The various options available to SMEs for investment of their excess funds in a sharia-compliant manner. One of the key stages in the life of a growing company is the investment of idle funds. SMEs look to investments with banks to increase and consolidate the company's growth, and improve the company's net worth. However, little is known about what SMEs can do to invest their funds if they choose to fully comply with the principles of Islam; what is now commonly termed 'sharia-compliance'.
To qualify as sharia-compliant, a company is required to follow the principles of Islam throughout its life cycle - from idea generation through to implementation of corporate social responsibility. For an investment to be considered Islamic or sharia-compliant, it must fulfill two important requirements. Firstly, there should be no fixed return tied to the face value of the investment. Instead, profits earned by investment of the monies should be pro-rated. Therefore, neither the investment (principal) amount nor the profit associated with it can be guaranteed. The subscribers enter into the investment knowing that their earnings are wholly dependent on the performance of the fund. If the investment earns large profits, the returns on subscriptions will increase accordingly. However, in case of poor performance, subscribers have to share in the losses proportionate to their investment contribution, unless the loss is caused by negligence or mismanagement, in which case the management, and not the investment fund, will be liable to compensate for losses.
Secondly, the manager of the funds is prohibited from making investments in industries Islamic law categorizes as haram (impermissible), such as those related to gambling, alcohol, interest-based organizations and arms manufacturing.
Two of the most popular investment instruments offered by an Islamic bank are the mudaraba deposits, where the contract is based on a partnership, and the wakala deposits, where the contract is based on agency.
Apart from the mudaraba and wakala Islamic deposit schemes, firms with excess funds may also invest in various types of Islamic funds offered by Islamic banks. Types of Islamic funds include:
1. Ijara investment fund: The literal meaning of ijara is leasing or renting. In this fund the subscription amounts are used to purchase shares of assets like real estate, motor vehicles, or other equipment for the purpose of leasing them out to their end users. The ownership of the assets remains with the fund and rental payments are charged from the end users. These rental payments are the source of earning for the funds which are then distributed pro-rated to the subscribers. However, it is imperative that the contracts, assets and its usufruct conform to the principles of sharia.
2. Equity fund: In an equity fund, the amounts raised are invested in shares of joint stock companies. Here, the profits are earned through capital gains achieved on the shares by purchasing them at a lower price and then selling them when the price increases. The profits can also be achieved through dividends distributed by the investment companies. Naturally, if the main business activity of the company is not sharia-compliant, it is not allowed for an Islamic fund to purchase, hold or sell its shares, because it will entail the direct involvement of the shareholder in that prohibited business.
3. Murabaha fund: This refers to a kind of fixed return fund that buys various commodities and then sells them at a cost-plus basis. This mode of sale has been adopted by contemporary Islamic banks and financial institutions as a mode of financing. They purchase the commodity for the benefit of their clients, and then sell it to them on the basis of deferred payment at an agreed margin of profit added to the cost, a share of which is distributed back to subscribers of the fund.
Check-list before investing:
To assist in choosing the right Islamic investment vehicle or deposit scheme, you should follow the steps outlined below:
Assess the full range of available sharia-compliant investment products before selecting the type you wish to use. Most banks offer several different options.
Ascertain how much risk you are prepared to undertake. Are you looking at maximum preservation of your capital (minimal risk), want minimal but fixed returns (low risk), open to variable returns but some degree of certainty (medium risk), prefer high returns and are open to potential loss of capital (high risk)?
Compare fund management charges between different providers.
Consider using index products such as exchange-traded funds to gain exposure to Islamic investment indices while at the same time avoiding the high fund management costs.
Some of the leading Islamic funds include Al-Hilal funds managed by Kuwait Investment Company, and the Al Fanar funds of the Jeddah-based Saudi Economic Development Company. Typical rules for such funds are that they contain no interest-bearing securities, preferred stock, futures, options, or haram companies (as determined by a board of advisors). The stocks represent companies that earn less than 5% of their income in interest and for which the ratio of total debt and liquid assets to market cap is less than 50%. Sharia advisors would normally suggest a minimum quantitative threshold for income earned through interest-based transactions, for example 5%, and this amount should be used for charitable purposes only.
© Zawya BusinessPulse QATAR 2014
To qualify as sharia-compliant, a company is required to follow the principles of Islam throughout its life cycle - from idea generation through to implementation of corporate social responsibility. For an investment to be considered Islamic or sharia-compliant, it must fulfill two important requirements. Firstly, there should be no fixed return tied to the face value of the investment. Instead, profits earned by investment of the monies should be pro-rated. Therefore, neither the investment (principal) amount nor the profit associated with it can be guaranteed. The subscribers enter into the investment knowing that their earnings are wholly dependent on the performance of the fund. If the investment earns large profits, the returns on subscriptions will increase accordingly. However, in case of poor performance, subscribers have to share in the losses proportionate to their investment contribution, unless the loss is caused by negligence or mismanagement, in which case the management, and not the investment fund, will be liable to compensate for losses.
Secondly, the manager of the funds is prohibited from making investments in industries Islamic law categorizes as haram (impermissible), such as those related to gambling, alcohol, interest-based organizations and arms manufacturing.
Two of the most popular investment instruments offered by an Islamic bank are the mudaraba deposits, where the contract is based on a partnership, and the wakala deposits, where the contract is based on agency.
Apart from the mudaraba and wakala Islamic deposit schemes, firms with excess funds may also invest in various types of Islamic funds offered by Islamic banks. Types of Islamic funds include:
1. Ijara investment fund: The literal meaning of ijara is leasing or renting. In this fund the subscription amounts are used to purchase shares of assets like real estate, motor vehicles, or other equipment for the purpose of leasing them out to their end users. The ownership of the assets remains with the fund and rental payments are charged from the end users. These rental payments are the source of earning for the funds which are then distributed pro-rated to the subscribers. However, it is imperative that the contracts, assets and its usufruct conform to the principles of sharia.
2. Equity fund: In an equity fund, the amounts raised are invested in shares of joint stock companies. Here, the profits are earned through capital gains achieved on the shares by purchasing them at a lower price and then selling them when the price increases. The profits can also be achieved through dividends distributed by the investment companies. Naturally, if the main business activity of the company is not sharia-compliant, it is not allowed for an Islamic fund to purchase, hold or sell its shares, because it will entail the direct involvement of the shareholder in that prohibited business.
3. Murabaha fund: This refers to a kind of fixed return fund that buys various commodities and then sells them at a cost-plus basis. This mode of sale has been adopted by contemporary Islamic banks and financial institutions as a mode of financing. They purchase the commodity for the benefit of their clients, and then sell it to them on the basis of deferred payment at an agreed margin of profit added to the cost, a share of which is distributed back to subscribers of the fund.
Check-list before investing:
To assist in choosing the right Islamic investment vehicle or deposit scheme, you should follow the steps outlined below:
Assess the full range of available sharia-compliant investment products before selecting the type you wish to use. Most banks offer several different options.
Ascertain how much risk you are prepared to undertake. Are you looking at maximum preservation of your capital (minimal risk), want minimal but fixed returns (low risk), open to variable returns but some degree of certainty (medium risk), prefer high returns and are open to potential loss of capital (high risk)?
Compare fund management charges between different providers.
Consider using index products such as exchange-traded funds to gain exposure to Islamic investment indices while at the same time avoiding the high fund management costs.
Some of the leading Islamic funds include Al-Hilal funds managed by Kuwait Investment Company, and the Al Fanar funds of the Jeddah-based Saudi Economic Development Company. Typical rules for such funds are that they contain no interest-bearing securities, preferred stock, futures, options, or haram companies (as determined by a board of advisors). The stocks represent companies that earn less than 5% of their income in interest and for which the ratio of total debt and liquid assets to market cap is less than 50%. Sharia advisors would normally suggest a minimum quantitative threshold for income earned through interest-based transactions, for example 5%, and this amount should be used for charitable purposes only.
© Zawya BusinessPulse QATAR 2014
