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 fund
2. Ijarah funds
3. Commodity funds
4. Murabaha funds
5. Bai al Dain
6. 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.

1. Principle of Islamic Investment funds
• 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.
 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 fund
2. Ijarah funds
3. Commodity funds
4. Murabaha funds
5. Bai al Dain
6. 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 Funds
Conditions 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 Funds
Conditions 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 Funds
What 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 Funds
3. 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 Funds
For 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 Funds
Management of funds
Management 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 contract
1. 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 parties
5. 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 funds
1. 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 Lecture
Today 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 fund
2. Ijarah funds
3. Commodity funds
4. Murabaha funds
5. Bai al Dain
6. Mixed funds
• Challenges being faced by Islamic funds
• Opportunities in the market