What are Shariah Compliant Mutual Funds?

These funds strictly avoid industries that are considered non-compliant with Shariah law like —

• Gambling
• Alcohol
• Traditional banking (involving ‘interest’ or riba)

Managed by Shariah boards of scholars and financial experts, these funds follow strict screening processes to focus on interest-free and socially responsible investments. 

Offering a halal investment option, a Shariah mutual fund allows investors to grow their wealth while staying true to their religious and ethical values.

Who Can Invest in Shariah-compliant Mutual Funds in the UAE?

Before proceeding, it’s worth emphasising this: you can invest in Shariah mutual funds irrespective of your religion. So whether you’re a Muslim or follow any other religion, you can choose these funds.

With that clear, let’s see the categories for which these funds are usually suitable —

Structure of Shariah-Compliant Mutual Funds

Islamic mutual funds have a structured framework to ensure they adhere to Islamic investment principles. Here’s how—

1. Ratings Intelligence Partners

Independent research agencies, such as Ratings Intelligence Partners (RI), inspect stocks determine their compliance with Islamic law. These agencies collaborate with regional banks to create Shariah-compliant mutual fund products.

2. S&P Index Committee

The S&P Index Committee works with the Ratings Intelligence Partners to implement clear guidelines for managing Shariah-compliant indices, ensuring transparency and compliance.

3. Shariah Supervisory Board

A Shariah Supervisory Board (SSB) is composed of Islamic scholars with expertise in finance and business. They review investment strategies, ensure compliance, and provide guidance on Shariah-related issues.

Key Requirements for Shariah-Compliant Mutual Funds

To be considered Shariah-compliant, mutual funds must meet the following criteria —

By adhering to these principles, Shariah-compliant mutual funds offer a faith-based, ethical, and socially responsible investment approach.

Features of Shariah Compliant Mutual Funds

Shariah mutual funds are governed by a set of strict guidelines to ensure that all investments are halal (permissible) and avoid haram (forbidden) activities. 
Here are the key features of these funds —

1. Ethical Screening: Positive and Negative

The funds employ both positive screening and negative screening methods.

• Positive Screening: Funds select companies involved in legal and ethical businesses such as technology, healthcare, and manufacturing
• Negative Screening: They exclude investments in companies engaged in activities prohibited by Shariah law — alcohol, gambling, tobacco, weapons manufacturing, pork, and more

2. Shariah Board Oversight

Each fund is overseen by a Shariah board, which comprises Islamic scholars and financial experts. This board ensures that the fund’s investments and operations strictly follow Islamic principles, with regular audits to maintain compliance.

3. No Interest or Riba

One of the core principles of Shariah mutual funds is the prohibition of interest or Riba, which is considered morally wrong in Islam

These funds avoid companies that earn significant income from interest-based activities. If a fund inadvertently earns income from interest, this income is often purified by donating it to charity

4. Avoidance of High-Debt Companies

Shariah compliant funds generally avoid companies with excessive debt. As per Islamic principles, high debt levels can lead to financial instability and are seen as unethical. 

5. Investment in Physical Assets

These funds often focus on asset-backed investments, particularly in industries that are guaranteed by physical assets. This reduces speculative risks and enhances transparency in investments, aligning with Islamic principles that encourage tangible and real-world investments.

6. Profit-and-Loss Sharing

In line with Islamic finance principles, Shariah compliant mutual funds encourage profit-and-loss sharing arrangements. These funds invest in businesses where profits are shared between investors and businesses, avoiding purely interest-based income and promoting ethical financial practices.

7. Sukuk (Islamic Bonds)

Often known as halal mutual funds in UAE, they may also invest in Sukuk or Islamic bonds. Unlike conventional bonds that are based on interest, Sukuk represents a share in the ownership of an asset, making them compliant with Shariah law.

8. Diversification for Risk Mitigation

To mitigate risk, Shariah-compliant mutual funds use diversification strategies. By investing across multiple sectors and asset classes, these funds spread risk and ensure that no single investment negatively impacts the overall portfolio.

9. Open to All Investors

Although these funds are designed with Islamic principles in mind, they are open to all investors, regardless of religion. Anyone interested in ethical, socially responsible investing can participate in these funds.

10. Transparency and Regular Audits

Halal mutual funds prioritise transparency. Regular audits and detailed reporting are conducted to ensure ongoing compliance with the law. This ensures that all investors can trust that their investments are ethically managed.

Factors to Consider Before Investing in Shariah Compliant Mutual Funds

You must know certain factors before investing in Shariah or halal mutual funds —

• Returns: It’s better to evaluate the historical performance of these funds, comparing both short-term and long-term returns with conventional funds
• Liquidity: Check the liquidity of the fund so that you can buy and sell units as needed without affecting your investment goals
• Higher Costs: These funds may have higher management and compliance fees due to the additional effort required to adhere to Shariah guidelines
• Restrictive Decision Making: Fund managers must follow Islamic rules, which can limit their flexibility in selecting investments and impact fund performance

Restrictions According to Shariah Law 

Here are the guidelines in line with Islamic principles, based on which Shariah compliant mutual funds operate —

• Interest-free Income: These funds avoid companies with significant interest-based income. However, finding companies with 100% interest-free income may be challenging — this is why these funds can often invest in companies where interest income does not exceed 3% of their total income.
• Restricted Industries: You are prohibited from investing in companies involved in activities considered unethical under the law, such as financial services like conventional banks, insurance companies, and more.
• Debt-to-Asset Ratio: Shariah mutual funds usually cannot invest in companies with a debt-to-asset ratio exceeding 25%. This ensures that investments are in financially stable companies with low levels of debt. 

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Best Shariah Compliant Mutual Funds in UAE

Before exploring the list, here are the 2 major indices — 

Key Shariah Indices

• S&P CNX Nifty Shariah: Tracks the 50 largest Shariah-compliant companies on the NSE
• S&P CNX 500 Shariah: A broader index of 500 Shariah-compliant companies

We have mentioned the key Shariah-compliant fund options in India —

1. Tata Ethical Fund

The Tata Ethical Fund offers a diversified equity portfolio, focusing on companies that comply with the law. It avoids sectors that are non-compliant with Islamic principles. 

Ideal for investors seeking long-term capital growth, this islamic mutual fund ensures exposure to ethical equity investments.

This fund has shown strong performance across different time periods —

• 1-Year Return: 27.8%
• 3-Year Return (Annualised): 11.8%
• 5-Year Return (Annualised): 19.8%

2. Nippon India ETF Shariah BeES (formerly Reliance ETF Shariah BeES)

The Nippon India ETF Shariah BeES tracks the Nifty50 Shariah Index, investing in companies that meet specific criteria. By mirroring the index’s composition, it provides a way to invest in a broad market portfolio with ethical considerations. 

Note: This halal mutual fund is ideal for medium to long-term growth but requires a Demat account for investment

While its returns may be lower compared to the equity funds, this ETF offers the advantage of being easier to trade and more liquid —

• 1-Year Return: 24.7%
• 3-Year Return: 6.33%
• 5-Year Return: 16.09%

3. Taurus Ethical Fund

Similar to the Tata Ethical Fund, the Taurus Ethical Fund invests in Shariah-compliant equity and equity-related instruments. It targets long-term capital appreciation while excluding sectors prohibited under Islamic law. 

This islamic mutual fund is suited for investors who want to invest in line with Islamic values.

• 1-Year Return: 34.72%
• 3-Year Return: 21.84%
• 5-Year Return: 19.86%

Note: The returns are updated on a regular basis. Hence, it’s better to keep a check before making any decision.

Other Considerations: Gold ETFs

While most gold mutual funds in India may invest in fixed-income securities that can conflict with Shariah principles, Gold ETFs remain a halal investment option. These ETFs invest in physical gold, which allows you to gain exposure to the precious metal while adhering to Islamic guidelines.

Tax Treatment of Shariah-Compliant Mutual Funds

Halal mutual funds in India usually follow the same tax rules as equity-oriented mutual funds as they primarily invest in stocks. 

Here’s a breakdown of how taxes apply to these funds as per the latest 2024 regulations —

1. Short-Term Capital Gains (STCG)
   If you sell your Shariah-compliant mutual fund units within 1 year of purchase, any gains are considered short-term. Short-term capital gains are taxed at a rate of up to 20%.

2. Long-Term Capital Gains (LTCG):
   If you hold the investment for more than 1 year, the gains are classified as long-term. Long-term capital gains are taxed at up to 12.5%, but there’s a key benefit — gains up to Rs. 1,25,000 in a financial year are tax-free. 
   Only the amount exceeding Rs. 1,25,000 is taxed at the 12.5% rate.
    
3. No Special Tax Benefits:
   There are currently no additional tax benefits or exemptions specific to Shariah-compliant mutual funds — they are taxed just like any other equity fund.

Conventional vs Shariah Compliant Mutual Funds

Here are the key differences and similarities between Shariah-compliant and conventional funds —

Frequently Asked Questions

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