All You Need to Know about Shariah-Compliant Mutual Funds
There are many mutual fund categories that abide by socially responsible investing. Shariah Compliant Mutual Funds are a type of socially responsible investing based on the Shariah or Shariat law of Muslim religion. These mutual funds adhere to the Shariah law which is a moral code of Islam.
Features Of Shariah – Compliant Mutual Funds
According to Islamic law, a Muslim is not allowed to invest in all categories of funds.
There are certain restrictions on their investment type. Shariah Compliant Mutual Funds are those which invest within the boundaries of Islamic laws. The key features of these funds are:
- Muslims cannot invest in anything that could harm other people either (physically or emotionally) or that could harm the environment or, for that sake, even in companies which promote weapons, etc.
So, these funds forbid investments in businesses that generate a major portion of their income by selling alcohol, tobacco, pork, weapons and other military equipment, gambling, and pornography. - Muslims are expected to avoid interests or Riba. As per the Kuran, it is considered that anyone who engages in this has engaged himself in the war against God. This is the reason why Muslims are also not allowed to invest in companies that deal blatantly in Riba.
So, these funds prohibit all forms of interest. An appointed Shariah board avoids such forbidden sources of income by distributing it to charity. - These funds tend to avoid immoderate levels of risk. Derivatives and companies with high debts are not included.
- These funds avoid investment in fixed-income instruments.
- These funds are not only confined to the followers of Islam, all investors of every religion are allowed to invest in the fund.
Restrictions As Per Shariah Law
Apart from the special features, there are certain rules that are required to be followed by a fund to be called a Shariah-Compliant Mutual Fund.
Total Debt to Asset Ratio
This fund cannot make investments in companies whose total debt is one-fourth of its total assets or more.
Interest-Free Companies
As it is impossible to find a company that has 100% interest free income, it is formulated that this fund can invest in companies whose interest income is up to 3% of its total income.
Restricted Business
This fund cannot acquire shares of a company that is involved in financial services like banks and insurance companies and also companies who manufacture liquor, pork, tobacco or are involved in gambling and nightclub activities, pornography, etc.
Examples Of Shariah Compliant Mutual Fund
The S&P were the first to launch Shariah indices in India in 2010. The two indices that were launched for Shariah Compliant Mutual Funds were:
- S&P CNX 500 Shariah
- S&P CNX Nifty Shariah
At present, there are three Shariah Compliant Mutual Funds in India. These are as follows:
- Tata Ethical Fund
Tata Ethical Fund is ideal for investors looking to invest in a diversified equity fund without banking and finance exposure.
It is suitable for those investors who are seeking long-term capital appreciation and wish to invest in equity and equity-related instruments of companies which are Shariah compliant.
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Taurus Ethical Fund
Taurus Ethical Fund is also for investors who want to invest in equity and equity-related instruments in accordance with Shariah law.
It is suitable for investors who are seeking long-term capital appreciation and wish to invest as per the Islamic investment principles.
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Nippon India ETF Shariah BeEs (formerly Reliance ETF Shariah BeES)
Nippon India ETF aims to generate returns that closely mimic the Nifty50 Shariah Index by investing money in various securities of that index.
Investments in the securities of Nifty50 Shariah Index will be made in similar proportion as in the index. It is suitable for investors who tend to invest for medium to long term period to generate long term capital appreciation.
Note: You will need a Demat account to invest in Nippon India ETF Sharia BeES as it is an ETF.
Conclusion
Shariah Compliant Mutual Funds are funds for those investors who are looking for a socially responsible form of investing.
With the restrictions put on investments by the Shariah law, the funds have to abide by the same and thus have a narrowly defined investment focus.
Due to this, the return is also bound by the performance of the specific sector of Shariah compliant companies. Thus, the investor should consider investing in Shariah Compliant Mutual Funds after knowing all the pros and cons of the same.
Happy Investing!
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.
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Research Analyst - Aakash Baid