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What is Shariah Law?

Shariah is Islam’s religious law derived from the Quran. It acts as a code of living that all Muslims adhere to and includes guidelines for praying, fasting and even investing.
Shariah investing means investing as per the set values of Shariah law. According to Shariah law, investments must not only benefit the investor but also contribute to the development of society[1]

3 Principal of Shariah Investing

  1. No-interest income: Shariah prohibits interest and doesn’t allow investors to pay or receive interest, as it is considered unjust. Let’s say, for example, you are planning to buy a house and need a loan. According to Shariah Law, you cannot take a loan from a bank. Instead, the bank will buy the house, and you will pay the rent to the bank. The rent you pay will be distributed to the depositors of the bank.
  2. Forbids investment in certain businesses: As per the Shariah Law, investors cannot invest in businesses involved in weapons, drugs, alcohol, pork products, and gambling. It also doesn’t allow investors to invest in companies that earn most of their income through interest.
  3. Balanced distribution of wealth: According to Shariah Law, a part of the wealth earned must go to charity. The law ensures that the investors share their wealth with the less fortunate. Moreover, the risks and returns of a transaction must be shared equally among both parties, and no party should be the only beneficiary. 

What are Shariah-Compliant Mutual Funds?

Shariah-compliant mutual funds invest based on the principles of the Shariah Law, and their portfolio is as per the Islamic religion. These funds are socially responsible funds that invest in companies that adhere to the Shariah Law. They offer capital appreciation, diversification, and income distribution and have Shariah indices as their benchmark. A Shariah-appointed board of Islamic scholars screens the companies that meet the principles of the Shariah Law [2]. Shariah-compliant funds invest in private equity or real estate companies. 

Features of Shariah-Compliant Mutual Funds

  • Shariah-compliant mutual funds do not invest in businesses that harm the environment or people. They do not invest in companies selling tobacco, alcohol, weapons, drugs, or pork products.
  • These funds do not invest in companies that pay or receive interest or ‘Riba’. As per the Quran, interest income is a forbidden source of income, and earning or paying interest goes against the law.
  • Shariah-compliant mutual funds avoid high levels of risk and do not invest in high-debt companies or derivatives.
  • These funds avoid fixed-income securities.
  • All investors of every religion can invest in Shariah-compliant mutual funds.

Restrictions as per Shariah Law

The Shariah Law has certain restrictions, which have to be followed by every Shariah-compliant investment.

  • Shariah-compliant funds cannot invest in companies whose debt is one-fourth or more of the total assets.
  • Since it is impossible to avoid interest altogether when investing, these funds can invest in companies whose interest income is up to 3-5% of the total income.
  • Shariah-compliant mutual funds cannot invest in banks or insurance companies as they earn all their income through interest. Moreover, companies manufacturing pork, alcohol, tobacco, and drugs and involved in gambling are also excluded from the list. 

Top Shariah Compliant Mutual Funds

India being a secular country, has several investment options complying with the Sharia Law. Following are the Shariah-compliant mutual funds in India.

  • Tata Ethical Fund: It is one of the oldest Shariah-compliant mutual funds, opened for investments in 1996. It aims to maximize returns by investing according to the principles of the Shariah law. It is suitable for investors who wish to invest as per the Shariah Law and want to earn long-term wealth.
  • Taurus Ethical Fund: Established in 2009, the fund is Shariah-compliant and is suitable for medium to long-term investing. The fund invests most of its assets in large-cap companies, followed by mid cap and small-cap companies
  • Nippon India ETF Shariah BeEs (formerly Reliance ETF Shariah BeES): A passively managed fund replicating the Nifty50 Shariah index. It invests only in large-cap companies and is suitable for investors who prefer earning market returns.

Who Can Invest in Shariah-Compliant Mutual Funds?

  • Investors with low-risk tolerance can consider investing in Shariah-compliant mutual funds as the law forbids the funds to invest in high-risk companies. 
  • These funds invest in equities and suit investors with a medium to long-term goals such as purchasing a car or retirement.
  • Shariah-compliant funds are not just for Muslims. Investors of any religion can invest in these funds. However, before investing, ensuring the fund’s objective aligns with your goals and risk tolerance levels is important.

Factors to Consider Before Investing in Shariah-Compliant Mutual Funds

  • Returns: Before investing, it is important to check the performance of any fund. One must compare the fund’s performance with its peers and benchmark before investing in them.
  • Liquidity: These funds invest in equity but do not trade on the secondary market. Hence they have less liquidity compared to other funds.
  • Limited options: There are very few Shariah-compliant funds to choose from, forcing investors to invest in the available funds.
  • High costs: Investing as per the Shariah Law can be costly. Fund managers must follow the Shariah law’s rules and ensure they comply with them. This can increase the costs of fund management.
  • Restricted decision-making: Fund managers are supposed to invest as per the Shariah Law, which takes a lot of effort. Moreover, these funds have Islamic scholars as advisors who advise and monitor fund managers’ activities. This restricts the fund managers’ decision-making ability.

Frequently Asked Questions

Can an investor from any religion invest in these funds?

Yes, investors from any religion can invest in Shariah-compliant mutual funds.

Do shariah mutual funds give any tax benefits?

No, there are no tax benefits for Shariah-compliant mutual funds.

What is the minimum amount to invest in shariah mutual funds?

The minimum investment amount for Shariah-compliant funds varies for different fund houses. For some funds, the minimum investment is Rs 10,000, and for some, it is Rs 5,000. It is important to note that Shariah-compliant funds have a very high minimum investment compared to other funds.

What is the benchmark for Shariah mutual funds?

Some of the benchmarks for Shariah mutual funds in India are the Nifty 500 Shariah Index, S&P BSE 500 Shariah Index, and Nifty 50 Shariah Index.

How do you invest in Shariah-Compliant Mutual Funds?

You can invest directly in Shariah compliant mutual funds through the asset management company’s website. Alternatively, you can invest through investment platforms such as Scripbox mutual fund.

What are faith-based funds?

Faith-based funds are similar to Shariah funds. These funds invest in companies that meet the principles and standards of a certain law, such as the Shariah Law.