Islamic Investment Funds

Summary of the Previous Lecture

We studied the concept of applications of Islamic

financing in

1. Project financing

2. Working capital financing

3. Import financing

4. Export financing

Learning outcomes

After this lecture you will be able to understand; • Principles of Islamic investment funds.• Modes of investment of funds and their management under Islamic

financial system, e.g.1. Equity fund2. Ijarah funds3. Commodity funds4. Murabaha funds5. Bai al Dain6. Mixed funds

• Challenges being faced by Islamic funds• Opportunities in the market

1. Principles of Islamic Investment funds

• Islamic Investment Funds are joint pool of funds wherein the

investors contribute their surplus money for the purpose of its

investment to earn halal profits in strict conformity with the

principles of Islamic Shariah

• Subscribers of funds receive a document may be called a certificate, a

unit, a share or any other name representing the value and will earn

pro rated profits on it.

• Management can share in the profits or can charge a fee for their

services on monthly or annual basis.

• Returns are tied up with the actual profits earned

or losses suffered.

• In case of loss caused by the negligence on the part

of management, compensation will be provided by

the management.

• Funds raised must be invested in Shariah approved

businesses.

1. Principle of Islamic Investment funds

Funds being Operated in the Market

• UBL Sharia stock fund

• United Islamic income fund

• HBL Islamic money market fund

• HBL Islamic stock fund

• Al- Meezan Mutual fund Ltd.

• Askari Islamic asset allocation fund

• …………………

2. Modes of Investment

1. Equity fund2. Ijarah funds3. Commodity funds4. Murabaha funds5. Bai al Dain6. Mixed funds

2.1 Equity Funds Equity funds are invested in joint stock companies.

Profits are generated through the trading of shares in the

stock market and the dividends.

It is prohibited to invest in stocks of those companies that

are involved in activities not approved by sharia, e.g.

companies manufacturing, selling or offering liquor, pork,

haram meat, or involved in gambling, night club activities,

pornography, prostitution, or involved in the business of hire

purchase or interest etc.

2.1 Equity Funds

If a company is doing Halal business but earns income from haram

sources as well, like interest payment/receipt on surplus/borrowed

money borrowed or deposited in the bank. In such situation the

investor should

1. Raise voice against such activities in annual general meeting of

the company.

2. Avoid investing in companies where the income from Haram

sources exceed 5% of the total income.

3. Deduct the proportion of Haram income from the profits earned

and give to charity. This is called purification.

2.1 Equity FundsConditions for investment in shares

• Not involved in Manufacturing , Selling or offering

Liquors, Pork, Haram meat, gambling, night clubs,

pornography.

• Business should be Halal like automobile and Textile etc.

• company's total short term and long term investment in

non-permissible business should not exceed 30% of the

company's total market capitalization.

2.1 Equity FundsConditions for investment in shares

The basis of 30% is that the 30% is less than one third

(1/3rd) of the total asset of the company and one third has

been considered abundant by the following Hadith of the

Holy prophet (SAW) "One third is big or abundant"

(Tirmizy). Hence whatever is less than one third, would be

insignificant.

2.1 Equity Funds

• The shares of a company are negotiable only if the

company owns some illiquid assets.

• If all the assets of a company are in liquid form, i.e. in

the form of money they cannot be purchased or sold

except at par value.

2.1 Equity FundsWhat should be the exact proportion of illiquid assets of a

company for warranting the negotiability of its shares?

1. Some scholars are of the view that the ratio of illiquid

assets must be 51% in the least.

2. Some other scholars are of the view that even if the

illiquid asset of a company is 33%, its shares can be

treated as negotiable. The basis of this view is a well-

known Hadith that means "One third is big or abundant"

(Tirmizy).

2.1 Equity Funds3. The third principle of the Hanafi School is that

whenever an asset is a combination of liquid and illiquid assets, it can be negotiable irrespective of the proportion of its liquid part. However, this principle is subject to two conditions:4. The illiquid part of the combination must not be

in insignificant quantity. It means that it should be in a considerable proportion.

5. The price of the combination should be more than the value of the liquid amount contained therein.

2.1 Equity FundsFor example, if a share of 100 dollars represents 75 dollars, plus some fixed assets, the price of the share must be more than 75 dollars. If the price of the share is fixed at 105, it will mean that 75 dollars are in exchange of 75 dollars owned by the share and the balance of 30 dollars is in exchange of the fixed assets. Conversely, if the price of that share is fixed at 70 dollars, it will not be allowed, because the 75 dollars owned by the share are less than 75. This kind of exchange falls within the definition of 'riba' and is not allowed. Similarly, if the price of the share, in the above example, is fixed at 75 dollars, it will not be permissible, because if we presume that 75 dollars of the price are against 75 dollars owned by the share, no part of the price can be attributed to the fixed assets owned by the share.

2.1 Equity FundsManagement of fundsManagement of the fund can be carried out in two ways;• Managers of fund may act as Mudarib.• To act as an agent for the subscribers and charge a pre agreed

fee for services, 1. Fee can be a fixed in lump sum or as a monthly or annual

remuneration. 2. Fee can also be based on a percentage of the net asset

value of the fund. For example, it may be agreed that the management will get 2% or 3% of the net asset value of the fund at the end of every financial year.

2.2 Ijara Fund Funds or subscription amounts are used to purchase

assets like real estate, motor vehicles, or other equipment's for the purpose of leasing.

The ownership of these assets remains with the Fund and the rentals are charged from the users.

Rentals on these assets are the income of fund. Each subscriber is given a certificate that is more

likely to be called Sukuk. Sale of these Sukuk certificates would simply change

the owner in the asset.

2.2 Ijara Fund

Some conditions of the Ijara contract1. The leased assets must have some usufruct, and the rental

must be charged only from that point of time when the usufruct is handed over to the lessee.

2. The leased assets must be of a nature that their Halal (permissible) use is possible.

3. The lessor must undertake all the responsibilities consequent to the ownership of the assets.

4. The rental must be fixed and known to the parties5. In this type of fund management will be offered a fee for their

services; it may be fix or a percentage of rentals received.

2.2 Ijara Fund

Management of the funds1. In this type of fund management will be offered a fee for

their services.2. Fee may be fixed or a percentage of rentals received.3. According to Muslim jurists such a fund cannot be created

on the basis of Mudarabah, because Mudarabah, according to them, is restricted to the sale of commodities and does not extend to the business of services and leases.

4. However, in the Hanbali School, Mudarabah can be effected in services and leases also. This view has been preferred by a number of contemporary scholars.

2.3 Commodity Funds This type of fund is used for purchasing commodities for

resale to earn profits. All the transactions should comply the sharia conditions like;

1. the seller must own the commodities.2. forward sales are not allowed except in case of salam

and istisna.3. Commodities must be Halal.4. The seller must have physical or constructive

possession over the commodity he wants to sell. 5. Price of the commodity must be fixed and known to the

parties, it can't be tied up with any uncertain event.

2.3 Commodity Funds

Management of the funds

1. In this type of fund management will be offered a fee for

their services.

2. Fee may be fixed or a percentage a the profits earned.

3. Mudarabah arrangement to share profits is also feasible

here.

2.4 Murabaha Fund kind of sale where the commodities are sold on a cost-

plus basis. This type of fund is a closed-end fund and its units are

not negotiable in the secondary market. As the Murabaha fund certificates don't represent a

physical ownership of assets rather it represents a claim of debt and profit there on, so the sale of debt is not allowed unless it is exchanged with exactly the same amount or at par value.

2.4 Murabaha Fund

Management of the funds

1. In this type of fund management will be offered a fee for

their services.

2. Fee may be fixed or a percentage a the profits earned.

3. Mudarabah arrangement to share profits is also feasible

here.

2.5 Bai al Dain / Sale of Debt Sale of debt is not allowed in Shariah, .e.g.

discounting of bills receivable or debts receivable.

Majority of Muslim jurists believe that bai-al-dain

with discount is not allowed in Shariah.

• Any increase or decrease from one side is similar to

'riba' and can never be allowed in Shariah.

However, Some of Malaysian scholars have allowed

this kind of sale.

2.5 Bai al Dain / Sale of Debt

• The Islamic Fiqh Academy of Jeddah, which is the

largest representative body of the Shariah scholars

and has the representation of all the Muslim

countries, including Malaysia, has approved the

prohibition of bai-al-dain unanimously without a

single dissent.

2.6 Mixed Fund

A fund where the subscription amount is invested in

different types of investments, like equities, leasing,

commodities, etc.

Certificates of units of funds are tradable in the

secondary market only if the tangible assets are more

than 51% while the liquidity and debts are less than 50%.

Otherwise it will be a closed end fund.

3. Challenges Being Faced By Islamic Funds

• Fund size is small.

• Lack in strong legal and institutional framework.

• Lack in supervisory framework.

• Lack of knowledge and understanding of the Islamic Fund.

• Lack in research and development in the field of Islamic

finance and economics.

• Lack in HR development and training to the banks staff on

Islamic Banking system.

3. Challenges Being Faced By Islamic Funds

• Lack of guidance and information system.

• Lack in Marketing of Islamic products /services and

their introduction in international market.

• Lack of financial engineering.

• Doubts about instruments used.

4. Opportunities

• Having qualified staff in the Islamic financial institutions

would produce the best results.

• Standard can be developed on the basis of efficient and

effective management practices.

• Transparency and reliability can be increased.

• Interest of investors and society at large can be enhanced.

• Industry can be driven Ethically and morally.

• Industry can be run effectively and efficiently.

4. Opportunities

• Future depends upon innovative instruments to enhance

liquidity.

• To develop secondary money and capital markets .

• To Introduce Public Finance instruments

• Having need of appropriate institutional arrangements,

legal framework and taxation issues .

• Development of Human Resource.

• Products and services are available for Non-Muslims also

and they are using the same.

Summary of the LectureToday we studied the following concepts of Islamic investment funds; • Principles of Islamic investment funds.• Modes of investment of funds and their management under

Islamic financial system.1. Equity fund2. Ijarah funds3. Commodity funds4. Murabaha funds5. Bai al Dain6. Mixed funds

• Challenges being faced by Islamic funds• Opportunities in the market