Shari’ah-compliant mutual funds are important today because they provide Muslim investors with investment opportunities that align with Islamic principles. Investment is a key aspect of financial growth, but for Muslim investors, it is equally important to ensure that their investments comply with Shari’ah guidelines. This blog will explore the concept of Islamic mutual funds, their structure, and their adherence to Shari’ah principles.
What is a Mutual Fund?
A mutual fund is an investment vehicle that pools money from multiple investors to invest in a diversified portfolio of assets such as stocks, bonds, and other securities. Professional fund managers handle these investments on behalf of investors.
Sharia-compliant mutual funds function similarly but strictly adhere to Shariah principles, ensuring that all investments are halal (permissible) according to Islamic law.
Types of Mutual Funds
Mutual funds can be categorized based on their structure and investment objectives:
1. Based on Structure
Closed-End Funds: (صناديق استثمار المغلقة) These funds have a fixed number of units. Once sold, no new investors can join, and units must be traded on a stock exchange if an investor wishes to exit.
Open-End Funds: (صناديق استثمار المفتوحة) These funds allow investors to enter or exit at any time. They can issue new units and set their pricing accordingly. Investors can directly buy and redeem units from the fund company.
2. Based on Investment Objectives
Income Funds: Focus on stable, income-generating stocks with low volatility.
Growth Funds: Invest in high-growth companies aiming for capital appreciation.
Stock Funds: Directly invest in the stock market, offering higher potential returns but with increased risk.
Money Market Funds: Invest in short-term assets, providing high liquidity and low risk.
Real Estate Funds: Specialize in real estate investments, offering moderate risk with steady returns.
Shariah-Compliant Mutual Funds
For a Shariah-Compliant Mutual fund, it must adhere to the following key principles:
1. Prohibition of Interest (Riba)
Islam strictly prohibits interest-based transactions. Therefore, a Sharia-compliant mutual fund must avoid investments in interest-bearing instruments such as conventional bonds and other debt securities.
2. Ethical and Transparent Transactions
Investments must be linked to real assets and businesses, ensuring they do not involve excessive uncertainty (Gharar) or gambling (Maisir). Transparency and ethical dealings are fundamental in Islamic finance.
3. Shariah-Compliant Holdings
Since mutual funds indirectly invest in multiple stocks, all underlying holdings must comply with Shariah screening rules.
4. Continuous Shariah Supervision
Shariah compliance requires ongoing monitoring by a qualified Shariah team to ensure the fund consistently adheres to Islamic principles. This supervision helps maintain integrity and prevents unintentional exposure to non-compliant assets.
Shariah-Compliant Investment Structures
Islamic mutual funds typically operate under two models:
1. Wakalah (وکیل بالاستثمار)
- The investor appoints the fund as an agent (Wakil bil Istithmar) to manage their investment.
- The fund fee must be pre-determined and cannot be linked to profit or loss.
- A performance-based bonus can be provided, but it must be voluntary and not obligatory.
2. Mudarabah (مضاربت)
- The investor provides capital to the fund, which manages it in exchange for a share of the profit.
- The fund cannot charge a fixed fee but instead earns a percentage of the profit.
- The investor cannot interfere in management decisions unless the fund violates agreed-upon Mudarabah terms.
Investors in Islamic mutual funds can sell their units or redeem them at any time. However, it is essential to assess the underlying assets of the fund to ensure continuous compliance with Islamic finance principles.
Important Note: Some mutual funds may claim to be Shariah-compliant, but investors must ensure that the fund adheres to the screening criteria they personally follow. Screening methodologies can differ, meaning that a stock considered non-compliant under one framework might be deemed compliant under another. Therefore, it is essential for investors to understand these differences and choose a screening approach that aligns with their beliefs.
Exchange-traded funds (ETFs) and Real Estate Investment Trusts (REITs) are also popular investment vehicles. Like mutual funds, they are managed by asset management companies. However, their structures and functions differ.
What About ETFs and REITs?
Exchange-Traded Funds (ETFs)
ETFs are investment funds that trade on stock exchanges, just like individual stocks. They provide investors with exposure to a diversified portfolio of assets while offering liquidity similar to traditional stocks. ETFs can track various indices, commodities, or asset classes.
Real Estate Investment Trusts (REITs)
REITs are companies that own, operate, or finance income-generating real estate properties. They allow investors to gain exposure to real estate without directly purchasing properties. REITs can specialize in commercial properties, residential housing, or infrastructure.
To be Sharia-compliant, both ETFs and REITs must:
- Invest only in Sharia-compliant assets, ensuring their holdings meet Islamic screening criteria.
- Avoid non-permissible activities, including derivatives, short selling, excessive speculation, and revenue from prohibited sectors like gambling and alcohol.
- Minimize interest-based financing and ensure that earnings do not include excessive interest income.
- Be supervised by a dedicated Shariah team that conducts regular audits and ensures compliance with Islamic finance principles.
Role of a Shariah Team
A qualified Shariah team ensures compliance through ongoing audits, fatwas, and regular screenings. Their supervision is essential in maintaining the integrity of Islamic financial products.
Conclusion
Shariah-compliant mutual Funds allow Muslim investors to participate in financial markets while adhering to their religious beliefs. However, investors must verify whether their chosen fund complies with Shariah principles. A dedicated Shariah team is crucial in maintaining compliance and ensuring transparency.
Final Note
IslamicStock does not screen any mutual fund, ETF, or REIT for Shariah compliance. Investors are encouraged to conduct their own research and ensure that the investment aligns with their screening criteria.
Reference: Jadeed maliyati idaray – By Molana khalid saifullah rehmani https://archive.org/details/JADEEDMALIYATIIDARAY_201608