Screening of Islamic investments
The Shari’ah supervisory board is an independent committee with an overwhelming power that makes the difference between Islamic and conventional mutual funds. The board establishes criteria for socially responsible or ethical investments by ensuring that the companies selected for investment are acceptable from the perspective of Shari’ah. This is carried out through a screening process to exclude stocks deemed unacceptable for investments, including alcoholic beverages and tobacco, gambling activities, pork, and arms manufacturing for other than defensive purposes. The screening process also avoids stocks which pay excess interest on debts. Companies that are not primarily involved with harem activities, but where such activities nevertheless constitute a significant proportion of their business, are also excluded. There are two major index specialists who provide Islamic screening, FTSE Shari’ah Global Equity Indexes and the Dow Jones Islamic Market Indexes.
However, most Islamic financiers accept that modern corporate capital structure inevitably includes some debt on the balance sheet and fixed-income liabilities. Many Shari’ah advisory boards have accepted portfolio investments in companies with low-interest income, and below-average debt-to-equity ratio, providing profits are purified. The purification of investment obliges fund managers to determine what percentage of a company's profit is derived from interest-bearing accounts, and then giving it to charities in form of Zakat. The criteria used when screening equities involve calculation of ratios, such as the proportion of interest-bearing debt to assets or the ratio of total debt to the average market capitalisation of a company over a period of 12 months. In addition, fund management groups seeking to comply with the Shari’ah examine the extent to which a company’s income is derived from interest, any proportion in excess of 15 per cent being unacceptable; they also consider the extent of debt-to-equity finance, DJIM Indexes advocate a limit of 25 per cent for the debt-to-capitalisation ratio (Islamic Equity Funds, the modes of resource mobilization and placement by Osman Babikir Ahmed; 2001), but there was no consensus on this. The general view is that a company’s interest-based loans may be considered insignificant if they total less than one third of that company’s total assets. Another of the screens prescribed by Muslim scholars is that interest-based, non-operating income must be less than five percent of revenues.
In addition, the criteria of purification exclude short sales and purchase on margin, however, it is acceptable to purchase shares of companies whose primary function is not lending or borrowing on Interest, or which do not deal in a prohibited item such as alcohol, provided the full price is paid and the shares are actually delivered. The price of the stock will reflect the true intrinsic worth of the company, and the transaction should be interest-free, made without any coercion on either party, and there should be no uncertainty about the price, date and place of delivery. If the basic elements of the transaction are valid from a Shari`ah standpoint, then a slight degree of impurity will not cancel the deal. But measures will have to be taken to rid the deal of the impure element.
In regard to the screen on accounts receivable, the Shari`ah allows investing in shares of companies in which the primary business activity is deemed lawful if the accounts receivable do not represent more than 50% of the total assets. Thus, if the primary business of the company is Halal and the sale methodology for obtaining corporate revenue is through instalment payments, which may be deemed subordinate if the accounts receivable do not exceed 45% percent of the total assets, then investment in such a company will be Halal. Therefore, if the accounts receivable do not exceed 45% of the total assets, consistent with the rule of majority determining ultimate judgment, an Islamic investor will not be prohibited from purchasing shares in such a company.
However, most Islamic financiers accept that modern corporate capital structure inevitably includes some debt on the balance sheet and fixed-income liabilities. Many Shari’ah advisory boards have accepted portfolio investments in companies with low-interest income, and below-average debt-to-equity ratio, providing profits are purified. The purification of investment obliges fund managers to determine what percentage of a company's profit is derived from interest-bearing accounts, and then giving it to charities in form of Zakat. The criteria used when screening equities involve calculation of ratios, such as the proportion of interest-bearing debt to assets or the ratio of total debt to the average market capitalisation of a company over a period of 12 months. In addition, fund management groups seeking to comply with the Shari’ah examine the extent to which a company’s income is derived from interest, any proportion in excess of 15 per cent being unacceptable; they also consider the extent of debt-to-equity finance, DJIM Indexes advocate a limit of 25 per cent for the debt-to-capitalisation ratio (Islamic Equity Funds, the modes of resource mobilization and placement by Osman Babikir Ahmed; 2001), but there was no consensus on this. The general view is that a company’s interest-based loans may be considered insignificant if they total less than one third of that company’s total assets. Another of the screens prescribed by Muslim scholars is that interest-based, non-operating income must be less than five percent of revenues.
In addition, the criteria of purification exclude short sales and purchase on margin, however, it is acceptable to purchase shares of companies whose primary function is not lending or borrowing on Interest, or which do not deal in a prohibited item such as alcohol, provided the full price is paid and the shares are actually delivered. The price of the stock will reflect the true intrinsic worth of the company, and the transaction should be interest-free, made without any coercion on either party, and there should be no uncertainty about the price, date and place of delivery. If the basic elements of the transaction are valid from a Shari`ah standpoint, then a slight degree of impurity will not cancel the deal. But measures will have to be taken to rid the deal of the impure element.
In regard to the screen on accounts receivable, the Shari`ah allows investing in shares of companies in which the primary business activity is deemed lawful if the accounts receivable do not represent more than 50% of the total assets. Thus, if the primary business of the company is Halal and the sale methodology for obtaining corporate revenue is through instalment payments, which may be deemed subordinate if the accounts receivable do not exceed 45% percent of the total assets, then investment in such a company will be Halal. Therefore, if the accounts receivable do not exceed 45% of the total assets, consistent with the rule of majority determining ultimate judgment, an Islamic investor will not be prohibited from purchasing shares in such a company.
