How to Identify non-Shariah Compliant Investments | Ethis (2024)

According to Shariah, we must only invest in companies that are completely halal. This means, among other things, that the company you’re investing in must follow a halal business strategy and not rely on interest-based loans to fund its operations. The difficult part is determining which stocks in the traditional stock market fit these criteria.

That isn’t to suggest it can’t be done. For hundreds of years, Islamic principles like mudharabah have allowed Muslims to invest in commercial endeavours.

We can verify that we’re meeting the Islamic standards while also constructing a more secure future for our families by applying the same ideas to our stock market investments.

Related – Halal Investment: A Beginner’s Guide

What are Shariah – compliant investments?

The standards of Shariah law and the values of Islam regulate shariah-compliant investments. They’re frequently thought of as a subset of ethical investing.

Companies involved in certain activities, such as conventional finance (non-Islamic banking, finance, and insurance, for example), alcohol, pork-related products and non-halal food production, packaging and processing or related activity, gambling, adult entertainment, and tobacco, will be filtered out of a shariah-compliant fund.

Furthermore, there are restrictions on the utilisation of debt and interest-bearing assets. Lenders and investors are prohibited from collecting and paying interest under Islamic law.

Islamic banks agree to share a portion of the profit or loss generated by the business in order to earn money without charging interest.

Screening process of funds

The investment screening method is similar to that of ethical funds that have been “negatively screened” based on ESG (environmental, social, and governance) factors. There’s a slight difference in Shariah-compliant funds, which will have a Shariah board composed of Islamic experts who will decide or check which companies comply with the standards.

Different funds will have slightly different policies depending on their advisory board’s ideas and interpretations, so investors should read the fund’s prospectus to make sure it aligns with their own values before investing.

The added layer of rules prohibits fund managers from some areas that could increase or subtract from results over time, just as it does with ethical investments.

Financials, such as banks, are typically excluded, although accounting for a significant portion of broader stock market indices. This area’s outperformance or underperformance would have an impact on fund returns.

There is frequently a sectoral bias toward healthcare and information technology as a result of the screening procedure.

Evaluating a business model

Checking the business model of the firm you’re considering investing in is the simplest screening you can do. By their very nature, some lines of commerce are haram and any companies in these industries should be ruled out right away.

Then there are the ambiguous zones. Companies in the financial services sector that generate interest, such as banks, insurers, and stockbrokers, may be considered to be breaking Sharia principles. (It’s worth noting that this approach also applies to other Islamic investments like Islamic mortgages.)

If in doubt, stay away. Alternatively, perform extensive study before committing your funds.

Aside from the company strategy, it’s also important to remember that halal enterprises must be established and operational.
This indicates that capital planning has been completed and that facilities and equipment have been purchased at the investment stage. Sharia includes additional restrictions that deter you from investing in a company’s “concept” that has not yet materialised.

Financial ratio screening

Screens can be met to ensure Shariah compliance with the financial ratio method, by analysing cash over total assets, where cash only refers to cash held in traditional accounts and instruments, while cash held in Islamic accounts and instruments is not included in the computation.

Debt over total assets can also be calculated, with debt only including interest-bearing debt and excluding Islamic debt/financing or sukuk from the computation. Both ratios must be less than 33 percent in order to quantify riba and riba-based items in a company’s balance sheet.

Inquire about interest-bearing debt

The percentage of interest-bearing debt in relation to total assets is the third halal criterion that a stock must meet to be considered halal. Total interest-bearing debt should not be more than 33% of total assets.

It’s worth noting that the 33 percent rule applies to all investments, not only halal ones. Many non-muslim investors use similar benchmarks for their stock screens since it is considered a safe amount of risk.

However, determining the amount of interest-bearing debt held by a company can be challenging. Borrowings listed as interest-free loans from directors, for example, can be found in some records. To get around this, get a copy of the additional notes on accounts, which break down the loans in more detail and will tell you exactly much you owe.

If you don’t have time to conduct a comprehensive search, you might choose zero-interest stocks.

Screen stocks with Islamic finance apps

To see if individual equities are compliant, utilise an Islamic financial app like Zoya or Islamically. Both applications have free versions that allow you to see whether a stock is a suitable halal investment right away.

It’s simple and effective for investors who don’t have time to thoroughly research securities but want to adhere to Islamic beliefs.

Invest in Islamic exchange-traded funds (ETFs)

Islamic ETFs exclusively track an Islamic benchmark index that includes shariah-compliant corporations as index constituents.

Furthermore, an appointed Shariah committee oversees the Islamic ETF, which is administered according to Shariah principles and rules. The Shariah committee analyses and audits the Islamic ETF on a regular basis to guarantee strict adherence to Shariah principles and practises.

MyETF Dow Jones Islamic Market Malaysia Titans 25 and MyETF MSCI Malaysia Islamic Dividend are two examples of Islamic ETFs.

At the end of the day, it is the obligation or duty for us as Muslims to ensure that the profit gains we are blessed with in this world are valid in the hereafter. We can only do our best to ensure Shariah-compliance in all investment and wealth management aspects we delve into, but the effort is crucial in making sure we navigate through the many forbidden elements in conventional finance.