Halal Investment in Stock Markets – How it is done

Halal defines what is permissible under Islamic Law known as “Shariah”. Halal Investments are financial products which are deemed adherent to Shariah. Interest is strictly forbidden in Islam. Holy Quran states: O ye who believe! Devour not interest, doubled and multiplied; but fear Allâh; that ye may (really) prosper.

According to the Quran ‘Those who eat Ribâ (interest) will not stand (on the Day of Resurrection) except like the standing of a person touched by Shaitân (Satan) leading him to insanity. That is because they say: “Trading is only like Ribâ (interest),” whereas Allâh has permitted trading and forbidden Ribâ (interest). So whoever receives an admonition from his Lord and stops eating Ribâ (interest) shall not be punished for the past; his case is for Allâh (to judge); but whoever returns [to Ribâ (interest)], such are the dwellers of the Fire – they will abide therein).

Now the question is what are the other means of investments in which interest must not be involved or which are termed as halal investments? This refers to investing funds or doing transactions that are compliant with the Islamic Sharia law. This investment is different from the other common forms of investment due to its prohibition of investment in debt laden companies that may cause high risk to the investor.

Halal investing requires investment decisions to be made in accordance with Islamic principles. As a faith-based approach to investment management, investors often consider halal investing to be a category of ethical or socially responsible investing.

Islamic principles require that investors share in profit and loss, that they receive no interest (riba), and that they do not invest in a business that is prohibited by Islamic law, or sharia. Before investing in a company, it is necessary to evaluate its business activities and financial records to determine where its primary revenue comes from and how its income and expenditures are managed. A company that meets certain criteria would be halal, or permissible. If it does not meet the criteria, it would be haram, or not permitted.

Interpretation of Islamic law as applied to business activities is nuanced, and halal investment guidelines can vary. Therefore, Muslim investors often rely on guidance from Islamic scholars to help determine whether an investment is halal.

Investments that sharia scholars universally consider unacceptable are companies whose primary business activities violate the core tenets of Islam, including the manufacture or marketing of alcohol; gambling or gaming activities; conventional interest-based financial services; pork and pork products; and pornography. In addition, most sharia scholars advise against investing in tobacco companies.

Islamic scholars have established financial guidelines to determine when a business activity is a core source of revenue and when it is not. For example, the five percent rule says that a core business activity is one that accounts for more than five percent of a company’s revenue, or gross income. This reasoning applies to the Islamic prohibition on riba, or interest, as well. If a company’s interest-based income or holdings exceed certain limits, then investing in the company is forbidden.

Often, it is not possible to avoid haram business activities. Islamic law requires “purification” of investment earnings that can be attributed to haram activities. One way to do this is through zakah, a form of charitable giving that can help you cleanse impure investment income by giving it away to acceptable charitable causes.

Benefits of Halal Investing

Investing according to Islamic principles can offer many benefits to Muslims and non-Muslims alike. Halal investing encourages a disciplined investment process that promotes in-depth security research and monitoring. Generally, the low debt requirements of Islamic screens facilitate a conservative approach that appeals to risk-averse investors.

The main benefit of halal investment is that it encourages people to invest in a socially responsible manner. They are advised to avoid investing in industries that promote alcohol, smoking, pornography and so forth. It is also Haram, that is, against the Islamic law, to invest in companies that derive their profits mainly from interest or interest (lending money for profit), Casinos and gambling, pork, hedging in silver and gold, ordinary insurance and financial services that generate their income from interest.

Halal investing discourages short-term speculation. The low turnover required in halal investment portfolios results in longer planned holding periods and close scrutiny of company financials. Low turnover also minimizes portfolio trading expenses, such as broker commissions, while increasing tax efficiency by avoiding rapid buying and selling of securities that can generate taxable capital gains.

Because Islamic principles preclude the use of interest-paying investments, halal cash reserves cannot be invested in traditional money market funds or deposited in an interest-earning bank account and therefore do not earn income.

It is the utmost duty of every Muslim to find a Shari’ah based investment that adheres to rules and regulations described in the Quran and Hadith. Allied Asset Advisors follows a methodology developed over the past 20 years for adhering to Islamic Principles.

Halal Investment in Stock Markets – How it is done

The word “Halal” in its simplest form means “permitted.” If an object or action is designated as Halal, its use is permissible under Islamic law. The opposite of Halal is “Haram,” which means forbidden.

Halal investing is also sometimes referred to as “Shariah-compliant” investing. What does this mean? Western discussions of Shariah law often focus on extreme interpretations of penal codes. But Shariah, which derives from the Qur’an and the religious teaching of Islam, is also applied to the finance sector, as well. In English, the word “Shariah” means “the path that leads to water.”

In other words, it’s the means by which our thirst for guidance and social justice is quenched. We believe that Halal investing can be seen as part of a wider movement towards the promotion of sustainability as a key element of economic life.

1) Screening and Filtering

We rely on the Halal security selection guidelines issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the gold standard for Islamic finance.

We employ our own disciplined filtering process, derived from AAOIFI guidelines and automated by our proprietary software, enabling us to actively avoid:

  • Riba, which is often translated as interest. Basically, it refers to an increase in capital without any real services provided, or the growth of money by the mere passage of time. Riba is prohibited on both sides of the transaction – giving as well as taking.
  • Gharar, which means chance, or any financial transaction or contract (such as insurance) which includes an element of chance.
  • Haram (forbidden) businesses or industries. Examples include companies which derive significant income (defined as more than 5% of their total income*) from the processing or sale of alcohol, tobacco or pork. Other prohibited industries are defense/weapons, gambling, pornography and financial firms that charge or pay interest.

In addition, companies selected for investment must also meet financial screens relating to their levels of debt. Per AAOIFI guidelines, we do not invest in companies whose debt ratios are greater than 30%, whose accounts receivables ratios are greater than 45%, or whose income from interest is greater than 5%.

We believe a sound investment considers the social and ethical consequences. That’s why we incorporate values into our investment management process and require our money managers to agree to accept our screens.

2) Planning and Diversification

Once you engage us as your financial planner, we will work with you to gather all your important financial information and organize it using advanced software. This tool will enable us to create specific and dynamic financial models that we can use to evaluate different scenarios and circumstances. This will help us develop a clear picture of your current financial situation by reviewing your income, assets, and liabilities, and evaluating your insurance coverage, your investment portfolio, your tax exposure, and your estate plan.

Next we will implement strategies that address your current financial weaknesses and build on your financial strengths. We will create an action plan for your new financial and estate plan and work closely with your other advisors, including attorneys, accountants and lawyers to ensure that your plan is comprehensive, consistent and implemented. We can handle relationships with these parties on your behalf, creating efficiency and saving you effort, time and money.

One of the most important parts of planning is how you choose to allocate your assets. “Asset allocation” refers to how a portfolio is divided among the various types of investments (also known as asset classes) that are available to invest in. Examples of asset classes include U.S. stocks, bonds, foreign investments, real estate, commodities and alternative assets such as precious metals. Most investment experts agree that asset allocation is an important determinant of portfolio performance.

How you allocate your assets depends on several factors, including your investment objectives, attitudes toward risk and investing, desired return, age, income, time horizon, and even your belief in what the market will do in the near term and long term. Your asset allocation will likely need to adjust over time as your circumstances change.

3) Hire the Qualified (Due Diligence)

Due diligence is the process of systematically researching and validating the methodology of a group or party. Due diligence is required to verify, confirm, and authenticate the strategies of our money managers. It means making sure their expertise is suitable and meets our expectations. It is also an ongoing process. The goal of the process is to ensure that our clients are associated with a financial endeavor that has minimized extra risk and vetted all pertinent data.

4) Back-End Screening and Filtering

After companies pass the filters outlined in Step 1 and are submitted to our money managers for a rigorous financial analysis, we continue to monitor holdings to make sure they do not fall out of compliance. In short, our ethics don’t end once a portfolio is created. We periodically re-screen our investments for compliance. If we find a company is no longer compliant, it will be sold.

We engage scholars who have knowledge of finance to certify initial compliance as well as ensure this ongoing compliance.

5) Proxy Voting and Shareholder Advocacy

Today, corporations make most decisions of consequence in our society. As the owner or shareholder of a stock or shares of a mutual fund, you are part owner of a corporation. That means you have both rights and responsibilities. You have the right to sit with management, be an insider and work for change—in short to enjoin the good and forbid wrongdoing.

An important aspect of this shareholder activism is proxy voting. We try to vote in harmony with our ethical investment philosophy. It’s a philosophy that strives to protect our clients’ financial interests as we incorporate cherished social and ethical values.

6) Purification

We also provide assistance with the purification process for our Muslim clients, which requires that any investment income be given to charity if it may have been generated from activities defined as unlawful according to Islamic investing principles.

Although We follows strict Islamic guidelines regarding the companies and services we invest in, the investment companies in the portfolio may earn insignificant income from interest and other prohibited lines of business, which are forbidden. We advise our clients to cleanse such income, and we calculate and accrue such purification amounts daily on our clients’ investment and retirement accounts. Purification amounts are usually accrued for the 12 months prior to a week before the month of Ramadan.

7) Zakah

Responsible investing for Muslims goes beyond avoiding the products and services that cause harm to society. It means helping those in need.

One of the ways we accomplish this is through Zakah, the annual sharing of wealth above Muslims’ basic needs. Every year, after deducting the annual purification amounts discussed above, We calculates the portion of our clients’ assets that our faith requires to be distributed to charity. We use a proprietary, self-developed software program to calculate the amount of money clients are advised to give to charity in order to fulfill their religious obligations. Clients disburse the money to the charity or charities of their choice.

These calculations are made in accordance with the traditional 12 lunar month cycle and are usually performed a week before the month of Ramadan.

Our clients appreciate our focus on principled Halal investing. We think you will, too. [ Modified from Azzad Investment Website ]