Investing in Exchange-Traded Funds (ETFs) has become one of the most popular ways for investors worldwide to diversify their investment portfolios. ETFs offer the opportunity to invest in a broad range of assets with low costs and high liquidity. However, for Muslim investors, an important question arises: How to invest in ETFs in accordance with Shariah principles?
In this article, we will examine what ETFs are, how they work, and what Shariah-compliant ETFs are available. We will analyze their structure, asset selection principles, and provide recommendations for Muslim investors who wish to invest in ETFs while adhering to Islamic financial norms.
What Is an ETF?
Definition and Key Characteristics
An ETF (Exchange-Traded Fund) is an investment fund whose shares are traded on stock exchanges, similar to company stocks. ETFs aim to track the performance of a specific index, sector, commodity, or other asset. They allow investors to buy shares in a wide range of assets through a single transaction.
Advantages of ETFs
- Diversification
- Broad Market Exposure: Investors gain access to an entire market or sector through a single investment.
- Low Costs
- Fees: ETFs typically have lower fees compared to actively managed funds.
- Liquidity
- Exchange Trading: ETFs can be bought and sold at any time during the trading day at current market prices.
- Transparency
- Information Disclosure: ETFs disclose their portfolios daily, allowing investors to know exactly what they are investing in.
How ETFs Work
- Index Tracking
- ETFs are created to track a specific index or set of assets. The management company purchases the assets included in the index in proportions corresponding to the index.
- Creation and Redemption of Shares
- Authorized Participants: Specialized financial institutions can create or redeem large blocks of ETF shares by exchanging underlying assets for fund shares.
Shariah Principles in Investing
Core Islamic Financial Principles
- Prohibition of Riba (Interest)
- Avoiding Receipt and Payment of Interest: Any forms of fixed interest income are considered haram.
- Avoidance of Gharar (Uncertainty)
- Transaction Transparency: All conditions must be clear and understandable to all parties.
- Prohibition of Maisir (Gambling)
- Avoiding Speculation: Investments should not be akin to gambling or speculative operations.
- Investment in Halal Sectors
- Exclusion of Haram Sectors: Investments in alcohol, gambling, pornography, pork production, and other prohibited sectors are not allowed.
- Principle of Profit and Loss Sharing
- Fair Distribution: All participants should fairly share risks and returns.
What Are Shariah-Compliant ETFs?
Definition
Shariah-compliant ETFs are exchange-traded funds that invest only in companies and assets that comply with Shariah principles. They undergo a special Shariah screening and are supervised by a board of Islamic scholars.
Structure and Features
- Shariah Screening
- Sector Screening
- Companies involved in haram sectors (alcohol, gambling, pornography, pork production, weapons, etc.) are excluded.
- Financial Screening
- Debt-to-Asset Ratio: Restrictions on the company’s level of debt.
- Interest Income: Limitation on the proportion of income from interest sources.
- Cash and Receivables: Restrictions on the proportion of liquid assets.
- Sector Screening
- Shariah Board
- Compliance Control: A board of Islamic scholars oversees the fund’s activities to ensure Shariah compliance.
- Purification of Income
- Cleansing: If a small portion of income is derived from non-permissible sources, it is calculated and directed to charity.
Benefits of Shariah-Compliant ETFs
- Compliance with Religious Beliefs
- Confidence in Halal Investments: Investors can be assured that their investments comply with Islamic principles.
- Diversification
- Expanded Investment Opportunities: Investments in a wide range of halal companies and sectors.
- Liquidity
- Exchange Trading: Ability to buy and sell ETF shares at any time during the trading day.
- Low Costs
- Efficient Management: Lower fees compared to actively managed funds.
Criteria for Asset Selection in Shariah-Compliant ETFs
Sector Screening
- Excluded Sectors
- Alcoholic Beverages
- Gambling and Casinos
- Pornography
- Pork Production and Sale
- Tobacco
- Weapons and Military Equipment
- Interest-Based Financial Services: Traditional banks and insurance companies.
- Permissible Sectors
- Technology
- Healthcare
- Energy (excluding prohibited activities)
- Industrials
- Consumer Goods
Financial Screening
- Debt Ratio
- Total Debt / Market Capitalization < 33%
- Liquidity Ratio
- (Short-Term Investments + Cash) / Market Capitalization < 33%
- Interest Income Ratio
- Non-Permissible Income / Total Income < 5%
Purification of Income
- Calculation of Non-Permissible Income
- Interest and Income from Prohibited Activities: Calculated and directed to charity.
Popular Shariah-Compliant ETFs
1. iShares MSCI World Islamic UCITS ETF
- Description
- Invests in global companies that comply with Shariah, tracking the MSCI World Islamic Index.
- Features
- Global Diversification: Access to developed country markets.
- Shariah Supervision: Overseen by a board of Islamic scholars.
2. SP Funds S&P 500 Sharia Industry Exclusions ETF
- Description
- Tracks the S&P 500 Shariah Industry Exclusions Index, excluding haram sectors.
- Features
- Focus on the USA: Investments in the largest American companies.
- Low Fees: Efficient management with low costs.
3. Wahed FTSE USA Shariah ETF
- Description
- Follows the FTSE USA Shariah Index, investing in American companies that comply with Shariah.
- Features
- Technology Sector: Significant investments in technology companies.
- Shariah Control: Supervised by a Shariah board.
4. HSBC MSCI Islamic Global Equity Index Fund
- Description
- Invests in global equities that comply with Shariah, tracking the MSCI ACWI Islamic Index.
- Features
- Global Coverage: Investments in developed and emerging markets.
- Support of a Major Bank: Managed by HSBC, one of the world’s largest banks.
How to Invest in Shariah-Compliant ETFs
Step 1: Choose a Broker
- Shariah Compliance
- Islamic Brokers: Some brokers offer Islamic accounts without swaps and interest.
- Regulation and Reliability
- Licensing: Ensure the broker is regulated by reputable financial authorities.
- Access to Desired ETFs
- List of Available ETFs: Check if the broker provides access to Shariah-compliant ETFs.
Step 2: Open an Account
- Registration
- Provide Necessary Documents: Identification, proof of address.
- Choose Account Type
- Islamic Account: If available, select an account that complies with Shariah.
Step 3: Research ETFs
- Study the Fund’s Prospectus
- Investment Strategy: Understand how the fund selects assets.
- Verify Shariah Compliance
- Presence of a Shariah Board: Ensure oversight by Islamic scholars.
- Analyze Performance
- Historical Returns: Assess how the fund has performed in the past.
- Fees and Expenses
- Expense Ratio: Understand the fees charged by the fund.
Step 4: Buy ETF Shares
- Place an Order
- Order Types: Market, limit, stop orders.
- Number of Shares
- Determine Investment Amount: Based on your investment plan.
- Confirm the Transaction
- Review Order Details: Ensure information is correct before confirming.
Step 5: Monitor Your Investments
- Regular Portfolio Review
- Assess Performance: Compare results with your goals.
- Market Analysis
- Stay Informed of News and Market Changes: These can affect your investments’ value.
- Portfolio Rebalancing
- As Needed: Adjust your portfolio to maintain desired risk and return levels.
Risks and Warnings
1. Market Risks
- Market Volatility
- The value of ETFs can fluctuate depending on market conditions.
2. Currency Risks
- Exchange Rate Fluctuations
- When investing in international ETFs, currency risks may arise.
3. Concentration Risk
- Limited Company Selection
- Due to Shariah screening, the portfolio may be less diversified.
4. Liquidity
- Trading Volume
- Some Shariah-compliant ETFs may have low trading volumes, affecting liquidity.
5. Operational Risks
- Fund Management
- The quality of fund management affects its performance.
Frequently Asked Questions
1. Can I invest in regular ETFs if they don’t invest in haram sectors?
- Answer: While some regular ETFs may avoid haram sectors, they may still not meet Shariah financial criteria, such as company debt levels or receipt of interest income.
2. How do I know if an ETF truly complies with Shariah?
- Answer: Check for a Shariah board, study the fund’s prospectus, and ensure it undergoes Shariah screening based on sector and financial criteria.
3. What is income purification, and do I need to do anything?
- Answer: Income purification is the process of cleansing income from non-permissible sources. Typically, the fund calculates the amount to be purified, and the investor should donate this amount to charity.
4. Can I receive dividends from Shariah-compliant ETFs?
- Answer: Yes, if the dividends are derived from halal sources and the companies paying them comply with Shariah.
Recommendations for Muslim Investors
1. Education and Awareness
- Study the basics of investing and Islamic finance.
2. Consultation with Financial and Shariah Advisors
- Get professional advice when choosing investment instruments.
3. Diversification
- Spread investments across different assets and sectors.
4. Long-Term Perspective
- Invest with long-term financial goals in mind.
5. Monitoring and Portfolio Adjustment
- Regularly review your portfolio and make necessary changes.
Conclusion
Shariah-compliant ETFs provide Muslim investors with the opportunity to effectively invest in global markets while adhering to Islamic financial principles. They combine the benefits of ETFs—such as diversification, low costs, and liquidity—with the assurance that investments comply with Shariah.
With the right approach and informed choice of instruments, investing in Shariah-compliant ETFs can be an effective way to achieve financial goals, providing both material well-being and spiritual satisfaction from adhering to religious beliefs.