Types of Shariah Fund |
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Equity Funds
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Fund managers are allowed to invest in common shares in an attempt to generate returns, mostly through capital gains but also from dividends as long as the shares are from companies that are deemed Halal by the Shariah Advisory Board.
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After picking companies that are deemed as Halal, these companies’ annual reports are then screened for Shariah compliant accounting principles which focuses on leverage, cash and revenues derived from impermissible activities, to further exclude non-compliers.
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As Shariah places these limitations on viable investments and effectively shrinks the potential investment pool, Shariah compliant funds can have higher volatilities relative to similar funds that operate in the same space.
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There are not many equity funds which are invested 100% in equities all the time. Many will have at least a modicum of exposure to money markets or the bank, making them not strictly Halal.
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Accordingly, any interest, dividends and sometimes even capital gains that exceed the generally accepted 5% allowance have to be ‘purified’ to nullify any gains that have accrued from interest bearing activities or other disagreeable aspects of the business.
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A good example of why the case is not as clear cut as ‘bad’ or ‘good’ would be hotels, which are not strictly outlawed, but fall into the middle ground because the profit they make in most cases is partly made up from the sale of alcohol.
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Different funds will have slightly different policies according to their Shariah advisory board, there is constant debate between scholars about the legitimacy of Riba in dividends, purification, hedging instruments and even whether certain businesses are really Haraam. Nonetheless, the policies of any fund will be fully described in the prospectus so that investors can decide for themselves and flag up any concerns before investing.
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Commodity Funds
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These are funds that are setup to purchase different Halal commodities for the purpose of reselling to generate profits. The fund must actually own the commodity at the time of sale, either physically or structurally (i.e. the risk attached to it is fully transferred to the fund) and the price of the commodity must be fixed and cannot be changed or dependent on certain events or the sale will be void.
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Because Shariah strongly prohibits gambling, Shariah compliant commodity funds cannot be involved in commodity futures. However, under some circumstances specific Islamic forwards (Bay Al-Salam & Istisna) can be used legitimately to generate profits.
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Ijarah Funds
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An Ijarah fund holds tangible assets like property, machinery, motor vehicles, and the like - usually with the aim of leasing out the asset for third parties for rental income. To comply with Shariah, the leased asset will have to be used in a Halal manner.
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The ownership of the asset remains with the fund, which is also responsible for its maintenance and hence the main source of income is derived from rentals. The subscriber to a Ijarah fund is issued a ‘Sukûk’ which is effectively the equivalent of a leasing bond which complies with Shariah law. Each Sukûk can be regarded as a separate unit, tradable in a secondary market, its price determined by conventional market forces in much the same way as an investment trust in the UK might be bought and sold.
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