Islamic Finance: Understanding Shariah-Compliant Funds, Examples, and Considerations
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Summary:
Shariah-compliant funds, integral to socially responsible investing, follow the principles of Islamic law. This detailed exploration covers their origin, growth, requirements, challenges, and examples, such as Saturna Capital and S&P Dow Jones Indices, shedding light on the intricacies of this unique investment avenue.
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What are Shariah-compliant funds?
Shariah-compliant funds constitute a distinct subset of socially responsible investing, operating under the tenets of Islamic law. Emerging in the late 1960s, these funds have gained traction recently, standing alongside other socially responsible categories, particularly within the environmental, social, and governance (ESG) framework.
Understanding Shariah-compliant funds
Falling under the broader umbrella of socially responsible investing, Shariah-compliant funds meticulously screen potential investments, aligning with the principles of the Islamic religion. Noteworthy growth in the early 21st century, marked by an annualized rate of 26%, is attributed to increased petrodollar liquidity and the maturation of capital markets in the Gulf Cooperation Council (GCC) countries.
According to a 2011 PricewaterhouseCoopers (PwC) report, Shariah-compliant funds demonstrated substantial growth during the first ten years of this century. The Malaysia Islamic International Financial Center reported global Islamic assets under management (AUM) at $70.8 billion in Q1 2017, compared to $47 billion in 2008.
The implementation of Shariah principles demands meticulous attention, requiring compliance with a comprehensive set of rules. Shariah-compliant funds necessitate the exclusion of investments deriving income from prohibited activities such as alcohol, pork, gambling, and more.
Requirements and challenges
Shariah-compliant funds come with stringent requirements, including the appointment of a Shariah board, annual Shariah audits, and purifying prohibited income by donating it to charity. These rules introduce complexity and costs, with Shariah boards comprising scholars whose fees can reach millions annually, reflecting varied interpretations of Islamic law.
Popular investment categories for Shariah-compliant funds include real estate and exchange-traded funds. However, private equity, while considered a good investment, faces challenges due to issues related to carried interest within Shariah law.
Examples of Shariah-compliant investments
Several products and indexes cater to Shariah-compliant investing. Saturna Capital offers Shariah-compliant investment funds through its Amana series, with the Amana Growth Fund being a notable example. Launched in 1994, it focuses on long-term capital growth, investing at least 80% of its assets in common stocks.
S&P Dow Jones Indices also contributes to the sector, offering Shariah-compliant indexes for Muslim investors. The S&P 500 Shariah Index, launched in 2006, includes constituents adhering to Islamic principles, with information technology dominating at 38%.
Frequently asked questions
What factors contributed to the growth of Shariah-compliant funds in the early 21st century?
The growth of Shariah-compliant funds in the early 21st century was influenced by increased petrodollar liquidity and the maturation of capital markets in the Gulf Cooperation Council (GCC) countries, as reported in a 2011 PwC study.
How do Shariah-compliant funds purify prohibited income?
Shariah-compliant funds purify prohibited income, such as interest, by donating it to charitable causes as per Shariah principles.
What are the challenges associated with private equity investments in Shariah-compliant funds?
Private equity investments in Shariah-compliant funds face challenges due to issues related to carried interest within Shariah law, limiting the seamless integration of this investment category.
Key takeaways
- Shariah-compliant funds align with Islamic principles in investing.
- Strict requirements, including Shariah boards and audits, contribute to ethical investing.
- Despite challenges, these funds have shown substantial growth in recent years.
- Examples like Saturna Capital and S&P Dow Jones Indices showcase diverse investment options.
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