After introducing a revolutionary digital system to the West that has transformed mathematics and commerce forever, it seems that Islamic principles can still be very useful to our wallets, thanks to Islamic finance. Halal investing, which is the cousin of Islamic finance, is most notably known to favour less risky and more stable investments.
What is Islamic finance?
It’s first and foremost a different financial system. Islamic finance differs from traditional finance in that financial products must comply with the principles of Sharia. Sharia, or Islamic law, is a code of conduct that provides Muslims with a set of rules and prohibitions. It represents “The way to respect God’s law”. Any operation must respect the Islamic legal system, which includes some prohibitions.
One of the main principles is the banning of charging interest or known in Arabic as “riba”. It is therefore impossible for an Islamic Bank to charge interest rates since Islam requires that any gain must result from the effort of work. Because money has no value (known today as fiat) money cannot be made with money.
If you can’t earn a return on money directly how can this alternative way of banking generate revenue? Enter the notion of trade. For example, If you want to buy a house but don’t have the funds to pay for it fully in cash, you won’t be borrowing money from a bank. Instead, you will use a financing transaction called “Murabaha” or commonly known as a credit-sale. As part of the Murabaha transaction, the bank will buy the house on your behalf and then immediately sell it back to you at a higher price where you will make monthly instalments over a set period of time.
Another transaction model called “Ijara” or most commonly known as a lease is also used to finance equipment or projects. Unlike Murabaha, it is linked to the sale of the usufruct, or in other words, the right to use the property without acquiring ownership of it. This product is generally used by companies wishing to acquire machinery or equipment and is often accompanied by a purchase option at the end of the lease.
A second major principle of Islamic finance is in the sharing of gains and losses, with the notion of fair sharing of risks between each stakeholder. Banks, therefore, cannot be mere lenders and must be directly involved in asset-backed or based transactions. As part of the financing of a project, the banks will act as a “Muwakil” or principle or a “Mudarib” or General Partner. The former allows the financier to use its discretion as to whether it would like to participate in profits or losses via equity ownership or just act as a financier where the latter only allows for the participation of profits or losses.
These are just a few examples of how banks have developed financial products that have adapted to Islamic principles.
Believe it or not, the world of Islamic investing also differs from its traditional counterpart.
What is halal investing?
Any investment wishing to comply with Sharia (also called halal investment) must respect the Islamic legal system. Each asset is therefore studied by an Islamic compliance committee known as the Sharia Supervisory Board, which will conclude whether or not it complies with Islamic finance principles.
Above, we saw how this system prohibits interest and promotes the sharing of gains and losses. Sharia law also prohibits pure speculation and investment in sectors deemed illegal. Investments with high degrees of uncertainty are therefore not allowed, thus derivatives and short selling are banned. It is also prohibited to invest in a business that derives its revenues from activities such as gambling, entertainment, alcohol, tobacco, pornography, cannabis, weapons, pork production or processing or anything else that goes against the principles of Islam.
A simple way to invest would be to use the WealthBar Robo-advisor, which enables you to invest in a diversified halal investment portfolio. There is no minimum investment and accompanies a low fee model which is an easy way to start investing in a halal manner.
To build your own portfolio of halal assets, you can, of course, select corporate stocks that you consider to be in accordance with Islamic law yourself. However, you will not be able to invest in bonds or any instrument that provides interest as a source of its return. Even if you have a brokerage account that pays default interest on uninvested deposits, you will have to pay that interest to a charity as a way of purification.
There are also ETFs that advertise themselves as Halal, so an independent investor will not have to choose each stock individually. The main halal investment funds are generally composed of stocks, real estate assets, commodities and/or currencies. These funds must meet the criteria of Islamic law and are approved by an Islamic compliance committee. Since speculation is prohibited, these funds generally have a long term investment strategy.
An example of a halal equity fund would be the Wahed FTSE USA Shariah ETF (HLAL), which is the very first NASDAQ listed ETF.
There are also platforms like Manzil that offer halal investments and financing solutions to their clients. It is currently the only shariah-compliant mortgage provider in Canada which is funded via its mortgage fund and is the only income deriving investment fund of its kind that has the advantage of not being correlated to equity returns.
Why should halal investments attract only Muslims?
Halal investing, albeit based on religion, is not exclusive to only Muslims. Because of its ethical and socially responsible focus, these types of investments have many advantages and attract investors from various backgrounds.
They inherently have a lower risk exposure because Islamic funds avoid companies managing their activities in a risky or speculative manner and who are highly indebted. Since debt is against the principles of Islam, the funds opt for stable companies that have little or no debt. In addition, sectors prohibited by Sharia law such as pornography or online gambling are often linked to regulatory and sectoral risks. Their absence from the halal portfolio thus once again limits the overall risks. As a result, the portfolios offered by halal investment funds are more conservative and less volatile, making them suitable for investors with lower risk appetite.
Are you sacrificing returns because you are limiting the risks? That is not necessarily the case, there are many academic studies that have shown that halal based investments have outperformed their conventional counterparts in economic downturns and in times of economic prosperity. An example of this can be seen in the Amana Growth fund, which in 2019 surpassed the S&P 500’s annual results by posting a return of 33.07% and 31.49% respectively. Therefore, halal investing can also result in performances superior to market indices! Are these results linked to the meticulous choices of portfolio managers or to the constraints imposed by Sharia law? It’s difficult to determine. But one thing is certain; halal investing should not be rejected blindly.
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