Sharia Law Compliant Mutual Funds

What Is Shariah Law?

Shariah Law is the Islamic legal system drawn from the Quran and the teachings of the Prophet Muhammad. It outlines guidelines for every aspect of a Muslim’s life, including prayer, fasting, business dealings, and even investing. Under Shariah, the goal is not just personal gain—investments should also help strengthen the community and promote fairness in society.

Shariah Investing

Shariah investing follows the principles set out by Shariah Law. It focuses on making money in a way that is considered halal (permissible) and avoids activities seen as haram (forbidden). Shariah-compliant investments aim to create wealth ethically while ensuring the money also contributes to society’s well-being.

3 Key Principles of Shariah Investing

1. No-Interest Income (Riba-Free):Shariah Law does not allow charging or paying interest, as it is seen as an unfair gain. For example, if you need money to buy a home, a typical mortgage might charge interest. Under Shariah principles, instead of lending you the money at interest, the bank would buy the property and lease it back to you. The monthly payments you make are like rent, shared fairly among the bank’s depositors.

2. Avoiding Certain Businesses:Shariah investing avoids companies involved in activities harmful to individuals and society. This includes businesses dealing in alcohol, weapons, tobacco, drugs, pork products, gambling, and those heavily dependent on interest income. Instead, it encourages putting money into businesses that are socially responsible and contribute positively to the community.

3. Balanced Distribution of Wealth:Sharing and fairness are at the heart of Shariah investing. Part of the wealth earned should go to charity or support the needy. Also, all parties in a transaction should share both the risks and returns. No single party should gain at the expense of others.

   
   

What Are Shariah-Compliant Mutual Funds?

Shariah-compliant mutual funds are investment funds guided by Shariah principles. They do not invest in companies or financial instruments that break Islamic rules. Instead, they focus on assets that align with Islamic values—often socially responsible businesses and sectors such as healthcare, technology (without haram elements), and ethically run real estate or private equity ventures.

A board of Islamic scholars reviews and approves these funds’ investments, ensuring they meet Shariah standards. The funds often use special Shariah indices as benchmarks to measure their performance against permitted assets.

Features of Shariah-Compliant Mutual Funds

• Ethical Investments:They avoid businesses that harm society or the environment, such as those dealing with alcohol, tobacco, weapons, drugs, or pork products.

• No Interest-Based Income:These funds steer clear of companies involved primarily in lending or borrowing with interest, since interest (riba) is not allowed in Islam.

• Lower Risk Approach:Shariah funds tend to avoid excessive speculation or high-debt companies. They also stay away from derivatives and other complex financial instruments that involve high uncertainty or gambling-like practices.

• No Fixed-Income Securities:Since interest is prohibited, these funds generally don’t invest in bonds or other fixed-income instruments.

• Open to All Investors:Anyone, regardless of faith, can invest in Shariah-compliant funds. Their appeal extends to individuals looking for ethical and socially responsible investments.

Restrictions Under Shariah Law

• Debt Limits:Companies with very high levels of debt (usually one-fourth or more of their total assets) are avoided since they are seen as too reliant on interest-based financing.

• Minimal Interest Exposure:While avoiding interest entirely is challenging, the income from interest-bearing activities must remain very low—often within 3-5% of total income. Any small amount of interest earned is usually “purified” by donating it to charity.

• Exclusion of Certain Sectors:Banks, insurance companies, and other businesses that earn mainly through interest do not qualify. Similarly, companies involved in alcohol, pork, gambling, and other prohibited activities are excluded.

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Top Shariah-Compliant Mutual Funds in India

• Tata Ethical Fund:One of the oldest Shariah-compliant funds in India (since 1996), it invests according to Shariah principles and aims for long-term growth.

• Taurus Ethical Fund:Launched in 2009, this fund is suitable for medium to long-term investing. It primarily invests in large-cap companies and follows Shariah guidelines strictly.

• Nippon India ETF Shariah BeES:Formerly known as Reliance ETF Shariah BeES, it’s a passively managed fund that follows the Nifty50 Shariah index. It invests mostly in large-cap companies and is suitable for those who want market-linked returns within a Shariah framework.

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Who Can Invest in Shariah-Compliant Funds?

• Low-Risk Investors:Those with lower risk tolerance may appreciate the cautious approach of Shariah funds, which avoid overly risky ventures.

• Medium to Long-Term Goals:Shariah funds are often equity-oriented, making them suitable for medium to long-term goals like buying a vehicle, saving for education, or planning for retirement.

• Investors of Any Faith:While based on Islamic law, these funds are open to everyone. Ethical and socially responsible investing appeals to investors who want their money to align with their values.

  
  

Factors to Consider Before Investing in Shariah-Compliant Funds

1. Returns:Check past performance and compare it to similar funds and benchmarks. While the goal is ethical investing, returns still matter.

2. Liquidity:Shariah-compliant funds may have slightly less liquidity since they avoid certain markets and instruments. Consider how quickly you might need the money.

3. Limited Choices:The number of Shariah-compliant funds is smaller than conventional options. This can limit diversification.

4. Costs:Ensuring compliance with Shariah principles might increase management costs. The fund managers work closely with Islamic scholars, which can add to the expense ratio.

5. Restricted Decision-Making:Fund managers operate within strict rules. While this ensures purity of investments, it may limit certain profit opportunities found in more flexible funds.

   
   

In a Nutshell

Shariah investing blends faith, ethics, and finance. By adhering to Islamic principles—avoiding interest, steering clear of harmful industries, sharing risks and returns fairly, and giving back to society—Shariah-compliant funds offer investors a chance to grow their wealth responsibly. Whether you follow the faith or simply value ethical investing, these funds can add diversity and moral alignment to your portfolio.