Spotting Shariah-Compliant Investment Opportunities

How to Spot Shariah-Compliant Investment Opportunities

Shariah-compliant investments have gained popularity not only in Malaysia and other Muslim-majority countries but also in the Western world such as UK and Australia. This follows the continuous education by various industry players advocating Shariah financial products after the Islamic finance frameworks were enacted and refined in the 1980s. Shariah-compliant investments are financial products that adhere to the principles of Islamic finance, which prohibit interest-based transactions, speculative investments, and unethical business practices. Islamic investment is based on varying mechanics. 

As demand continues to grow and evolve requires sophisticated products, new ones will be introduced. 

In Malaysia, where Islamic finance is rapidly growing, more Shariah-compliant investment options, such as the Mudarabah contract, are entering the market. Let’s discuss how to spot Sharia-compliant investment opportunities and the challenges of investing in them.

Basic principles of Shariah-compliant investments

Based on the principles of Islamic finance, Shariah-compliant investments aim to promote fairness, social responsibility, and risk-sharing in financial transactions. The basic principles include the following:

  • Prohibition of interest (Riba) — Shariah-compliant investments do not involve interest-based transactions. Instead, they rely on profit-sharing, leasing, and other alternative modes of financing that ascertain underlying activities instead of charging on top of money.
  • Prohibition of uncertainty (Gharar) — Shariah-compliant investments avoid speculative and uncertain investments that involve excessive risk.
  • Prohibition of gambling (Maisir) — Shariah-compliant investments do not include any form of gambling or speculation.
  • Prohibition of involvement in Shariah non-compliant activities (Haram) — Shariah-compliant investments do not involve any investments in unethical businesses, such as alcohol, tobacco, or pornography.

Key Considerations for Spotting Shariah-Compliant Investment Opportunities

Even though more than 60% of the Malaysian capital market is Shariah-compliant, investors might still need help to spot the appropriate investments. Shariah-compliant investments will avoid all items above that are considered prohibited sectors, including gambling, alcohol, and tobacco to spot Shariah.

Interested investors also need to screen for financial ratios that comply with Shariah law, analyse the company’s business activities to ensure they are Shariah-compliant, and review the company’s debt structure to ensure it complies with Shariah principles.

Examples of standard Shariah-compliant investment vehicles that can be identified are exchange-traded funds (ETFs), including the FTSE Bursa Malaysia EMAS Shariah Index (FBMS), FTSE Bursa Malaysia Hijrah Shariah Index (FBMSH), and Dow Jones Islamic Market Malaysia Index (DJIM Malaysia).

Resources for Identifying Shariah-Compliant Investments

Investors can turn to Shariah advisory boards and research firms to identify Shariah-compliant investments. Other alternatives include Shariah-compliant indexes such as the FTSE Shariah Global Equity Index and the Dow Jones Islamic Market Index. Additionally, platforms like Wahed Invest and StashAway offer Islamic-compliant investment options.

Benefits of Investing in Shariah-Compliant Investments

Investors concerned about their values and beliefs might consider investing in Shariah-compliant investments. Ethically, the concepts behind these investments can help prevent social harm and unjust treatment of the individuals involved. As both parties share the risks, they won’t gain at the expense of someone else.

These Islamic-compliant investments may also offer potentially higher returns due to a focus on financially stable and ethical companies. Furthermore, Shariah-compliant investments can diversify an investment portfolio and provide various investment vehicles that cater to different risk appetites.

Risks and Challenges of Investing in Shariah-Compliant Investments

However, risks and challenges are also associated with investing in Shariah-compliant investments. One of them is the limited investment opportunities due to Shariah screening. There may also be differences in the interpretation of Shariah law among various advisory boards, which can lead to inconsistencies in investment decisions. That’s why there is a need for specialised professionals, including Shariah advisors, fund managers, and auditors.

Lower liquidity in some Shariah-compliant investment vehicles and potentially higher fees for specialised investment products are also challenges to consider. For example, Shariah-compliant ETFs can have higher expense ratios and management fees than their conventional counterparts. This situation is due to the additional costs associated with the screening process and the involvement of specialised professionals.

Shariah-compliant investments allow investors to invest in financially stable and ethical companies while adhering to their personal values and beliefs to make a difference in society. However, it’s essential to seek professional advice before investing in these specialised products, as risks and challenges are involved.

Before making Shariah-compliant investment decisions, investors should avoid prohibited sectors, consider Islamic finance principles, and the importance of ethical and socially responsible investing.