AN OVERVIEW OF SHARIAH-COMPLIANT FUNDS

Shariah-compliant funds are expanding quickly as a different asset class primarily because of their origin in moral corporate conduct. While Shariah-compliant investments may be obligatory for Islamic clients, other investors choose to follow this policy because of the benefits it provides. In this article, we present a brief overview of Shariah-compliant funds and discuss their relevance.

Islamic law expressly defines Islamic financial principles, and this results in morally upright operations and procedures as Shariah-compliant investment weeds out firms that engage in activities that are viewed as improper, thus making room for socially responsible investing.

As such, investment in highly leveraged enterprises is not allowed for Shariah-compliant funds since the idea of debt is incompatible with Islamic teachings. This has increased demand for Shariah-compliant funds in the investment industry, and analysts predict that this trend will continue. Therefore, it is anticipated that there will be an increase in the number of Shariah-compliant funds on the market as fund managers strive to access the stock supply made accessible by Islamic investors.

WHAT ARE SHARIAH-COMPLIANT FUNDS?

To put it simply, any investment vehicle that completely adheres to Islamic standards is known as a Shariah-compliant fund.

For a fund to be Shariah-compliant, it must not entail an excessive level of Gharrar (risk) or involve Maisir (speculation), as these are regarded as illegal activities. Because of this, a Shariah-compliant fund is unable to deal in options or other derivatives that serve as hedging instruments. Another requirement for a Shariah-compliant fund is the exclusion of assets whose primary source of income is the sale of alcohol, pornography, and any other activity that is prohibited by Islamic teachings.

Hence, Islamic funds must either create a Shariah supervisory board to supervise their adherence to Sharia principles or base their investment decisions on established Shariah-compliant investment criteria.

SIGNIFICANCE OF SHARIAH-COMPLIANT FUNDS

Sharing risk and benefit is the fundamental tenet of any Shariah-compliant financial transaction as the financier and the client agree to split any earnings and share the risk of investments since Islam prohibits taking on financial risks in order to increase profits.

Investment vehicles that adhere to Shariah offer a way to invest while honoring Islamic norms and tenets. Hence, Shariah-compliant funds encourage investing in a manner akin to the specialized ethical funds by taking into account certain requirements as per Islamic law, much like any other socially responsible fund within the environmental, social, and governance (ESG) realm.

Furthermore, since investments in businesses engaged in gambling, the manufacturing of weapons, or the sale of alcohol are prohibited under shariah, investors who want to solely buy low-risk, environmentally friendly stocks can consider Shariah-compliant funds. This also applies to Individuals of other religions and beliefs who desire to invest in assets that adhere to the ideals of social responsibility as these funds are not restricted to Muslims.

TYPES OF SHARIAH-COMPLIANT FUNDS

For every investment a fund makes, there are specific guidelines that must be followed. As mentioned earlier for each Shariah fund, an appointed board comprising Islamic experts evaluates the firms to ensure that they adhere to the rules.

Presented below is a description of the typical types of funds that adhere to sharia:

• Islamic commodity funds

Islamic commodity funds purchase products to resell them for a profit in the future, with the exception of those that are prohibited, like alcohol or porn, or those that are used as money, like gold and silver.

Since shorting commodities is prohibited, the fund must literally or constructively own the commodity before reselling it (i.e., the risk of the commodity must have been transferred to the fund).

The fund management may employ istisna’a or salam contracts to pre-agree on the price of items to be created and delivered at a specific future date, despite the fact that the manufacturer profits from receiving the agreed-upon sale price in advance.

• Islamic equity funds

It is forbidden for Islamic equity funds to own, purchase, or trade in the stock of corporations engaged in a haram activity. When selecting equity investments, Islamic equities funds frequently use Shariah screening procedures that focus on the commercial conduct of the firm in question as well as its financial measures.

Equity funds make direct investments in businesses by buying their shares. This new, more progressive mindset permits investment in businesses that operate in permitted industries, with the caveat that a portion of the returns generated for the fund from any interest-bearing deposits held by the business must be donated to charity.

• Islamic exchange-traded funds

A mutual fund that monitors an underlying index and trades its shares on one or more stock exchanges is known as an exchange-traded fund (ETF).

Accessing liquidity pools for a variety of stock markets is reasonably inexpensive, straightforward, and tax-efficient using Islamic exchange-traded funds. The vast majority of exchange-traded funds produced are made to replicate an underlying index, enabling investors to hedge their positions in a group of securities or acquire exposure to a certain industry without having to buy the underlying assets.

• Ijarah

Ijarah is a type of leasing fund that buys assets and then rents them out to a different party in exchange for a regular rental payment. In each situation, the fund maintains ownership of the asset and is responsible for ensuring that it is always used in line with Islamic principles.

• Murabahah

A development fund called Murabaha buys assets and then sells them to a customer at a defined price that includes the cost of the item plus a profit margin.

Murabahah investment vehicles also referred to as “cost-plus” funds, don’t maintain long-term ownership of the assets; instead, they make money by meeting the commitments they have taken on to make payments.

FINAL THOUGHTS

Shariah-compliant investment vehicles have gained attention as an alternative to traditional ones as they forbid speculating and encourage holding onto an investment for a period of time to provide profits for investors. Hence, investments in ethically questionable sectors like those connected to gambling or alcohol are not permitted by these funds.

A Shariah-compliant fund must also include an appointed Shariah board, a yearly Shariah audit, and the ability to donate some forms of revenue that are banned by Shariah, such interest, to charity.