Islamic Investment Funds

Summary of the Previous Lecture We studied the concept of applications of Islamic financing in Project financing Working capital financing Import financing 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. Equity fund Ijarah funds Commodity funds Murabaha funds Bai al Dain 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 Equity fund Ijarah funds Commodity funds Murabaha funds Bai al Dain 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 Raise voice against such activities in annual general meeting of the company. Avoid investing in companies where the income from Haram sources exceed 5% of the total income. 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? Some scholars are of the view that the ratio of illiquid assets must be 51% in the least. 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 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: The illiquid part of the combination must not be in insignificant quantity. It means that it should be in a considerable proportion. 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, Fee can be a fixed in lump sum or as a monthly or annual remuneration. 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 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. The leased assets must be of a nature that their Halal (permissible) use is possible. The lessor must undertake all the responsibilities consequent to the ownership of the assets. The rental must be fixed and known to the parties 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 In this type of fund management will be offered a fee for their services. Fee may be fixed or a percentage of rentals received. 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. 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; the seller must own the commodities. forward sales are not allowed except in case of salam and istisna. Commodities must be Halal. The seller must have physical or constructive possession over the commodity he wants to sell. 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 In this type of fund management will be offered a fee for their services. Fee may be fixed or a percentage a the profits earned. 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 In this type of fund management will be offered a fee for their services. Fee may be fixed or a percentage a the profits earned. 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. Equity fund Ijarah funds Commodity funds Murabaha funds Bai al Dain Mixed funds Challenges being faced by Islamic funds Opportunities in the market