All You Need to Know about Shariah-Compliant Mutual Funds

Last Updated: 4 May 2024

Investing in a way that aligns with your religious beliefs can be quite challenging. But what if I told you that there’s a solution that offers equity investment avenues that strictly adhere to Islamic investing guidelines? This article explores their unique proposition. 

Read on to learn about their functioning, benefits, and performance viability amid ethical constraints.

Understanding Shariah-Compliant Investments

Shariah refers to the religious law of Islam guiding the principles and rules that Muslims should follow in their personal and professional lives. There are some Muslims who follow certain religious principles that forbid them from investing in businesses or financial activities that are considered unethical or socially irresponsible.

Certain investments follow a set of rules called Shariah guidelines. These investments avoid businesses that don’t align with these guidelines and ensure that their activities are ethical. This type of investing is meant to promote socially responsible practices that align with Islamic values.

What are Shariah-Compliant Mutual Funds?

Shariah-compliant mutual funds are investment funds that invest only in businesses and securities that follow Islamic principles. The fund managers ensure that the investments they choose comply with strict guidelines to ensure the portfolio remains compliant with Shariah.

These rules prevent investing in companies that are heavily involved in certain activities:

• Alcohol 
• Tobacco
• Pork-related products
• Conventional financial services (banking, insurance, etc.)
• Weapons and defence
• Gambling/casinos
• Music
• Cinema 

Additionally, the funds avoid investing in assets that generate interest, and they also avoid investing in companies that have high levels of debt or interest income. A board of experts on Islamic law ensures that the fund follows these rules.

Evolution of Shariah Funds in India

A few years ago, some new types of investment options were introduced in India. These investments were created with certain religious and ethical beliefs in mind. They are called “Shariah-compliant” investments. 

In 2010, two new types of stock market indicators were launched in India, which were specifically designed for these types of investments. These indicators helped investors track the performance of companies aligned with the Shariah-compliant guidelines. 

After that, in 2011, a new type of mutual fund was launched in India, which was also Shariah-compliant. This mutual fund avoided investing in companies related to gambling, alcohol, tobacco, hotels, banks, and financial institutions. 

A few other mutual fund companies have also launched similar types of funds, but the number of investors in this area still needs to grow.

There are three main Shariah-compliant mutual fund schemes available for Indian investors:

• Tata Ethical Fund
• Taurus Ethical Fund 
• Nippon India ETF Shariah BeES

Shariah-Compliance Certification and Monitoring 

To ensure that mutual funds align with Islamic financial laws, they hire a group of respected Islamic scholars known as the Shariah supervisory board. These scholars have a good understanding of modern business and finance.

The board creates a set of rules, checks the mutual fund’s investments regularly to make sure they follow these rules, and verifies that they comply. Any income that doesn’t meet the guidelines is donated to charity.

Further, mutual funds also work with companies like S&P Dow Jones Indices and Ratings Intelligence Partners. These companies help create a list of companies that comply with Shariah law and ensure that the mutual fund portfolio only includes such companies.

Key Features of Shariah Mutual Funds

Here are some notable features of Shariah-compliant mutual funds in India:

• Strict Exclusion Criteria: They exclude companies engaged in alcohol, tobacco, pork products, conventional finance, weapons, gambling, etc.

• Focus on Social Responsibility: They promote ethical and socially responsible investing that is aligned with Islamic principles.

• Active Portfolio Purification: The Shariah board channels any non-compliant income to charity to purify earnings.

• High Equity Exposure: Shariah law says they avoid fixed income and interest-bearing securities. Hence, the funds invest significantly in equity. 

• Open for All Investors: Although these funds adhere to Islamic investing guidelines, they remain open for investors from any religious faith.

Potential Benefits of Investing

Here are some key reasons to consider investing in Shariah-compliant mutual funds:

• Gain Socially Responsible Exposure: The funds promote ethical practices by excluding sin stocks. Investors can align investments with their values.

• Diversification Benefits: The unique selection criteria lead to a differentiated portfolio uncorrelated to mainstream funds. It enhances diversification.

• Competitive Returns: The funds invest predominantly in equity, providing an opportunity to generate inflation-beating returns over the long term.

• Low-Risk Approach: The avoidance of excess leverage, derivatives, and interest-based securities contributes to moderated risk levels.

• Easy-to-Invest Option: A mutual fund structure offers professional management, liquidity, regulatory protection, and low investment amounts preferred by retail investors.

Tax Treatment of Shariah Funds

The tax treatment of Shariah-compliant funds remains the same as that of other mutual fund schemes as per Indian tax laws. Here is an overview:

• Equity Fund Taxation Norms: Equity taxation norms apply when funds are invested mainly in equity.

• Short-Term Capital Gains (STCG): 15% tax on gains from units held for 12 months or less.

• Long-Term Capital Gains (LTCG): 10% tax on gains exceeding ₹1 lakh from units held for over 12 months.

• No Tax Deduction: Investing in Shariah funds is not eligible for tax deductions under Section 80C.

Are Shariah Funds Profitable For You?

Shariah-compliant funds are an investment option that follows ethical guidelines based on Islamic principles. These funds ensure that the investments made align with the Islamic community’s beliefs and values. 

While these funds offer good returns over time, it’s important to note that they have some rules about which stocks can be included. This means that the options for investing are limited and usually focused on specific sectors.

Therefore, before investing in these funds, it is important to evaluate your personal preferences regarding risk, expected returns, and investment objectives.

Conclusion

Shariah mutual funds are investment options that allow devout Muslims to invest in the financial market while following their religious beliefs. They are also attractive to investors who prioritise ethical standards in their investments. Though these funds have yet to be very popular, the trend of socially responsible investing and faith-based investing is gaining momentum in India. If you are considering investing in these funds, it is important to evaluate them based on your expectations of risk and return

Frequently Asked Questions

1. What exactly are Shariah-compliant mutual funds?

In simple terms, shariah-compliant mutual funds are investment funds that align their investment approach with Islamic religious principles. They construct their portfolio by avoiding companies engaged in businesses considered unethical under Shariah law – like alcohol, tobacco, weapons, etc. The idea is to allow investors to put their money as per their faith and values.

2. Who manages compliance in Sharia-based funds?

Shariah funds appoint an independent panel called the Shariah Supervisory Board. These scholars thoroughly review fund portfolios to check adherence to Shariah guidelines. They also purify earnings by donating any non-compliant income to charity. Additionally, specialised agencies assist in screening companies.

3. Can non-Muslims invest in these funds too?

Absolutely. Shariah funds do not impose any religion-based restrictions on investors. They aim to facilitate ethical investing that is aligned with Islamic values. So, any investor who wishes to get exposure as per Shariah principles is welcome to invest. The investor’s personal faith or religious beliefs play no role.

4. How are Shariah funds taxed in India?

Shariah mutual funds enjoy no special tax benefits under Indian laws. Since they primarily invest in equities, they are taxed as per equity fund taxation norms. This means you pay a 15% tax on short-term gains and a 10% tax on gains above ₹1 lakh after a year.

5. Should I invest in Sharia-compliant funds?

That depends on your personal preferences and financial goals. If you wish to exclude sin stocks as per your beliefs, then Shariah funds help align investments with your values. Their differentiated approach can also aid portfolio diversification. However, analyse if their concentrated approach suits your risk profile before investing.