1.1 Introduction
Savings refer to that part of a personâs income that is not spent on consumption. Investment is expenditure that is not for consumption purposes, but aims at the creation of new capital assets such as buildings, land, stocks, mutual funds and so on. Investments are made so as to obtain benefit in the future. When money is kept idle, that is, not invested, it loses its value or purchasing power over time because of inflation. Studies have conclusively proven that uninvested cash has lost over 93% of its purchasing power over the last 200 years. The same studies have also shown that investing in stocks has proven to be more rewarding than investments in securities and bonds with a fixed rate of return. There are basically two categories of assets one can invest in:
- physical assets such as real estate, gold, etc.
- financial assets such as stocks, mutual funds, etc.
Financial assets are usually preferred because they are more liquid than physical assets. This means that they can be bought and sold and cash can be realised at any time, even at short notice. Yet financial assets are also more volatile, meaning that their value can decrease or increase regularly. They offer two types of return: cash income and capital gains.
1.2 Elements of Islamic Investment
When investing funds, Muslims must take care to follow certain Islamic regulations that are based on the principles of Shariâah in order to avoid any elements that are prohibited by Islam. Any fund must follow strict procedures to ensure its success and legal approval.
To ensure that things are genuine and to avoid misdirecting funds, various principles must be borne in mind so as to guide investment:
- investment must not involve interest or Riba
- investment must not be in unethical or immoral business
- economic reward should be profit or fee based
- investments must not involve prediction, speculation, uncertainty or gambling. They must all be based on Islamic teaching.
Allah (swt) says:
Those who devour usury will not stand except as stands one whom the Evil One by his touch hath driven to madness. That is because they say âTrade is like usury.â But Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (the offence) are Companions of the Fire; they will abide therein (forever). (Qurâan 2:275)O ye who believe! Intoxicants and gambling, (dedication of) stones, and (divination by) arrows, are an abomination of Satanâs handiwork: eschew such (abomination) that ye may prosper. (Qurâan 5:90)
Further examples of areas prohibited by the Shariâah pertain to ethical and ecological issues such as products based on animal testing, human rights abuses and others matters such as tobacco, pork, alcohol and pornography. The involvement of Shariâah is needed at all stages in order to create and maintain consumer confidence in the genuineness of the application of Islamic principles to funds. For import and export businesses, any practices prohibited according to Shariâah are not allowed. The operation will not be successful if it is considered unlawful.
1.3 Shariâah Guidelines for Investment
Islam encourages all the devout to follow Shariâah in all matters. Hence, in the field of Islamic investment specific stipulations are in place to educate people to obey the ethics that were determined by Allah. In order to follow Islamic principles, investors must follow several rules that are imposed by Islamic scholars. These stipulations are as follows:
- If the main business of a company is Halal (permissible), such as being engaged in automobiles, textiles and so forth, but it deposits surplus amounts in an interest-bearing account or borrows money on interest, then the shareholder must express his disapproval of such dealings, preferably by raising his voice against such activities at the annual general meeting of the company.
- If some income from interest-bearing accounts is included in the income of the company, the proportion of such income in the dividend paid to the shareholder must be given to charity, and must not be retained by him. This is called purification or dividend cleansing. According to many prominent Islamic fund companies, a Muslim investor cannot invest in the shares of a company if non-Shariâah-compliant sources of income comprise 5% or more of the companyâs total income.
- The shares of a company are negotiable only if the company owns some non-liquid assets. If all the assets of a company are in liquid form, that is, in the form of money that cannot be purchased or sold, except on par value, because in this case the share represents money only, then the money cannot be traded in except at par.
1.4 Stocks in Shariâah Rulings
In conventional practice, ownership of shares is divided into two classes. These are equity stock and preferred stock. The basic difference between the two types of stock are that equity stock does not have a fixed return on dividends to the shareholders, while preferred stock has a fixed return on dividends to shareholders. But this is prohibited in Shariâah rules. The relevant Shariâah concept is based on Riba al-fadl. Muslims investors may thus trade only in common stock and not in preferred stock.
1.5 Islamic Investment Funds
The term âIslamic investment fundâ commonly refers to a joint pool wherein the investors contribute their surplus money for the purpose of investment to earn Halal profits in strict conformity with the precepts of Islamic Shariâah. The subscribers to the fund may receive a document that certifies their subscription, entitling them to profits after investment in the fund. These documents may be called âcertificatesâ, âunitsâ, âsharesâ or may be given any other name. Their validity in terms of Shariâah will require two basic conditions:
- Instead of a fixed return tied up with their face value, they must carry a pro rata profit actually earned by the fund. Therefore, neither the principal nor a set rate of profit (tied up with the principal) can be guaranteed. The subscribers must enter into the fund with a clear understanding that the return on their subscription is tied up with the actual profit earned or loss suffered by the fund. If the fund earns huge profits, the return on their subscription will increase proportionally; however, in case the fund suffers loss, they will have to share it also, unless the loss is caused by negligence or mismanagement, in which case the management, and not the fund, will be liable to compensate it.
- The amounts so pooled must be invested in a business acceptable to Shariâah. This means that not only the channels of investment but also the terms agreed for them must conform to Islamic principles.
Keeping these basic requisites in view, Islamic investment funds may accommodate a variety of modes of investment, which are discussed in the following subsections.
1.5.1 Equity Funds
In an equity fund, investorsâ money is invested in shares of joint-stock companies. Profits are achieved in two ways, namely capital gains earned on buying and selling the shares, and also from the dividends distributed by the respective companies. It should be noted that the fund portfolio must comprise of Islamically acceptable companies whose primary business is Halal. It is prohibited for the Muslim investor to buy or sell shares of companies dealing in Haram activities such as gambling, alcohol, pornography, interest and so on.
Companiesâ businesses and financial practices must conform to Shariâah regulations for them to be accepted as legitimate investment avenues. This means that not only should their core business be Halal, but the company must not deal in any interest-based activities (i.e. it should neither borrow money on interest nor should it deposit its excess cash in interest-bearing deposits). But evidently such companies are rare, hence the need for certain rules for investment. Contemporary Islamic scholars have unanimously concluded that a company will be considered a Halal investment when its primary business is Halal and lawful, if its debt to equity ratio is less than 1:3, if its non-operating interest income is less than 5% and lastly if its liquid assets are less than 45% of the total assets.
1.5.2 Ijarah Funds
Ijarah literally means âleasingâ or ârentingâ. In such a fund, the invested amounts are used to purchase assets such as real estate, motor vehicles, machines and other equipment for the purpose of leasing them out to their ultimate users. The ownership of assets lies with the fund, but the rentals are charged from the users. These rentals form the source of income for the fund and are distributed pro rata among the subscribers. Each subscriber is given a certificate as proof of his subscription, and to ensure his entitlement to the pro rata share in the income. These certificates are called Sukuk, a term recognised in traditional Islamic jurisprudence. Since these Sukuk represent the pro rata ownership of their holders in the tangible assets of the fund, and not the liquid amounts or debts, they are fully negotiable and can be purchased and sold on the secondary market. Anyone who purchases these Sukuk replaces the sellers in the pro rata ownership of the relevant assets and all the rights and obligations of the original subscriber are passed on to him. The price of these Sukuk will be determined on the basis of market forces and are normally based on their profitability. It should be noted that contracts of leasing must conform to Shariâah principles. Some of the basic principles are summarised below:
- Leased assets must have some usufruct, and rental must be charged only from that point when the usufruct is handed over to the lessee.
- The leased assets must be of a nature that their Halal use is possible.
- The lessor must undertake all the responsibilities consequent to the ownership of the assets.
- The rental must be fixed and known to the parties right at the beginning of the contract. In this type of fund, the management should act as an agent of the subscribers and should be paid a fee for his services. The management fee may be a fixed amount or a proportion of the rentals received. Most Muslim jurists are of the view that such a fund cannot be created on the basis of Mudarabah, because according to them Mudarabah is restricted to the sale of commodities and does not extend to the business of services and leases. However, in the Hanbali School, Mudarabah can apply in services and leases also. This view has been preferred by a number of contemporary scholars.
1.5.3 Commodity Funds
In a commodity fund, the subscription amounts are used in purchasing different commodities for the purpose of resale. Any profits generated by the sale are the income of the fund are distributed pro rata among the subscribers. In order to make this fund acceptable under Shariâah, it is necessary that all the rules governing the transactions are fully complied with. For example:
- The commodity must be owned by the seller at the time of sale; therefore, short sales where a person sells a commodity before he owns it are not allowed in Shariâah. Forward sales are not allowed except in the case of Salam and Istisnaâ...