Shariah investments

Sharia (other variations Shariah, Shari’ah) is the Muslim or Islamic law which regulates many aspects of a Muslim’s life including the type of investments allowed. For instance, interests are considered usury according to the Riba rule therefore bonds are prohibited to investors following the Sharia law. A Shariah compliant fund is an investment vehicle fund structured in accordance to Shariah rules. Shariah funds can be managed as mutual funds, ETFs or hedge funds. They are in essence common funds with an extra layer of Islamic rules integrated in the investment polices of the fund not dissimilar to SRIs. The funds are required to be fully compliant with Shariah rule; however, the companies structuring, managing and promoting the funds do not have to be necessarily Shariah compliant.

It is an attempt to instill communal, ethical and socially responsible values into investing. E.g. It prohibits taking undue profits, overcharging of commodities in scarce supply, manipulation of demand-supply gap to the benefit of hoarders, etc., It also does not allow excessive debts, It prohibits investing into Tobacco, Cigarette, Alcohol, and other domains which are harmful for health. Hence it brings in a sense of responsibility as well as humanity into how your investment will give you fair returns by preserving the ethics and values.

Commodities funds generate profits by buying and reselling Halal commodities. Because of the restrictions on the use of derivatives, commodities fund make use of two types of Shariah approved contracts:

Istisna- It’s a contract where the buyer of an item funds upfront the production of the item. A detailed specification of the item has to be agreed before production starts and the cost of production can be paid partially according to manufacturing stages.

Bay al-salam- It’s similar to a forward contract where the buyer pays in advance for the delivery of raw materials or fungible goods at a given date. The spot price of the item includes the profit of the person who has taken the task of purchasing good and, of course, the cost of the product.

Funds that invest in common shares in companies engaged in halal business. Companies are also screened in order to check for Shariah compliant accounting principles. Because of the limited pool of companies the funds can invest into, equity funds can have higher volatility compared to similar funds in the same space.

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Wikipedia