment options- such as:
Screening for Shariah Compliance: Halal mutual funds, perform a positive screen on companies that do permissible activities in sectors like technology, healthcare, and manufacturing.
Shariah Board Oversight: A committed Shariah board comprising Islamic scholars and financial experts supervises the operations of Indian halal mutual funds to ensure that the operations conform to Islamic principles.
Debt-Free Investing: Ordinarily, Shariah-compliant mutual funds do not invest in companies with large debt and leverage.
Profit-and-Loss Sharing: Correspondingly, as with Islamic banking rules, these funds also enable profit-and-loss sharing agreements to be made wherein businesses and the funds share profits jointly.
Asset-Backed Investments: Shariah-compliant funds are often invested in tangibly asset-backed instruments that minimize speculative risks and advance transparency.
Purification Process: The net purification process for compliance involves identifying and deducting income from non-compliant Shariah investments. The amount purified is donated for charitable purposes.
Investments in Sukuk: Sukuk or Islamic bonds form one of the key constituents of the halal mutual fund as they open up an avenue for compliant investment.
Diversification Strategies: These funds follow diversification strategies that provide wide risk dispersion across different markets and industries.
Regular Reporting and Audits: Transparency is paramount in Shariah-compliant finances, and regular audits are conducted to ensure ongoing compliance with Shariah principles.
What Investors Stand to Gain by Investing in Shariah-Compliant Mutual Funds:
It is apparent that investing in Shariah-compliant mutual funds has several benefits for investors.
Consistency with Personal Values: Such funds advocate for ethical investing and social responsibility due to the integration of principles of Shariah law. Thus, investment decisions and personal values can be reconciled.
Reduction of Risk: Shariah-compliant mutual funds expose investors to many Shariah-compliant firms operating within many industries, which helps reduce risk and perhaps enhance returns.
Professionally Managed Investments: Such funds incorporate the best of both worlds by utilizing the expertise of seasoned Islamic finance and sometimes conventional investment professionals. As a result, investors have the advantage of professionally managed funds.
Sharia-compliant stocks
It adheres to Islamic law, avoiding usury, gambling, and ambiguity. This means abstaining from investing in sectors involved in prohibited activities.
The Criteria for Determining Halal Stocks
Islamic scholars have established a methodology similar to the negative screening used in ethical funds, utilizing ESG criteria to evaluate business operations in accordance with Shariah principles. A Sharia-compliant fund generally features an advisory board composed of Islamic scholars who ensure compliance with AAOIFI regulations. Each fund functions based on the interpretations and beliefs of its Shariah Board. The screening process consists of:
Business Activity Screening: This phase eliminates companies contradicting Shariah principles, including interest-based transactions, alcohol production, pork-related products, gambling, adult entertainment, tobacco, marijuana, cloning, firearms, and defense sectors.
Financial Ratio Compliance: This analysis assesses companies based on these specified ratios or set target limits. Regarding interest-bearing products, the limits are as follows: 33% debt, which must not exceed 33% of total average assets, and interest-bearing securities/assets should be less than 30% of the average market capitalization over the last 36 months.
Investors are encouraged to review potential investments to ensure they meet expectations based on interest-bearing products. This allows investors to protect them and manage their expectations. It is important to remember that it would also be prudent not to invest in a company that provides any income level from Shariah non-compliance. If the income is examined, the revenue from Shariah non-compliance activities does not exceed 5% of total income – then trouble can be avoided. A delay mitigates issues; one could donate a share of the profits toward a charitable cause and vocally denounce the activity.
The Importance of Shariah-Compliant Stocks
The primary objective of investing in shares or funds is to generate income. However, for those seeking to earn revenue that aligns with halal principles, it is essential to identify Shariah Compliant Stocks or Shariah Compliant funds for investment purposes. Investing in Shariah-compliant stocks or funds allows investors to maintain adherence to Islamic principles while avoiding involvement in Haram activities, such as the trade of pork products, weapons, alcohol, and drugs. This approach not only ensures compliance with Islamic values but also facilitates personal financial growth and contributes to the broader economic development of the nation.
Shariah-compliant stocks in India
Shariah-compliant funds comprise all investment opportunities that are performed based on criteria set out by Shariah law, in conformity with interpretation made by qualified scholars.
It is essential to be aware that such fund types are invested in companies that meet the criteria for Sharia-compliant business models. Companies are screened based on guidelines issued by Shariah Boards to ensure adherence to those guidelines.
While the idea is not always new, it does have considerable momentum today. The key dwelling point for these funds is to be sure to avoid investing in specific stocks that generate returns from selling or producing pork, alcohol, drugs, gambling, weapons, or any addicting or dangerous activity that goes against the rules of Shariah laws.
Today, Shariah-compliant stocks are becoming more prevalent and increasingly popular in places like India! This headway lays the groundwork for examining Shariah-compliant funds.
Conclusion
Shariah-compliant investing is an innovative combination of ethical finance and Islamic values, ensuring that investment operations are consistent with moral and religious precepts. Through the ban on interest (riba), undue uncertainty (gharar), and investments in industries that are considered haram, it provides a socially responsible investment vehicle extending beyond the traditional financial models. The combination of Shariah screening, sukuk, and mutual funds enables the investor to participate in ethical wealth creation while securing financial stability and economic progress.With the growing international interest in ethical and sustainable investing, Shariah-compliant investment products are an appealing option for investors who want to enjoy financial returns as well as Islamic legal compliance. The structured governance through Shariah advisory boards guarantees compliance and creates investor trust. In addition, the focus on asset-backed transactions, profit-and-loss sharing, and risk diversification increases transparency and financial strength. As the Islamic finance industry grows, Shariah-compliant investments will be a key driver of responsible investing globally. By reconciling ethical values with financial returns, these investments provide the potential for sustainable growth while maintaining the values of fairness, equity, and social responsibility.
FAQS
1. What is Shariah-compliant investing?
It adheres to Islamic principles, excluding interest (riba), gambling, and immoral industries while encouraging ethical investing.
2. In what ways is it different from traditional investing?
It eschews interest, speculation, and undue uncertainty, opting for profit-sharing, asset-backed investments.
3. What financial instruments are employed?
Typically, sukuk (Islamic bonds), Shariah-compliant mutual funds, and ethical equities.
4. How is it ensured to be compliant?
Shariah boards filter investments to guarantee compliance with Islamic finance fundamentals.
5. Can non-Muslims invest?
Yes, because of its social and ethical nature.
