The role of Sharia compliant investments in global diversification

 Rosie Kmeid

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The growing popularity of Islamic finance has led to the development of new Sharia-compliant investment tools that are modelled to a certain extent after conventional finance structures but fully adhering to Islamic principles.

The Sharia or sacred law of Islam is a fundamental religious concept which governs the practical aspects of a Muslim’s daily life. It is comprised of five main branches, Adab (behavior, morals and manners), Ibadah (ritual worship), Mutakadat (core beliefs), Muamalat (transactional jurisprudence) and Uqubat (penal laws). These branches combine to create a society based on justice, fair dealing and equality for every member of society.

In commerce, the Sharia can determine business style and indicate the need to comply with Halal (lawful) and ethical investing. Traditionally, analysts have argued that devout Muslims are the primary users of Islamic investment products. Today, other investors who are non-Muslims do so for the benefits these products confer, including greater returns, transparency and diversification.

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The concepts and principles of Islamic investments

Islamic investments are a unique form of socially responsible investments because Islam makes no separation between the spiritual and the secular. They are the perfect option for someone who wishes to invest responsibly to meet his short and long-term financial goals.

One of the most notable differences between Islamic investments and other forms of investment is the existence of a Sharia board which comprises of a group of independent and respected Islamic scholars or jurists who are highly qualified to issue Fatwas i.e. religious rulings on financial transactions. Their sources for interpretation follow a hierarchy of authority: The Quran; the Hadith; the Ijma, or consensus of scholars on a particular issue; and Qiyas which are scholarly legal deductions. This panel of Sharia experts approves or rejects potential investments non-compliant with Islamic law according to certain criteria. They also make periodic reviews to make sure that the investments remain Sharia-compliant every step of the way. Under Islamic law, Gharar (uncertainty), Maysir (gambling) and Riba (interest) are considered as totally inequitable. In addition, financiers cannot invest in industries that deal with alcohol, tobacco, pork, gambling, and adult entertainment that are deemed Haram (unlawful). They are required to carefully maintain social responsibility and ethics in their investment choices.

Once the Sharia board rules an investment Sharia-compliant, investors are free to proceed with making investments. While, in many respects, the processes are similar to what we find in traditional banking, they do incorporate some distinctive featuresthat are unique to Islamic investing. The main types of investment vehicles compatible with Sharia are profit and loss sharing (PLS) scheme or participatory banking and mark-up contracts; and financial certificates that are known as Sukuk, similar to bonds in Western finance but structured in such a way as to generate returns to investors without infringing Islamic law.

 

Investing in accordance with Sharia law

While it’s the utmost duty of every Muslim to find an investment that adheres to rules and regulations described in the Quran and ahadith, this new type of investment is growing rapidly as an appealing alternative for all investors, both Muslim and non-Muslim for its ethical foundation, sustainability and social responsibility. Its main benefit is that it encourages people to invest with a social conscience. Of course, the ability of investors to make strategic faith-based choices is inhibited by the quality and type of guidance received from their financial institutions. In the event that investments are considered unethical, Islam encourages the process of purification, and hence any proportion of revenue received from suspected non-compliant activities are paid to charity and thereby purified. The tolerance levels of these activities are evaluated on a case-by-case basis.

Today, the market environment is potentially beneficial for Sharia-compliant funds, and the prospective client base looking for values-based investments is expanding. Experts believe that faith-based investing will undeniably outperform conventional investing over the long-term horizon due to the growing potential of diversification benefits, and because it provides a comprehensive framework for risk management and prudent investing.

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How does Sharia govern Islamic investment funds?

The term Islamic investment fund means a joint pool wherein the investor contributes his excess money for the purpose of investment to earn profit in strict conformity with the precepts of Sharia. This means that not only the channels of investment, but also the terms agreed with him must conform to the Islamic doctrine.

The subscriber to the fund may receive a document entitling him to the pro-rata profit actually earned by the fund. This document may be called certificate, unit or share, and its validity will always be subject to two main conditions: The Sharia board approval and the Sharia review and audit.

Keeping these basic requisites in view, Islamic investment funds may accommodate a variety of desirable modes of investment such as commodity funds, equity or money market funds and real estate funds,long regarded as a favorite form of investment.

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What about islamic ETF’s?

An exchange-traded fund (ETF) is an investment vehicle characterized by an open-ended, index-tracking unit trust fund that consists of a group of securities listed and traded on a stock exchange like a single security. The relatively new class of Sharia-compliant ETFs has emerged alongside the rapid growth of Islamic finance. These ETFs track only benchmark indices that consist of Sharia-compliant securities or assets. They seek to provide investment opportunities beyond the existing pool of investment, for both Muslim and ethical investors with the usual benefits of transparency,low management costs, high liquidity, relative safety and solid appreciation potential as a mid to long-term investment. Obviously, Islamic ETFs’ screening process is overseen by leading Islamic scholars and results in a portfolio of securities in adherence with Sharia law.

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Conclusion

With a large expanding, untapped and underserved market segment, there are likely to be more Islamic investment opportunities in the future. Demographics point to strong future demand for Sharia-compliant propositions, and hence there will be a drive towards product sophistication and innovation to cater for the increasing business complexity of investors. 

Through the insights derived from several research platforms, we conclude that the Islamic investment universe is moving to maturity. But while continuing growth seems likely, some challenges persist. Experts expect these issues will fall away with time and the Islamic investment landscape will soon develop into a deeper and more liquid market, with a wider range of faith-based investment opportunities available for the benefit of all.

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