Islamic principles require that investors share in profit and loss, that they receive no interest (riba), and that they do not invest in a business that is prohibited by Islamic law, or sharia. Before investing in a company, it is necessary to evaluate its business activities and financial records to determine where its primary revenue comes from and how its income and expenditures are managed. A company that meets certain criteria would be Halal, or permissible. If it does not meet the criteria, it would be haram, or not permitted.
Interpretation of Islamic law as applied to business activities is nuanced, and halal investment guidelines can vary. Therefore, Muslim investors often rely on guidance from Islamic scholars to help determine whether an investment is Halal.
Investments that sharia scholars universally consider unacceptable are companies whose primary business activities violate the core tenets of Islam, including the manufacture or marketing of alcohol; gambling or gaming activities; conventional interest-based financial services; pork and pork products; and pornography. In addition, most sharia scholars advise against investing in tobacco companies.
Islamic scholars have established financial guidelines to determine when a business activity is a core source of revenue and when it is not. For example, the five percent rule says that a core business activity is one that accounts for more than five percent of a company's revenue, or gross income. This reasoning applies to the Islamic prohibition on riba, or interest, as well. If a company's interest-based income or holdings exceed certain limits, then investing in the company is forbidden.
Often, it is not possible to avoid haram business activities. Islamic law requires "purification" of investment earnings that can be attributed to haram activities. One way to do this is through zakah, a form of charitable giving that can help you cleanse impure investment income by giving it away to acceptable charitable causes. For more information on zakah, and how Saturna Capital can help, please refer to our Zakah page.
Halal Investment Screening
Halal investment screens help assess whether a company's business activities are Halal or haram. The screens facilitate the elimination of haram investments from consideration.
Halal investing screens seek to eliminate
- bonds and other interest-based investments
- stocks of companies that have high debt (sometimes referred to as highly leveraged)
- securities of companies in industries that do not adhere to Islamic principles, such as liquor, gambling, pornography, pork, insurance, banks, etc.
- mutual funds or hedge funds that trade securities frequently (have high turnover rates) because frequent trading is seen as gambling by some Islamic scholars
Saturna Capital, adviser to the Amana Funds, employs proprietary screens and an investment process developed in collaboration with Islamic scholars of the Fiqh Council of North America (FCNA), a non-profit organization serving the Muslim community. In addition to the business sector screens listed above, Saturna Capital applies the following financial screens, seeking to eliminate companies with
- greater than five percent of their revenue coming from haram sources
- greater than 33 percent total debt as compared to their market capitalization (trailing 12 month average)
- greater than 45 percent accounts receivable as compared to their total assets (trailing 12 month average)
If a company fails the screening process it is considered an unacceptable investment. However, Halal investment screening is not always straightforward. When considering whether an investment is Halal, it is necessary to look deeply into a company's business activities to discover its core sources of revenue, or how it actually makes its money.
A company's industry sector, or part of the economy to which it belongs, may not always tell you the whole story. A computer software company may write programs used in gambling. A company that publishes children's books may also produce books that are considered pornographic. An agricultural producer might sell its crops exclusively to breweries. On the surface, each of these companies may not appear to be haram, but a closer examination reveals otherwise.
Saturna's investment analysts use NEPTUNE® software, developed in-house by Saturna, to screen, grade, and monitor more than 10,000 securities traded worldwide monthly. Securities that receive an "A" grade are subject to further in-depth review prior to purchase.
The Halal investment process does not end with a security's purchase. We monitor the securities in the Amana Funds' portfolios for ongoing compliance with Halal investing criteria and sell if they fail screens at a later date.
Benefits and Risks of Halal Investing
Investing according to Islamic principles can offer many benefits to Muslims and non-Muslims alike. Halal investing encourages a disciplined investment process that promotes in-depth security research and monitoring. Generally, the low debt requirements of Islamic screens facilitate a conservative approach that appeals to risk-averse investors.
Halal investing discourages short-term speculation. The low turnover required in Halal investment portfolios results in longer planned holding periods and close scrutiny of company financials. Low turnover also minimizes portfolio trading expenses, such as broker commissions, while increasing tax efficiency by avoiding rapid buying and selling of securities that can generate taxable capital gains.
The limitations imposed on investment opportunities by Islamic principles potentially creates risk. For example, among the securities researched monthly by Saturna Capital for the Amana Funds, less than half pass the initial screens necessary to be considered Halal. Restricting investment choices to a smaller universe means that a Halal portfolio may not be as diversified as other portfolios, which may increase the risk of loss. The returns from various market sectors rise and fall at different times. Islamic principles may limit opportunities to gain when prohibited market sectors, such as financial services, rally.
Because Islamic principles preclude the use of interest-paying investments, Halal cash reserves cannot be invested in traditional money market funds or deposited in an interest-earning bank account and therefore do not earn income.
Halal Mutual Funds
In 1984, Dr. M. Yaqub Mirza suggested the idea to create the first US mutual fund managed according to Islamic principles, which became the Amana Income Fund. As an active member of a Muslim investing group, Mirza found it difficult and time-consuming to vet securities for his own Halal portfolios. He felt a professional investment advisory firm, with greater collective expertise and resources, would be better suited to carry out the complex Islamic screening process. He also felt a mutual fund would be the ideal Halal investment vehicle because its structure ensures that investors share in profit and loss.
Today, a variety of Halal investment products serve the needs of Muslim investors, including the original Amana Income Fund started in 1986, the Amana Growth Fund started in 1994, and the Amana Developing World Fund started in 2009.
For more information about Halal Investing:
A Muslim's Guide to Investing & Personal Finance by Virginia Morris in collaboration with Monem Salam.
Five Pillars of Prosperity, Essentials of Faith-Based Wealth Building by Dr. M. Yaqub Mirza