Islamic investment refers to investment activities that comply with the principles and guidelines of Islamic finance, which are derived from Shariah law. Shariah-compliant investments adhere to ethical and moral standards outlined in Islamic teachings. These principles guide investment decisions to ensure that they align with Islamic values, which prohibit certain activities, such as earning or paying interest (riba) and engaging in speculative or unethical businesses.
Shariah compliance refers to the adherence of financial and business practices to the principles and guidelines of Shariah law, which is derived from Islamic teachings. Shariah compliance ensures that activities, transactions, products, and services are in line with ethical, moral, and legal standards outlined in Islamic jurisprudence. This concept is primarily associated with Islamic finance and business operations.
Shariah-compliant investments and conventional investments differ primarily in their adherence to Islamic principles and ethical guidelines. These differences influence the types of assets, transactions, and practices that are considered acceptable or prohibited. Here's a comparison of the key distinctions between Shariah-compliant and conventional investments:
Prohibition of Interest (Riba):
- Shariah-Compliant: Prohibits earning or paying interest (riba), as it is considered exploitative and unjust.
- Conventional: Interest-based transactions are common, and earning or paying interest is a fundamental part of many financial products.
Avoidance of Speculation (Gharar):
- Shariah-Compliant: Discourages excessive uncertainty and speculative practices (gharar).
- Conventional: Speculation and risk-taking are inherent in many conventional investment strategies.
Ethical and Moral Standards:
- Shariah-Compliant: Avoids industries and activities that conflict with Islamic values, such as alcohol, gambling, pork, and usurious practices.
- Conventional: May invest in a wide range of industries, including those that may not align with ethical or social considerations.
Asset-Backed Investments:
- Shariah-Compliant: Emphasizes investments backed by tangible assets or real economic activities.
- Conventional: Investments may include a mix of asset-backed and non-asset-backed instruments.
Risk and Profit Sharing:
- Shariah-Compliant: Encourages risk-sharing and equitable distribution of profits and losses.
- Conventional: Profit and loss distribution may vary based on contractual terms.
Role of Leverage:
- Shariah-Compliant: Avoids excessive borrowing or leverage, which can lead to interest-based transactions.
- Conventional: Leverage is commonly used to amplify returns and may involve interest-bearing loans.
Transparency and Fairness:
- Shariah-Compliant: Emphasizes transparency, fairness, and avoidance of exploitation in business dealings.
- Conventional: Focuses on maximizing returns for investors, with varying levels of emphasis on fairness.
Governance and Oversight:
- Shariah-Compliant: Requires approval from a Shariah board or council composed of Islamic scholars to ensure compliance.
- Conventional: Regulatory oversight may vary based on financial market regulations.
Shariah, often spelled as "Sharia," is a comprehensive system of Islamic law and ethical principles that govern various aspects of life for Muslims. It is derived from the teachings of the Quran (the holy book of Islam) and the Sunnah (the practices and sayings of the Prophet Muhammad). Shariah encompasses religious, moral, social, economic, and legal guidelines that guide the beliefs and actions of Muslims.
Key Aspects of Shariah:
Religious Practices: Shariah prescribes the rituals and acts of worship that Muslims should follow, including prayer, fasting, pilgrimage, and charity.
Moral and Ethical Conduct: Shariah emphasizes honesty, integrity, compassion, and respect for others. It provides guidelines for personal behavior and interactions within society.
Social and Family Laws: Shariah covers family matters such as marriage, divorce, inheritance, and child custody, aiming to establish just and equitable relationships.
Economic Principles: Shariah offers guidelines for economic activities, including ethical business practices, fair trade, and prohibition of usury (riba) and unjust enrichment.
Legal System: Shariah provides a framework for Islamic jurisprudence (fiqh), which guides legal rulings and judgments based on Quranic teachings and the Sunnah.
Punishments and Penalties: Shariah outlines penalties for certain crimes in Islamic legal systems, including theft, adultery, and apostasy. Implementation varies across different regions.
Charity and Welfare: Shariah emphasizes charitable giving (zakat) and encourages the support of the less fortunate through acts of kindness and social welfare.
It's important to note that interpretations of Shariah can vary among different Islamic scholars and schools of thought. In some countries, Shariah is integrated into legal systems, while in others, it is practiced within personal, religious, and community contexts. Shariah plays a central role in shaping the values, behaviors, and moral compass of Muslims, guiding them toward a life that aligns with their faith and beliefs.
In Shariah-compliant investing, certain segments or industries are considered prohibited due to their non-compliance with Islamic principles and ethical guidelines. These prohibitions are based on the teachings of Shariah law and are aimed at avoiding investments in activities that are considered harmful, exploitative, or contrary to Islamic values. Some of the segments that are typically prohibited in Shariah-compliant investing include:
Interest-Based Financial Institutions: Investments in conventional banks or financial institutions that engage in interest-based transactions (riba) are prohibited.
Alcohol and Tobacco: Investments in companies involved in the production, distribution, or sale of alcoholic beverages and tobacco products are prohibited.
Gambling and Entertainment: Investments in gambling activities, casinos, betting, and entertainment that promote unethical or harmful behaviors are avoided.
Pork and Non-Halal Food Production: Investments in companies involved in pork and non-halal food production or distribution are prohibited.
Weapons and Defense Industry: Investments in companies manufacturing weapons, firearms, and ammunition, or those involved in the defense industry, may be avoided due to ethical concerns.
Conventional Insurance: Investments in conventional insurance companies, which often involve interest-based practices, are generally not compliant with Shariah.
Unethical Business Practices: Investments in companies engaged in unethical practices such as fraudulent activities, bribery, or environmental harm are prohibited.
Speculative Trading: Excessive speculation and trading that involve excessive uncertainty (gharar) or gambling-like behavior are discouraged.
Usurious Lending Activities: Companies involved in predatory lending practices that exploit vulnerable individuals through high-interest loans may be avoided.
It's important to note that the specifics of Shariah compliance can vary based on interpretations by Islamic scholars and financial institutions. To ensure compliance, many financial products and investment funds undergo rigorous screening and are approved by Shariah advisory boards composed of Islamic scholars.
Determining whether a company is Shariah-compliant involves a detailed analysis of its business activities, financial practices, and overall operations to ensure alignment with Islamic principles. This analysis is typically conducted by Shariah scholars or advisors, who assess various aspects of the company's operations. Here are the general steps and considerations used to determine if a company is Shariah-compliant:
S&P Shariah Indices
Debt / Market Value of Equity (12-month average) <= 33%
Accounts receivables / Market value of equity (12-month average) <=49%
Cash + Interest bearing Securities / Market value of equity (12-month average) <=33.33%
Dow Jones Islamic Market Indices
Total debt / Trailing 12-month average market cap <=33%
Cash + Interest bearing securities / Trailing 12-month average market cap <= 33%
Accounts receivables / Trailing 12-month average Market cap <=33%
SEC, Malaysia
Income from prohibited activities such as Riba, gambling, liquor and pork <=5%
Mixed contributions from the activities that involve element of 'umum balwa' <=10%
Income from mixed contributions from activities which are permissible under Shariah and have element of public interest<=25%
Meezan Islamic fund criteria, Pakistan
Debt / total asset <=45%
Net illiquid asset / total asset <=10%
Total investment of the investee company in Shariah non-compliant business <=33%
Income from Shariah non-compliant investment <=5%
MSCI
Debt / total asset <=33.33%
Cash + Interest bearing securities / Total Asset <=33.33%
Accounts Receivables / Total Asset <=70%
FTSE
Debt / Total asset <=33%
Cash + Interest bearing securities / Total Asset <=33%
Accounts Receivables + Cash / Total Asset <=50%
TASIS
Debt / Total Assets <=25%
(Interest Income + 8% of Interest-bearing Investments) / Total Income <=3%
(Cash + Receivables) / Total Assets <=50%
When you start trading, whether in the stock market, forex market, or any other financial market, you expose yourself to various types of risks. Understanding these risks is crucial for making informed trading decisions and managing your portfolio effectively. Here are some of the common types of risks associated with trading:
Market Risk (Systemic Risk): Also known as systematic risk, this risk arises from factors that affect the entire market, such as economic conditions, geopolitical events, interest rate changes, and natural disasters. Market risk can lead to broad market declines that impact all investments.
Specific Risk (Unsystematic Risk): Also referred to as unsystematic risk, this risk is specific to an individual company, industry, or asset. It includes factors like management changes, product recalls, or regulatory issues that affect a single investment.
Liquidity Risk: Liquidity risk occurs when you can't easily buy or sell an asset without causing a significant price change. Illiquid markets can lead to difficulties in executing trades at desired prices.
Credit Risk: Credit risk, also known as counterparty risk, arises when the other party in a trade (e.g., a broker, financial institution) fails to meet its obligations. It can result in financial losses if the counterparty defaults.
Operational Risk: Operational risk refers to risks stemming from internal processes, systems, and human errors. These risks can lead to trading mistakes, technical glitches, or regulatory non-compliance.
Volatility Risk: Volatility risk is the potential for rapid and unpredictable price fluctuations. High volatility can lead to substantial gains or losses, depending on the direction of the market movement.
Political and Geopolitical Risk: Political events, government policies, and geopolitical tensions can impact financial markets. Sudden changes in leadership, trade disputes, or international conflicts can lead to market uncertainty.
Interest Rate Risk: Interest rate changes can affect the value of investments, especially bonds. Rising interest rates can lead to lower bond prices and vice versa.
Currency Risk (Exchange Rate Risk): Currency risk arises when trading in international markets. Changes in exchange rates can impact the value of your investments denominated in different currencies.
Regulatory and Legal Risk: Changes in regulations or legal issues affecting a particular industry or asset can impact trading outcomes. Non-compliance with regulations can also lead to penalties.
Market Timing Risk: Trying to time the market to buy or sell at the "perfect" moment can lead to missed opportunities or losses if the timing is incorrect.
Behavioral Bias Risk: Emotions and cognitive biases can influence trading decisions, potentially leading to impulsive actions or following crowd behavior.
Model Risk: Reliance on complex financial models or algorithms can lead to errors if the models fail to accurately predict market movements.
It's important to note that all trading involves some level of risk, and there is no way to eliminate risk entirely. Successful traders focus on risk management strategies, such as diversification, setting stop-loss orders, and maintaining a well-defined trading plan, to minimize potential losses and protect their capital.