Shariah-compliant investing: the key ideas

Many people in the GCC and around the world want their money to grow in line with Islamic principles. Islamic finance has a clear set of ideas, from avoiding riba to screening companies, that are worth understanding whatever your background.

Core principles

• The IMF's Islamic finance factsheet lists the main prohibitions as riba (interest), gharar (excessive uncertainty) and maysir (gambling), along with short sales and financing activities considered harmful to society.
• Parties are expected to share the risks and rewards of a business transaction, and deals should serve a real economic purpose without heavy speculation.
• The IMF notes that banking business based on sale or lease must have an underlying asset, which is part of the transaction itself rather than just collateral.
• In practice, this means money should earn returns from real trade, ownership or business activity, not from simply lending at interest.

Screening shares: business activity

• Shariah-compliant share funds and indices screen companies before including them. The FTSE IdealRatings Islamic Index Series is one published example.
• It excludes companies earning more than 5 per cent of revenue from activities such as alcohol, tobacco, gambling, pork-related products, adult entertainment, weapons and conventional financial services.
• Its list also includes some categories, such as music, cinema and advertising, where scholarly views and index rules vary.
• Islamic financial institutions are exempt from these screens in that methodology.

Screening shares: financial ratios

• Even a halal business may borrow at interest or hold interest-bearing cash, so screens also check the balance sheet.
• In the FTSE IdealRatings methodology, a company is excluded if its conventional debt exceeds 33 per cent of its average market value over the previous 24 months.
• It is also excluded if its cash and short-term interest-bearing securities exceed 33 per cent of that value, or if interest and other non-compliant income exceeds 5 per cent of total income.
• Different index providers and Shariah boards use different thresholds, so 'compliant' under one standard may not be under another.

Purification

• Because a small share of a screened company's income may still come from non-compliant sources, investors may 'purify' their returns by giving that portion to charity.
• The FTSE IdealRatings document states that 'best practice suggests that an appropriate purification level of dividends should be 5%'.
• Many Shariah-compliant funds explain their purification approach in their documents; read it before investing.

Sukuk: the Shariah-compliant alternative to bonds

• The IMF explains that sukuk must be structured so that there is an underlying asset, the principal is not guaranteed, and returns track the performance of the underlying assets.
• A real example: the UK government issued a 500 million pound sukuk in 2021, paying investors from rental income on government-owned office properties 'in lieu of interest payments which are not consistent with Islamic principles'.
• Sukuk are traded on UAE markets, which the UAE government portal lists alongside shares, bonds and funds.
• Like any investment, sukuk carry risks, including that the issuer or the underlying assets do not perform as expected.

Checking and respecting the label

• Look for which Shariah board or standard has certified a fund or product, and read its screening rules.
• A 'halal' label in an advert or app is not proof on its own. Ask what screening was used and who oversees it.
• If compliance matters to you or your family, a qualified scholar or a licensed Islamic finance professional can help with personal questions.
• Shariah-compliant investments still go up and down in value; compliance is about how money is earned, not a guarantee of returns.