Islamic Investment Funds
30th August 2014
Islamic investing involves adhering to the principles of the Shariah, which bans the charging, accepting, or dealing in interest, and dealing in prohibited activities such as pork, tobacco, gambling, alcohol and weapons.
Islamic financial institutions work on a philosophy of prohibiting transactions considered immoral and promoting greater social justice by sharing risk and reward. The customer and the Islamic bank share the risk of any investment on agreed terms, and divide any profits between them. Islamic finance does not allow creating new financial risks in order to gain profit; it is about protecting society from deception and social tensions. In that regard excessive risk taking and gambling are prohibited.
Shariah products also stress accountability, fairness and transparency. It is ensured that not only the underlying investments but also the contractual terms agreed between the investors and the investment manager conform to Islamic principles. Islam disallows certain contracts due to inherent elements which render them unlawful, such as short selling, futures, derivatives and conventional insurance.
Shariah compliant investments must all be certified by experts, generally through a panel or board comprised of respected Shariah scholars who are highly qualified to issue religious rulings (fatwas) on financial transactions. All Islamic investment fund companies have appointed Shariah boards which not only provide approvals on individual investments on a regular basis but also conduct a Shariah audit annually to ensure all activities of the investment funds are fully compliant.
There are a number of transaction types that are used to structure Shariah compliant investments and contracts. The most common structures are explained below:
- Musharakah: a partnership where profits are shared according to a pre-agreed ratio while losses are shared in proportion to the capital investment of each partner.
- Mudarabah: an investment partnership under which the investor provides capital to the investment manager in order to undertake a business or an investment activity. While profits are shared on a pre-agreed ratio, losses are borne only by the investor.
- Ijarah: an Islamic lease agreement. Instead of lending money and earning interest, Ijarah allows the investor to earn profits by charging rentals on the asset leased to the user.
- Murabaha: instead of lending money, the investor purchases the desired asset from a third party and resells it at a predetermined higher price to the user. By paying this higher price over instalments, the user of the asset has effectively obtained credit without paying interest.
Types of Islamic Investment Funds
The most common forms of Shariah compliant investment funds are equity funds, real estate funds and money market funds. These investment funds employ Islamic contracts which ensure that the terms and rights of all parties are safeguarded in conformity with Islamic principles. The significant portion of Islamic funds is concentrated in equity investments. However, Islamic finance has also recently developed a wide range of products in the area of fixed income and private equity where there were significant product gaps.
- Equities: this is the most popular asset class within Islamic asset management, investments are not only selected through an industry screen as mentioned in the above section, but must also adhere to certain ratios. Debt to assets should be less than 33.33%; cash and interest bearing items should be less than 33.33% of total assets; accounts receivable should be less than 50% of total assets; total interest and non-compliant activities income should not exceed 5% of total revenue.
- Commodities: this asset class is well-suited for shariah compliant investment. However, a differentiation must be made between the underlying tangible investment and the futures contract. Only investing in the underlying commodity is permissible in Islam.
- Fixed income: this market has exhibited strong growth in the last 5 years, as the need for fixed income investments from banks, asset managers and takaful companies have driven demand, while on the supply side governments and corporations in Islamic countries have had the need to raise Shariah compliant debt financing.
- Real estate: like commodities, real estate is another asset class which is well suited for the Islamic finance industry as it deals with a tangible asset. There has been growing demand for real estate products as there has been a global recovery in real estate prices since the global financial crisis.
How to Access Islamic Investment Funds
If you are interested to find out more about this type of investments, and would possibly like to enter these funds, please get in touch. Astra have an exclusive partnership with an industry leader offering top quartile islamic investment funds in various asset classes and currencies.