All You Need To Know About Shariah-Compliant Mutual Funds

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Nowadays, with the popularity of mutual funds on the rise, mutual fund houses are making them more and more appealing to investors. Some mutual fund types fall under the category of ‘socially responsible’ funds. One of these types of funds is aligned with the moral laws and codes of the religion of Islam - the Shariah Law. Shariah-compliant mutual funds adhere to Shariah law and if you wish to invest in these, you should have an in-depth understanding of these funds.

Additional Read: Mutual Funds

About Shariah-Compliant Mutual Funds

According to the tenets of the Islamic Shariah Law, people of the Muslim community are not permitted to make investments in stocks of certain companies, aligned with the products they produce. The Islamic law regarding investments also lays down restrictions linked to company earnings. Consequently, while investing in certain companies, Muslim investors must take into account such things as whether a company relies heavily on interest earnings or has accumulated debt. Investment in stocks of such companies is prohibited for people of the Islamic religion.

Features of Shariah-Compliant Mutual Funds

Since people of the Muslim community have to adhere to Shariah law, they must know the features of Shariah-compliant mutual funds before making decisions to invest. The features are mentioned below:

Specific Investments

As Shariah law prohibits certain kinds of investments, Shariah-compliant mutual funds do not allocate your capital to any instruments that may harm or cause injury to others or the environment. For example, such mutual funds will not invest in stocks of a weapons manufacturing company.

Likewise, Shariah-compliant mutual funds will not include stocks or instruments related to companies that produce such products as alcohol, pork, tobacco, military equipment, weapons, etc, or companies involved in the promotion of gambling or any other spurious activities.

Consideration of Interest Earnings or Riba

According to Shariah law, individuals from the Muslim community must avoid any interest earnings by companies. In case a person from the community engages in any action connected to interest earnings or Riba, they are deemed to be engaged in a ‘war against God’. This is one of the highest offences of a person following the religion of Islam. This is why Shariah-compliant mutual funds do not invest in those companies that are involved with interest earnings.

In case the mutual fund does invest any capital in interest-bearing companies, the earnings through interest are to be distributed to charity.

No-risk Funds

Mutual funds that comply with Shariah law do not deal with instruments with a high degree of risk. Instead, the law permits a certain degree of risk in mutual fund investment, as long as it's not considered an immoderate amount. Furthermore, companies having high debt and derivatives are not included in these investments. Fixed-income instruments are also avoided for investment purposes.

Anyone can Invest

Shariah-compliant mutual funds are open to investors from all communities and not just those from the Muslim community.

Limitations Based on Shariah Law

Besides the special features of funds that adhere to Shariah law, there are certain restrictions placed on these kinds of mutual funds. You should know about the following restrictions before you invest:

Companies with Zero Interest

Since it is not possible to find any companies that do not earn any interest, Shariah-compliant mutual funds have the leeway to invest in stocks of companies that have an interest income of up to 3% of their entire income.

Debt-to-Asset Ratio

Funds that are compliant with Shariah law can only invest in companies with a total debt-to-asset ratio equal to less than one-fourth of their total assets.

Restricted Industry/Sectoral Investment

Shariah-compliant mutual funds are not permitted to acquire stock of companies involved in any finance sectors or industries, such as insurance companies and banks. Furthermore, as stated earlier, they cannot invest in any companies that manufacture certain goods or those linked to spurious activities like gambling. For example, mutual funds of this kind cannot acquire shares of hotels that may have casinos or nightclubs.

Additional Read: Blogs 

Shariah-Compliant Mutual Funds - Some Examples

With regulations and restrictions imposed on mutual funds, you can find certain ethically compliant mutual funds that operate according to Shariah law.

Final Words on Shariah-Compliant Mutual Funds

If you wish to be ethical in your mutual fund investment journey, Shariah-compliant mutual funds may be considered. Nonetheless, these funds have regulations and restrictions stringently imposed on them, and consequently, they have a narrowly defined focus on investment. Since this is the case, you may consider the fact that returns from such funds may be bound by the particular sectors and industries invested in. Before you invest, you may want to think of your investment goals and financial plans.

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

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