All you need to know about Shariah-compliant mutual funds

Shariah compliant mutual funds are a type of investment fund that follows the principles of Sharia Law. These funds avoid investing in assets considered haram or prohibited under the law. Shariah-compliant mutual funds have gained popularity recently, particularly in Muslim-majority countries, due to the increasing demand for ethical and socially responsible investing.

In this article, we will discuss the principles of Shariah-compliant mutual funds, their advantages and disadvantages, and their regulatory framework in India. But before that, let's delve into the history and growth of Shariah-compliant investing.

Principles of Shariah-compliant mutual funds

Shariah-compliant mutual funds operate on principles that align with Shariah Law and follow the principles of Islam. These principles guide the investments made by these funds, and they include the following:

• Prohibited industries and activities: These funds exclude investments in companies the make alcohol, tobacco, gambling, weapons, pork and other such products.
• Ethical and socially responsible investing: Shariah-compliant mutual funds invest in companies with a positive social impact and uphold ethical practices. The funds avoid investing in companies which earn the interest income or pay interest.

Screening process for Shariah compliance

Shariah-compliant mutual funds undergo a screening process to ensure compliance with Islamic principles. A Shariah supervisory board carries out the screening process, which reviews the mutual fund's investment portfolio. 

Advantages of Shariah-compliant mutual funds

Shariah-compliant mutual funds in India offer several advantages to investors. Some of them are listed below:

Diversification of portfolio: Investing in Shariah-compliant mutual funds allows investors to diversify their portfolios across various sectors and industries. It helps to reduce the risk of concentration in a single sector or industry.

Ethical investing: Shariah-compliant mutual funds follow the principles of ethical and socially responsible investing. They invest in businesses that adhere to Islamic principles and avoid those involved in prohibited industries and activities. 

Disadvantages of Shariah-compliant mutual funds

Shariah-compliant mutual funds have some possible drawbacks that investors should consider before investing. These include: 

Limited investment options: As they prohibit investment in some industries and activities under Islamic law, this may result in a narrower range of investment options than conventional mutual funds.

Higher cost: Investors may face higher fees and expenses when investing in Shariah-compliant mutual funds. The cost of managing the fund and screening to ensure Islamic principles can increase the cost of fund management. 

Shariah-compliant mutual funds in India

Shariah compliant mutual funds have gained popularity in India over the past few years as more and more investors seek ethical and socially responsible investment options. Currently, there are three Shariah compliant mutual funds in India namely, Tata Ethical Fund, Taurus Ethical Fund and Nippon India ETF Nifty 50 Shariah Bees.

Comparison with conventional mutual funds

Shariah-compliant mutual funds are often compared to conventional mutual funds to assess their performance and benefits. 

The primary difference between the two is the investment philosophy and process. In conventional mutual funds, the fund manager has complete discretion and can invest in any company as long as it meets the fund's objectives. On the other hand, Shariah-compliant mutual funds follow a rigorous screening process to ensure that the investments comply with Shariah principles.

Conclusion

Shariah-compliant mutual funds provide an ethical and socially responsible investment option for individuals who want to align their investment decisions with their religious beliefs. Despite some limitations, such as limited investment options and higher fees, these funds offer competitive returns and diversification of portfolios.

Disclaimer

The investment options and stocks mentioned here are not recommendations. Please go through your own due diligence and conduct thorough research before investing. Investment in the securities market is subject to market risks. Please read the Risk Disclosure documents carefully before investing. Past performance of instruments/securities does not indicate their future performance. Due to the price fluctuation risk and the market risk, there is no guarantee that your personal investment objectives will be achieved.