Islamic Unit Trust , Mutual Fund, Exchange Traded Fund

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Islamic Unit Trust

Unit Trusts are based on the concept that risks and rewards are shared by the investors, employing the expertise of professional managers. This is in conformity with Islamic partnership principles of musharakah and mudarabah and is already applied within the Islamic financial system.

 (1) Investment must be made in ethical sectors. In other words, profits cannot be generated from prohibited activities such as alcohol production, gambling, pornography etc.

(2) Investing in interest (riba)-based financial institutions are not allowed.

(2) All wealth creation should result from a partnership between an investor and the user of capital in which rewards and risks are shared. Returns in invested capital should be earned rather than be pre-determined.

Islamic Unit Trusts

The Islamic unit trust schemes are collective investment funds which offer investors the opportunity to invest in a diversified portfolio of Shari’ah-compliant securities which are managed by professional managers in accordance with the Shari’ah. The Islamic unit trust schemes are required to additionally appoint a Shari’ah committee or a Shari’ah adviser to ensure that their operations are in accordance with Shari’ah.

The main objective of an Islamic Unit Trust is to invest in a portfolio of “halal” (permissible) stocks which comply with the principles of the Shari’ah. Such “halal” stocks will exclude companies involved in activities, products or services related to conventional banking, insurance and financial services, gambling, alcoholic beverages and non-halal food products.

The returns of the Islamic Unit Trust must also avoid the incidence of ‘riba‘ or usury interest through the process of cleansing or purification by the removal of such amounts representing the interest element. Such proceeds are normally donated to charities.

The common types of financial contracts and products that are used by Islamic financial institutions are recounted below:

1. Mudarabah: a contract in which all the capital of a venture is provided by the Unit Trust and the business expertise and management is the responsibility of the third party. Profits are divided between the third party and the Trust according to the terms of the contract.

2. Murabaha: a contract in which a third party wishing to purchase equipment or goods (primarily commodities) requests the Trust to purchase such items and charge them the cost plus a reasonable profit. The profits accrue to the Trust.

3. Musharakah: a joint venture in which both the Trust and the third party contribute funds, producing equity participation.

4. Ijara and ijara wa iqtina: a contract in which the Trust finances equipment, a building or an entire project for a third party against an agreed rental and the third party undertakes to make payments to the Trust which will eventually result in the ownership by the third party of the equipment or project The difference in value between the cost of the original finance provided and the total payments made by the third party accrues to the Trust. There is no doubt that investment in interest-bearing securities or businesses dealing in pork meat, alcohol, gambling and other activities prohibited by the Shari’ah cannot be acceptable. Profit in itself is not prohibited by the Shari’ah. Indeed, trade is encouraged, through which legitimate profit can be derived. The main objection against conventional business practices is that the profit on their transactions is primarily based on interest-bearing borrowing and lending.

Buying and selling company shares is a matter of investing and earning and there is no participation in management. This includes mergers, take-over, joint ventures and venture capital projects. Although there are differences of opinion among Muslim scholars about shareholding, those who have considered it most deeply generally hold the following opinion:

“If a company is not involved in the manufacture or sale of haram goods and its business is not based on interest or gambling, it is permissible for a Muslim to buy its ordinary shares and benefit from its dividends. However, buying its preference shares is not permissible.

“Sometimes objections are raised about the purchase of such companies’ shares, from the Shari’ah point of view, on the ground that these companies borrow from banks, etc., on interest, but in these cases interest is paid rather than received, and so the element of interest is not included in the companies’ profits. Doubts may be expressed that these companies open interest accounts with banks and include interest accrued on their deposits in their profits. But it can be argued that the amounts receivable from interest accounts are generally very small in comparison with the total profits and therefore rather insignificant, which is why the bulk of the profits may be accepted without hesitation.

“Besides this, keeping in view the evolutionary period through which the Islamic financial institutions are passing, there is scope to deal with non-Muslim companies to this extent, unless and until the Islamic Institutions become so strong that they are able to deal with non-Muslim institutions on their own terms only.”

There are many financial products in conventional financial markets which are not interest-based, or where the element of interest could be eliminated. For example:

a) Property funds and property investment trusts,

b) Trading in commodities,

c) Financial options and futures,

d) Forward transactions in foreign currencies; and

e) General trade-financing transactions.

The Islamic Unit Trust may combine three important factors:

a) Conventional investment expertise,

b) Islamic finance expertise; and

c) Shari’ah guidelines provided by Islamic religious scholars.

In this way, individual Muslim investors, Muslim corporate bodies and Islamic financial institutions can take part in the international markets and thus benefit from the growth of these markets.

Islamic Unit Trusts will give priority to equity investments in:

a) Islamic banks and financial institutions’

b) Stock markets of Muslim countries; and

c) Companies managed under the Islamic system.

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