A halal investment is an investment in which it is permissible for Muslims to participate according to the Islamic ethico-legal system (Shari`ah)1. A halal investment fund is a one that is structured, managed, and operated so as to offer investors access to halal investments. A certified halal investment fund is one that has been reviewed, audited, and inspected by an independent panel of experts in Islamic ethics and law who have issued (and thereafter periodically re-issue) a formal certificate of compliance stating that the fund is in fact halal. It should be noted that in order for the fund to be found to be halal, the management must also comply with the principles of the Shari`ah in matters pertaining to the operations of the fund. At Wahed, we have a full time Ethical Review Board that reviews our systems, business practices, and investments in order to ensure the strict Shari`ah compliance of the platform.
Halal investing brings a sense of responsibility to bear on how investments generate returns by preserving a concern for ethics and values. Investments in domains that may cause harm to human beings or other elements of creation, for that matter, (i.e. the environment) are prohibited. This is where socially responsible investing (SRI) and halal investing overlap (we’ll be discussing similarities and differences towards the end of the article). We are proud to make this form of investing accessible at Wahed with low account minimums and seamless online account opening and funding.
This simple guide will provide you with some practical tips to identify halal investment options.
Or, if you’d like to watch our educational series on YouTube with Sheikh Dr. Yasir Qadhi, click here.
1) AAOIFI-Conformant Shari’ah Board
Standards matter. Each and every halal investment fund must have appointed a Shari’ah board whose membership conforms to the competency standards of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the leading standards issuing body for the halal financial services sector. There must be three members, at least two of whom are recognized Shari`ah experts with mufti-class. The Shari`ah Board’s role is to review, monitor, and advise on the structure, policies, and activities of the fund managers so as to insure that returns are permissible. A consistent, periodic, expert review aims to reduce the chances of generating returns from impermissible sources. Having a full time Shari’ah board is a necessity, which can not be satisfied by merely having a third party annual review.
2) Business and Financial Screening
There are two main screening levels for halal investments. A business screening by default refers to the review of a company’s business practices, products sold, and revenue sources. A company is prohibited from generating returns from the selling or producing of alcohol, pork products, weaponry, gambling, adult entertainment, or Riba (interest). The main business screening criteria are highlighted below:
- Prohibition of interest (Riba)
- Profit and loss sharing between the lender and the borrower
- Prohibition of hazard or uncertainty (gharar), notably speculation
- The lack of existence of an underlying asset, i.e. the obligation to back all investments with real assets
- Prohibition of investments in forbidden assets (haraam)
To add on, there are certain limits imposed on a company’s debt levels to better control for excessive risk taking. The financial screen lays out three broad pre-defined financial ratios mentioned below.
- Conventional debt/Total market capitalization < 30%
- (Cash + Interest-bearing deposits)/Total market capitalization < 30%
- (Total interest + income from non-compliant activities)/Revenue < 5%
Investments are considered halal only if a company’s financial ratios conform to those of AAOIFI set standards. Usually, if a company’s cumulative revenue from non-compliant activities and non-operating interest income exceeds 5%, it is required to purify its assets by giving that money to charity in order to maintain its halal status.
3) Operational Level Compliance
The company operating and managing the investment fund must also comply with Shari’ah regulations. The management company must refrain from taking on interest bearing debt and follow certain business practices.
4) Investment Policy
A fund must also establish an Islamic investment policy where the Shari’ah Board vets the investment products for Shari’ah compliance, and conducts ongoing due diligence on them. The policy will clearly outline the screening methods employed, the criteria used, and investment methodology implemented (selection process, absence of day trading, among other restrictions).
5) Purification Reports
Following up on point number one, a more transparent Shari’ah board will also provide the investors with a “purification report”. This will highlight any returns that may have been generated from impermissible sources, which are advised to be donated to charity to purify one’s income. Although this is not necessary, it helps the investors gain peace of mind by knowing the exact sources of their income. At Wahed, we provide our clients with an annual purification report to assure them that their returns are permissible, which further highlights our commitment to halal investing.
Final Tip – Socially Responsible and Halal Investing: Similarities and Differences
While many may think that halal investing is the same as SRI there are a few differences between the two concepts. SRI and halal investments both prohibit investments in certain industries such as alcohol, gambling and weaponry. The main difference is that halal investing prohibits the use of interest (Riba) and follows the aforementioned criteria on company leverage. SRI on the other hand focuses business ethics and practices such as community engagement and company diversity. The below Venn diagram will help you visualize the two concepts.
It is key to understand the criteria that defines halal investing to ensure that your returns inshaAllah will be halal. Unfortunately the “halal” stamp can be abused to attract business, so it is your duty as a Muslim or Muslimah to review the investment you’re getting into, and inshaAllah Allah will grant you barakah in your ventures.
*As with any investment, capital is at risk, as the value of your investment can go down as well as up. Consult your financial advisor before implementing any plans as your needs may differ.
1 These principles of the Shari`ah are derived from the Qur’an and authoritative life example (sunnah, literally ‘custom’) of the Prophet Muhammad (upon whom be peace).