Historically shares have outperformed all the other investment instruments and given the maximum returns in the long run In the twenty-five year period of 1980-2005 while the other instruments have barely managed to generate returns at a rate higher than the inflation rate (7.10%), on an average shares have given returns of more than 17% in a year and that does not even take into account the dividend income from them. Were we to factor in the dividend income as well, the shares would have given even higher returns during the same period.
Slowly but surely the world's economic centre of gravity is shifting away from the established, wealthy economies of Europe, Japan, and North America to the emerging economies like China, India, and South East Asia.
China and India in particular are projected to become the two largest economies of the world in the next fifty years. China riding high on its manufacturing ability, has recorded tremendous economic growth in the recent past.
But as far as foreign investments are concerned, it is still looked at with suspicion, mainly for its political setup and the economic model. On the other hand India the world’s largest democracy, offers some very clear advantages.
India is one of the fastest-growing large economies in the world. With a population of over 1.3 billion, with huge human and natural resources, and with costs that are at the very low end of the global average, India represents economic opportunities on a massive scale.
India's institutional framework is well suited for the world economy. Corporate India has been performing well and this factor, coupled with strong macroeconomic fundamentals, growing industrial and service sectors, provides great potential for investment in the Indian economy.
Its legal framework which protects foreign investments is one of the best in the region. The economy offers an abundance of technical and managerial talent, with international experience.
And most importantly, India has a demographic advantage that will see its working age population continue to grow in the next couple of decades. The huge capital inflows into the country mirror the confidence of foreign investors in the Indian economy's ability to match this expectation.
India as compared to many other developing countries has been a star performer in recent years, both in terms of returns and attracting funds from overseas. Favorable demographics, wide opening of the economy and global competitiveness have put India on the economic radar of the global players.
Leading indicators and available information both suggest that the Indian economy is poised to build upon the gains in macroeconomic performance secured in the recent past. Robust strengthening of manufacturing activity, high corporate profitability, buoyant equity markets, robust merchandise exports and imports and lead indicators of service sector activity all point to a brightening of prospects for the Indian economy in the future.
Consequently, the return from the equity market has also been very handsome. Ethical Wealth institutions that are looking for investment opportunities beyond the Arabian Gulf can find Indian stock market a very good place to put their funds.
Over the last ten years Islamic finance has grown quite impressively. With the growth in Islamic finance the need for shariah compliant Wealth products have also increased very much.
However, Islamic capital markets in various Muslim countries are still quite underdeveloped. In these circumstances there have emerged a number of Indices developed by Dow Jones, FTSE and others to track shariah compliant stocks from the world over.
In India Muslims are second largest populations after Indonesia, Indian Muslims population estimated to be more than 150, millions. Inspite of this India is routinely ignored in the vast majority of the books articles on the subject of Islamic banking and or investments.
Dow Jones has Islamic index, FTSE of Britain has not only Islamic Index but also a full fledge Islamic bank, but unfortunately there is not a single Islamic Product or an Islamic benchmark in Indian investment environment.
Even more bizarre India is not covered and not included for any of their research work by any Islamic institution or bank. Although India is the big market for Islamic investments, and according to me no research work of any research institution could be complete without including India. Although India has a good Islamic structure which provides opportunity of riba (intrest) free investment and finance which gives us lots of benefit.
Shariah conscious domestic investors can also find Indian stock market a better place to invest. They all will find a large number of stocks consisting various sectors from IT, drugs and pharmaceuticals, automobile to core sectors like energy, cement, steel and mining etc. In fact the Islamic options available in India are wider and much better than the availability of the same in many Islamic countries.
Today business and investments have several different approaches, of which the Stock Exchanges offer an important one; provided we have the right information and guidance. We will be inviting people to invest any surplus money in equity shares as it is an extremely profitable option for wealth creation. India is a land of opportunity waiting to be explored and as the markets are near the bottom we think it’s the ideal time for new investors to select quality companies which will multiply their money many folds.
Sunday, October 11, 2009
Saturday, October 10, 2009
PRINCIPLE OF SHARIA INVESTMENT
(Research Paper Presented by Mufti Taqi Usmani)
The term ‘Islamic Investment ’ in this article means a joint pool wherein the investors contribute their surplus money for the purpose of its investment to earn halal profits in strict conformity with the precepts of Islamic Shari’ah. The subscribers of the Fund may receive a document certifying their subscription and entitling them to the pro-rata profits actually accrued to the Fund. These documents may be called ‘certificates’ ‘units’ ‘shares’ or may be given any other name, but their validity in terms of Shari’ah, will always be subject to two basic conditions
Firstly, instead of a fixed return tied up with their face value, they must carry a pro-rata profit actually earned by the Fund. Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. The subscribers must enter into the fund with a clear understanding that the return on their subscription is tied up with the actual profit earned or loss suffered by the Fund. If the Fund earns huge profits, the return on their subscription will increase to that proportion; however, in the case the Fund suffers loss, they will have to share it also, unless the loss is caused by the negligence or mis-management, in which case the management, and not the Fund, will be liable to compensate it.
Secondly, the amounts so pooled together must be invested in a business acceptable to Shari’ah. It means that not only the channels of investment, but also the terms agreed with them must conform to the Islamic principles.
Keeping these basic requisites in view, the Islamic Investment Funds may accommodate a variety of modes of investment, which are discussed briefly in the following paragraphs.
Equity Fund:
In an equity fund the amounts are invested in the shares of joint stock companies. The profits are mainly achieved through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also achieved by the dividends distributed by the relevant companies.
It is obvious that if the main business of a company is not lawful in terms of Shari’ah, it is not allowed for an Islamic Fund to purchase, hold or sell its shares, because it will entail the direct involvement of the share holder in that prohibited business.
Similarly the contemporary Shari’ah experts are almost unanimous on the point that if all the transactions of a company are in full conformity with Shari’ah, which includes that the company neither borrows money on interest nor keeps its surplus in an interest bearing account, its shares can be purchased, held and sold without any hindrance from the Shari’ah side. But evidently, such companies are very rare in the contemporary stock markets. Almost all the companies quoted in the present stock market are in some way involved in an activity, which violates the injunctions of Shari’ah. Even if the main business of a company is halal, its borrowings are based on interest. On the other hand, they keep their surplus money in an interest bearing account or purchase interest-bearing bonds or securities.
The case of such companies has been a matter of debate between the Shari’ah experts in the present century. A group of the Shari’ah experts is of the view that it is not allowed for a Muslim to deal in the shares of such a company, even if its main business is halal. Their basic argument is that every share-holder of a company is a sharik (partner) of the company, and every sharik, according to the Islamic jurisprudence, is an agent for the other partners in the matters of the joint business. Therefore, the mere purchase of a share of a company embodies an authorization from the shareholder to the company to carry on its business in whatever manner the management deems fit. If it is known to the share-holder that the company is involved in an un-Islamic transaction, still, he holds the shares of that company, it means that he has authorized the management to proceed with that un-Islamic transaction, In this case, he will not only be responsible for giving his consent to an un-Islamic transaction, but that transaction will also be rightfully attributed to himself, because the management of the company is working under his tacit authorization.
Moreover, when a company is financed on the basis of interest, its funds employed in the business are impure. Similarly, when the company receives interest on its deposits an impure element is necessarily included in its income which will be distributed to the shareholders through dividends.
However, a large number of the present day scholars do not endorse this view. They argue that a joint stock company is basically different from a simple partnership. In partnership, all policy decisions are taken by the consensus of all the partners, and each one of them has a veto power with regard to the policy of the business. Therefore, all the actions of a partnership are rightfully attributed to each partner. Conversely, the policy decisions in a joint stock company are taken by the majority. Being composed of a large number of share-holders, a company cannot give a veto power to each shareholder. The opinions of individual shareholders can be overruled by a majority decision. Therefore, each and every action taken by the company cannot be attributed to every share-holder in his individual capacity. If a shareholder raises an objection against a particular transaction in an Annual General Meeting, but his objection is overruled by the majority, it will not be fair to conclude t hat he has given his consent to that transaction in his individual capacity, especially when he intends to withdraw from the income relatable to that transaction
Therefore, if a company is engaged in a halal business, however, it keeps its surplus money in an interest-bearing account, where from a small incidental income of interest is received, it does not render all the business of the company unlawful. Now, if a person acquires the shares of such a company with clear intention that he will oppose this incidental transaction also, and will not use that proportion of the dividend for his own benefit, how can it be said that he has approved the transaction of interest and how can that transaction be attributed to him?
The other aspect of the dealings of such a company is that it sometimes borrows money from financial institutions. These borrowings are mostly based on interest. Here again the same principle is relevant. If a shareholder is not personally agreeable to such borrowings, but has been overruled by the majority, these borrowing transactions cannot be attributed to him.
Moreover, according to the principles of Islamic jurisprudence, borrowing on interest is a grave sinful act for which the borrower is responsible in the Hereafter; however, this sinful act does not render the whole business of the borrower as haram or impermissible. The borrowed amount being recognised as owned by the borrower, anything purchased in exchange of that money is not unlawful. Therefore, the responsibility of committing a sinful act of borrowing on interest rests with the person who wilfully indulged in a transaction of interest, but this fact does not render the whole business of a company as unlawful.
Conditions for investment in Shares
In the light of the foregoing discussion, dealing in equity shares can be acceptable in Shari’ah subject to the following conditions:
(1). The main business of the company is not violative of Shari’ah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shai’ah, such as the companies manufacturing, selling or offering liquors, pork haram meat, or involved in gambling, night club activities, pornography etc.
2. If the main business of the companies is halal, like automobiles, textiles etc, but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share-holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company.
3. If some income from interest-bearing accounts is included in the income of the company, the proportion of such income in the dividend paid to the shareholder must be given to charity, and must not be retained by him. For example, if 5% of the whole income of a company has come out of interest-bearing deposits, 5% of the dividend must be given to charity.
4. 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 on par value, because in this case the share represents money only and the money cannot be traded in except at par.
What should be the exact proportion of illiquid assets of a company for the negotiability of its shares? The contemporary scholars have different views about this question. Some scholars are of the view that the ratio of illiquid assets must be 51% at the least. They argue that if such assets are less than 50%, the most of the assets are in liquid form, therefore, all its assets should be treated as liquid on the basis of the juristic principle:
‘The majority deserves to be treated as the whole of a thing’
Some other scholars have opined that even if the illiquid asset of a company are 33%, its shares can be treated as negotiable.
The third view is based on the Hanafi jurisprudence. The principle of the hanafi school is that whenever an asset is a mixture 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:
Firstly, the illiquid part of the mixture must not be in ignorable quantity. It means that it should be in a considerable proportion.
Secondly, the price of the mixture should be more than the price of the liquid amount contained therein. 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. In this case, if the price of the share is fixed as 105, it will mean that 75 dollars are in exchange of 75 dollars owned by the share and the rest of the 30 dollars are in exchange of the fixed assets. Conversely, if the price of that share is fixed as 70 dollars, it will not be allowed, because the 75 dollars owned by the share are in this case against an amount which is 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 as 75 dollars, it will not be permissible, because if we presume that 75 dollars owned by that share, no part of the price can be attributed to the fixed assets of the share. In thi s case, the remaining amount will not be adequate for being the price of 75 dollars. For this reason the transaction will not be valid. However, in practical terms, this is merely a theoretical possibility, because it is difficult to imagine a situation where the price of a share goes lower than its liquid assets.
Subject to these conditions, the purchase and sale of shares is permissible in Shari’ah. An Islamic Equity Fund can be established on this basis. The subscribers to the Fund will be treated in Shari’ah as partners ‘inter se’. All the subscription amounts will form a joint pool and will be invested in purchasing the shares of different companies. The profits can accrue either through dividends distributed by the relevant companies or through the appreciation in the prices of the shares. In the first case i.e. where the profits earned through dividends, a certain proportion of the dividend, which corresponds to the proportion of interest earned by the company, must be given in charity. The contemporary Islamic Funds have termed this process as ‘purification’.
The Shari’ah scholars have different views about whether the ‘purification’ is necessary where the profits are made through capital gains (i.e. by purchasing the shares at a lower price and selling them at a higher price). Some scholars are of the view that even in the case of capital gains the process of ‘purification’ is necessary, because the market price of the share may reflect an element of interest included in the assets of the company. The other view is that no purification is required if the share is sold, even if its results in a capital gain. The reason is that no specific amount of the price can be allocated for the interest received by the company. It is obvious that if all the above requirements of the ‘halal’ shares are observed, the most of the assets of the company are ‘halal’, and a very small proportion of its assets may have been created by the income of interest. This small proportion is not only unknown, but also ignorable as c ompared to the bulk of the assets of the company. Therefore, the price of the share, in fact, is against the bulk of the assets, and not against such a small proportion. The whole price of the share therefore, may be taken as the price of the ‘halal’ assets only.
Although this second view is not without force, yet the first view is more precautious and far from doubts. Particularly, it is more equitable in an open-ended equity fund because if the purification is not carried out on the appreciation and a person redeems his unit of the Fund at a time when no dividend is received by it, no amount of purification will be deducted from its price, even though the price of the unit may have increased due to the appreciation in the process of the shares held by the fund. Conversely, when a person redeems his unit after some dividends have been received in the fund and the amount of purification has been deducted there-from, reducing the net asset value per unit, he will get a lesser price as compared to the first person.
On the contrary, if purification is carried out both on dividends and on capital gains, all the unit-holders will be treated at par with regard to the deduction of the amounts of purification. Therefore, it is not only free from doubts but also more equitable for all the unit-holders to carry out purification in the capital gains also. This purification may be carried out on the basis of an average percentage of the interest earned by the companies included in the portfolio.
The management of the fund may be carried out in two alternative ways. The managers of the Fund may act as ‘mudaribs’ for the subscribers. In this case a certain percentage of the annual profit accrued to the Fund may be determined as the reward of the management, meaning thereby that the management will get its share only if the fund has earned some profit. If there is no profit in the fund, the management will deserve nothing, but the share of the management will increase with the increase of profits.
The second option for the management is to act as an agent for the subscribers. In this case, the management may be given a pre-agreed fee for its services. This fee may be fixed in lump sum or as a monthly or annual remuneration. According to the contemporary Shari’ah scholars, the 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 value of the fund (1) at the end of every financial year.
However, it is necessary in Shari’ah to determine any one of the aforesaid methods before the launch of the fund. The practical way for this would be to disclose in the prospectus of the fund on what basis the fees of the management will be paid. It is generally presumed that whoever subscribes to the fund agrees with the terms mentioned in the prospectus. Therefore, the manner of paying the management will be taken as agreed upon by all the subscribers.
The term ‘Islamic Investment ’ in this article means a joint pool wherein the investors contribute their surplus money for the purpose of its investment to earn halal profits in strict conformity with the precepts of Islamic Shari’ah. The subscribers of the Fund may receive a document certifying their subscription and entitling them to the pro-rata profits actually accrued to the Fund. These documents may be called ‘certificates’ ‘units’ ‘shares’ or may be given any other name, but their validity in terms of Shari’ah, will always be subject to two basic conditions
Firstly, instead of a fixed return tied up with their face value, they must carry a pro-rata profit actually earned by the Fund. Therefore, neither the principal nor a rate of profit (tied up with the principal) can be guaranteed. The subscribers must enter into the fund with a clear understanding that the return on their subscription is tied up with the actual profit earned or loss suffered by the Fund. If the Fund earns huge profits, the return on their subscription will increase to that proportion; however, in the case the Fund suffers loss, they will have to share it also, unless the loss is caused by the negligence or mis-management, in which case the management, and not the Fund, will be liable to compensate it.
Secondly, the amounts so pooled together must be invested in a business acceptable to Shari’ah. It means that not only the channels of investment, but also the terms agreed with them must conform to the Islamic principles.
Keeping these basic requisites in view, the Islamic Investment Funds may accommodate a variety of modes of investment, which are discussed briefly in the following paragraphs.
Equity Fund:
In an equity fund the amounts are invested in the shares of joint stock companies. The profits are mainly achieved through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also achieved by the dividends distributed by the relevant companies.
It is obvious that if the main business of a company is not lawful in terms of Shari’ah, it is not allowed for an Islamic Fund to purchase, hold or sell its shares, because it will entail the direct involvement of the share holder in that prohibited business.
Similarly the contemporary Shari’ah experts are almost unanimous on the point that if all the transactions of a company are in full conformity with Shari’ah, which includes that the company neither borrows money on interest nor keeps its surplus in an interest bearing account, its shares can be purchased, held and sold without any hindrance from the Shari’ah side. But evidently, such companies are very rare in the contemporary stock markets. Almost all the companies quoted in the present stock market are in some way involved in an activity, which violates the injunctions of Shari’ah. Even if the main business of a company is halal, its borrowings are based on interest. On the other hand, they keep their surplus money in an interest bearing account or purchase interest-bearing bonds or securities.
The case of such companies has been a matter of debate between the Shari’ah experts in the present century. A group of the Shari’ah experts is of the view that it is not allowed for a Muslim to deal in the shares of such a company, even if its main business is halal. Their basic argument is that every share-holder of a company is a sharik (partner) of the company, and every sharik, according to the Islamic jurisprudence, is an agent for the other partners in the matters of the joint business. Therefore, the mere purchase of a share of a company embodies an authorization from the shareholder to the company to carry on its business in whatever manner the management deems fit. If it is known to the share-holder that the company is involved in an un-Islamic transaction, still, he holds the shares of that company, it means that he has authorized the management to proceed with that un-Islamic transaction, In this case, he will not only be responsible for giving his consent to an un-Islamic transaction, but that transaction will also be rightfully attributed to himself, because the management of the company is working under his tacit authorization.
Moreover, when a company is financed on the basis of interest, its funds employed in the business are impure. Similarly, when the company receives interest on its deposits an impure element is necessarily included in its income which will be distributed to the shareholders through dividends.
However, a large number of the present day scholars do not endorse this view. They argue that a joint stock company is basically different from a simple partnership. In partnership, all policy decisions are taken by the consensus of all the partners, and each one of them has a veto power with regard to the policy of the business. Therefore, all the actions of a partnership are rightfully attributed to each partner. Conversely, the policy decisions in a joint stock company are taken by the majority. Being composed of a large number of share-holders, a company cannot give a veto power to each shareholder. The opinions of individual shareholders can be overruled by a majority decision. Therefore, each and every action taken by the company cannot be attributed to every share-holder in his individual capacity. If a shareholder raises an objection against a particular transaction in an Annual General Meeting, but his objection is overruled by the majority, it will not be fair to conclude t hat he has given his consent to that transaction in his individual capacity, especially when he intends to withdraw from the income relatable to that transaction
Therefore, if a company is engaged in a halal business, however, it keeps its surplus money in an interest-bearing account, where from a small incidental income of interest is received, it does not render all the business of the company unlawful. Now, if a person acquires the shares of such a company with clear intention that he will oppose this incidental transaction also, and will not use that proportion of the dividend for his own benefit, how can it be said that he has approved the transaction of interest and how can that transaction be attributed to him?
The other aspect of the dealings of such a company is that it sometimes borrows money from financial institutions. These borrowings are mostly based on interest. Here again the same principle is relevant. If a shareholder is not personally agreeable to such borrowings, but has been overruled by the majority, these borrowing transactions cannot be attributed to him.
Moreover, according to the principles of Islamic jurisprudence, borrowing on interest is a grave sinful act for which the borrower is responsible in the Hereafter; however, this sinful act does not render the whole business of the borrower as haram or impermissible. The borrowed amount being recognised as owned by the borrower, anything purchased in exchange of that money is not unlawful. Therefore, the responsibility of committing a sinful act of borrowing on interest rests with the person who wilfully indulged in a transaction of interest, but this fact does not render the whole business of a company as unlawful.
Conditions for investment in Shares
In the light of the foregoing discussion, dealing in equity shares can be acceptable in Shari’ah subject to the following conditions:
(1). The main business of the company is not violative of Shari’ah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shai’ah, such as the companies manufacturing, selling or offering liquors, pork haram meat, or involved in gambling, night club activities, pornography etc.
2. If the main business of the companies is halal, like automobiles, textiles etc, but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share-holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company.
3. If some income from interest-bearing accounts is included in the income of the company, the proportion of such income in the dividend paid to the shareholder must be given to charity, and must not be retained by him. For example, if 5% of the whole income of a company has come out of interest-bearing deposits, 5% of the dividend must be given to charity.
4. 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 on par value, because in this case the share represents money only and the money cannot be traded in except at par.
What should be the exact proportion of illiquid assets of a company for the negotiability of its shares? The contemporary scholars have different views about this question. Some scholars are of the view that the ratio of illiquid assets must be 51% at the least. They argue that if such assets are less than 50%, the most of the assets are in liquid form, therefore, all its assets should be treated as liquid on the basis of the juristic principle:
‘The majority deserves to be treated as the whole of a thing’
Some other scholars have opined that even if the illiquid asset of a company are 33%, its shares can be treated as negotiable.
The third view is based on the Hanafi jurisprudence. The principle of the hanafi school is that whenever an asset is a mixture 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:
Firstly, the illiquid part of the mixture must not be in ignorable quantity. It means that it should be in a considerable proportion.
Secondly, the price of the mixture should be more than the price of the liquid amount contained therein. 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. In this case, if the price of the share is fixed as 105, it will mean that 75 dollars are in exchange of 75 dollars owned by the share and the rest of the 30 dollars are in exchange of the fixed assets. Conversely, if the price of that share is fixed as 70 dollars, it will not be allowed, because the 75 dollars owned by the share are in this case against an amount which is 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 as 75 dollars, it will not be permissible, because if we presume that 75 dollars owned by that share, no part of the price can be attributed to the fixed assets of the share. In thi s case, the remaining amount will not be adequate for being the price of 75 dollars. For this reason the transaction will not be valid. However, in practical terms, this is merely a theoretical possibility, because it is difficult to imagine a situation where the price of a share goes lower than its liquid assets.
Subject to these conditions, the purchase and sale of shares is permissible in Shari’ah. An Islamic Equity Fund can be established on this basis. The subscribers to the Fund will be treated in Shari’ah as partners ‘inter se’. All the subscription amounts will form a joint pool and will be invested in purchasing the shares of different companies. The profits can accrue either through dividends distributed by the relevant companies or through the appreciation in the prices of the shares. In the first case i.e. where the profits earned through dividends, a certain proportion of the dividend, which corresponds to the proportion of interest earned by the company, must be given in charity. The contemporary Islamic Funds have termed this process as ‘purification’.
The Shari’ah scholars have different views about whether the ‘purification’ is necessary where the profits are made through capital gains (i.e. by purchasing the shares at a lower price and selling them at a higher price). Some scholars are of the view that even in the case of capital gains the process of ‘purification’ is necessary, because the market price of the share may reflect an element of interest included in the assets of the company. The other view is that no purification is required if the share is sold, even if its results in a capital gain. The reason is that no specific amount of the price can be allocated for the interest received by the company. It is obvious that if all the above requirements of the ‘halal’ shares are observed, the most of the assets of the company are ‘halal’, and a very small proportion of its assets may have been created by the income of interest. This small proportion is not only unknown, but also ignorable as c ompared to the bulk of the assets of the company. Therefore, the price of the share, in fact, is against the bulk of the assets, and not against such a small proportion. The whole price of the share therefore, may be taken as the price of the ‘halal’ assets only.
Although this second view is not without force, yet the first view is more precautious and far from doubts. Particularly, it is more equitable in an open-ended equity fund because if the purification is not carried out on the appreciation and a person redeems his unit of the Fund at a time when no dividend is received by it, no amount of purification will be deducted from its price, even though the price of the unit may have increased due to the appreciation in the process of the shares held by the fund. Conversely, when a person redeems his unit after some dividends have been received in the fund and the amount of purification has been deducted there-from, reducing the net asset value per unit, he will get a lesser price as compared to the first person.
On the contrary, if purification is carried out both on dividends and on capital gains, all the unit-holders will be treated at par with regard to the deduction of the amounts of purification. Therefore, it is not only free from doubts but also more equitable for all the unit-holders to carry out purification in the capital gains also. This purification may be carried out on the basis of an average percentage of the interest earned by the companies included in the portfolio.
The management of the fund may be carried out in two alternative ways. The managers of the Fund may act as ‘mudaribs’ for the subscribers. In this case a certain percentage of the annual profit accrued to the Fund may be determined as the reward of the management, meaning thereby that the management will get its share only if the fund has earned some profit. If there is no profit in the fund, the management will deserve nothing, but the share of the management will increase with the increase of profits.
The second option for the management is to act as an agent for the subscribers. In this case, the management may be given a pre-agreed fee for its services. This fee may be fixed in lump sum or as a monthly or annual remuneration. According to the contemporary Shari’ah scholars, the 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 value of the fund (1) at the end of every financial year.
However, it is necessary in Shari’ah to determine any one of the aforesaid methods before the launch of the fund. The practical way for this would be to disclose in the prospectus of the fund on what basis the fees of the management will be paid. It is generally presumed that whoever subscribes to the fund agrees with the terms mentioned in the prospectus. Therefore, the manner of paying the management will be taken as agreed upon by all the subscribers.
INVESTING IN STOCK MARKET: THE SHARIAH WAY
--SHARIQ NISAR
Islamic economists and financial experts agree that if certain conditions are met, it is lawful to invest in the stock market. Any earnings that result from such investments will be halal. The logic behind this argument is that when one purchases shares in a company he actually becomes a shareholder and thus becomes a partner in the business. Thus, this arrangement is akin to the Islamic concept of musharakah. However, there are a host of conditions that must be satisfied before one is allowed to invest in stocks. To start with, one must be sure that the business of the corporation/company offering the stock must be halal. Over and above this, shariah scholars have developed certain financial parameters for stocks selection. These are mainly related to the capital structure of the company. The purpose of these criteria is to determine the level of involvement of riba (interest) and gharar (uncertainty) in the overall business of the company.
One should keep in mind that these criteria are the results of modern fiqh scholarship (ijtihad) and therefore, should be seen to represent the current state of thinking on the issue. In that way, they represent the maximum tolerance levels and not the last word on the subject. In short, if a Muslim investor is contemplating investment in the stock market, he must not only be careful about the profitability but also about the compliance of shariah. These can be done by looking at the nature of business, percentage of income from interest and the financial soundness of the company. While there are a number of tools available to help understand the financial soundness of a company there are not many that can guide an investor in determining the shariah compliance of a stock. Following screening patterns may be helpful in determining the shariah compliance of stocks.
Islamic Investment Criteria
A. Qualitative Screens
There are two types of qualitative screens:
(I) Industry screening
Is the company in a business that is prohibited or abhorred in Islam? Apart from investment in banking and finance there are a number of business activities that are considered to be prohibited in Islam, and thus investing in these kinds of businesses is not something a Muslim would like to undertake such as alcoholic beverages, pork and pork products, tobacco products, gambling, lottery, pornography and adult oriented material, prostitution and drugs etc.
(ii) Business practices:
Following shariah principles are applicable to investing and trading practices applicable to individual investors as well as Islamic financial institutions:
(a) Investible funds must be free of interest based debt:
The investor cannot borrow on interest to finance his investments, and therefore cannot trade on margin i.e., borrow to purchase shares. Conventional hedge funds, arbitrage funds, and leveraged buy-out (LBO) funds are prohibited for Islamic investors as they all borrow heavily in order to finance their investment practices.
(b). Prohibition of speculation:
Unlike conventional investors Muslims cannot base their investment decisions on short-term speculation. They cannot enter the market as speculators but only as investors.
B. Quantitative Screens
There are three types of quantitative screens:
(i). Debt/Asset Ratio:
Has the company borrowed funds on interest? Ideally there should be no interest-based debt, but based on the Islamic legal principle "li al-akthar hukm al-kul" (to the majority goes the verdict of the whole) and subsequent scholarly opinions, a company is not a permissible investment if debt financing is more than 33% of its capital. This could be calculated as Total Debt divided by Trailing 12-Month Average Market Capitalization (where Total Debt = Short-Term Debt + Current Portion of Long-Term Debt + Long-Term Debt).
(ii).Interest-related Income:
Does the company generate any interest or interest-related income? This only includes those companies which do not make earning interest their business, but place their surplus funds in investments that yield interest income. As in the previous case, ideally no income should come from interest-related sources. However, looking at the current situation shariah scholars have permitted to invest in stocks of companies whose income from interest forms less than 5% of a company's total income. Some scholars have fixed that ceiling at 10% of a company’s total income.
(iii) Monetary Assets:
To invest in shariah compliant companies, one has to be very careful about company's monetary assets. Accounts receivables and liquid assets such as bank accounts and marketable securities have to be below the limits fixed by shariah scholars for the investment to be permissible. Some scholars have set this minimum at 51% whereas the majority of shariah scholars agree that "Accounts Receivables" should not be over 45% of company's total assets (where Accounts Receivables = Current Receivables + Long-Term Receivables).
C. Trading Practices:
(i)Day Trading:
Day trading has little to do with actual investing. Usually day traders watch the market and buy and sell on short-term price fluctuation (normally within one day). For this reason, a number of Islamic scholars have termed this as closer to gambling and thus it is prohibited.
ii. Margin Trading:
Margin trading is buying stocks using money loaned from the broker. Interest is paid for this loan, and therefore it is prohibited. Moreover this is a very risky (and complicated) practice, as one can lose more than what he has borrowed.
iii. Derivatives - Options and Futures:
Option is purchasing the right to buy or sell a stock or a commodity at a future date for a fixed price (regardless of the then prevailing price in the market). Exercising this option means buying at the price set in the past. Not exercising the option results in the investor paying the option fee. A great majority of scholars are of the opinion that Futures trading is not permitted in Islam.
iv. Short Selling:
Short selling is borrowing a stock from the brokerage firm and selling it in anticipation that the stock price will further go down. Once the prices are a bit stabilised the stock is purchased back to square up the sale transaction. Thus, the investor as a “shorter” keeps the difference. This transaction involves huge risk that almost has no upper limits. Moreover, from shariah point of view you cannot sell what you do not posses.
The author is PhD in Islamic Economics. At present he is Investment Consultant and Joint Editor Islamic Economics Bulletin. He can be contacted at: shariqnisar@yahoo.com
Islamic economists and financial experts agree that if certain conditions are met, it is lawful to invest in the stock market. Any earnings that result from such investments will be halal. The logic behind this argument is that when one purchases shares in a company he actually becomes a shareholder and thus becomes a partner in the business. Thus, this arrangement is akin to the Islamic concept of musharakah. However, there are a host of conditions that must be satisfied before one is allowed to invest in stocks. To start with, one must be sure that the business of the corporation/company offering the stock must be halal. Over and above this, shariah scholars have developed certain financial parameters for stocks selection. These are mainly related to the capital structure of the company. The purpose of these criteria is to determine the level of involvement of riba (interest) and gharar (uncertainty) in the overall business of the company.
One should keep in mind that these criteria are the results of modern fiqh scholarship (ijtihad) and therefore, should be seen to represent the current state of thinking on the issue. In that way, they represent the maximum tolerance levels and not the last word on the subject. In short, if a Muslim investor is contemplating investment in the stock market, he must not only be careful about the profitability but also about the compliance of shariah. These can be done by looking at the nature of business, percentage of income from interest and the financial soundness of the company. While there are a number of tools available to help understand the financial soundness of a company there are not many that can guide an investor in determining the shariah compliance of a stock. Following screening patterns may be helpful in determining the shariah compliance of stocks.
Islamic Investment Criteria
A. Qualitative Screens
There are two types of qualitative screens:
(I) Industry screening
Is the company in a business that is prohibited or abhorred in Islam? Apart from investment in banking and finance there are a number of business activities that are considered to be prohibited in Islam, and thus investing in these kinds of businesses is not something a Muslim would like to undertake such as alcoholic beverages, pork and pork products, tobacco products, gambling, lottery, pornography and adult oriented material, prostitution and drugs etc.
(ii) Business practices:
Following shariah principles are applicable to investing and trading practices applicable to individual investors as well as Islamic financial institutions:
(a) Investible funds must be free of interest based debt:
The investor cannot borrow on interest to finance his investments, and therefore cannot trade on margin i.e., borrow to purchase shares. Conventional hedge funds, arbitrage funds, and leveraged buy-out (LBO) funds are prohibited for Islamic investors as they all borrow heavily in order to finance their investment practices.
(b). Prohibition of speculation:
Unlike conventional investors Muslims cannot base their investment decisions on short-term speculation. They cannot enter the market as speculators but only as investors.
B. Quantitative Screens
There are three types of quantitative screens:
(i). Debt/Asset Ratio:
Has the company borrowed funds on interest? Ideally there should be no interest-based debt, but based on the Islamic legal principle "li al-akthar hukm al-kul" (to the majority goes the verdict of the whole) and subsequent scholarly opinions, a company is not a permissible investment if debt financing is more than 33% of its capital. This could be calculated as Total Debt divided by Trailing 12-Month Average Market Capitalization (where Total Debt = Short-Term Debt + Current Portion of Long-Term Debt + Long-Term Debt).
(ii).Interest-related Income:
Does the company generate any interest or interest-related income? This only includes those companies which do not make earning interest their business, but place their surplus funds in investments that yield interest income. As in the previous case, ideally no income should come from interest-related sources. However, looking at the current situation shariah scholars have permitted to invest in stocks of companies whose income from interest forms less than 5% of a company's total income. Some scholars have fixed that ceiling at 10% of a company’s total income.
(iii) Monetary Assets:
To invest in shariah compliant companies, one has to be very careful about company's monetary assets. Accounts receivables and liquid assets such as bank accounts and marketable securities have to be below the limits fixed by shariah scholars for the investment to be permissible. Some scholars have set this minimum at 51% whereas the majority of shariah scholars agree that "Accounts Receivables" should not be over 45% of company's total assets (where Accounts Receivables = Current Receivables + Long-Term Receivables).
C. Trading Practices:
(i)Day Trading:
Day trading has little to do with actual investing. Usually day traders watch the market and buy and sell on short-term price fluctuation (normally within one day). For this reason, a number of Islamic scholars have termed this as closer to gambling and thus it is prohibited.
ii. Margin Trading:
Margin trading is buying stocks using money loaned from the broker. Interest is paid for this loan, and therefore it is prohibited. Moreover this is a very risky (and complicated) practice, as one can lose more than what he has borrowed.
iii. Derivatives - Options and Futures:
Option is purchasing the right to buy or sell a stock or a commodity at a future date for a fixed price (regardless of the then prevailing price in the market). Exercising this option means buying at the price set in the past. Not exercising the option results in the investor paying the option fee. A great majority of scholars are of the opinion that Futures trading is not permitted in Islam.
iv. Short Selling:
Short selling is borrowing a stock from the brokerage firm and selling it in anticipation that the stock price will further go down. Once the prices are a bit stabilised the stock is purchased back to square up the sale transaction. Thus, the investor as a “shorter” keeps the difference. This transaction involves huge risk that almost has no upper limits. Moreover, from shariah point of view you cannot sell what you do not posses.
The author is PhD in Islamic Economics. At present he is Investment Consultant and Joint Editor Islamic Economics Bulletin. He can be contacted at: shariqnisar@yahoo.com
Saturday, October 3, 2009
The End of a Speculative Trading
Once upon a time in a village in Punjab , a man announced to the villagers that he would buy monkeys for Rs10.
The villagers seeing there were many monkeys around, went out to the forest and started catching them.The man bought thousands at $10, but, as the supply started to diminish, the villagers stopped their efforts.The man further announced that he would now buy at $20. This renewed the efforts of the villagers and theystarted catching monkeys again.
Soon the supply diminished even further and people started going back to their farms. The offer rate increasedto Rs 25 and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it!
The man now announced that he would buy monkeys at Rs 50! However, since he had to go to the city on somebusiness, his assistant would now act as buyer, on his behalf.
In the absence of the man, the assistant told the villagers: 'Look at all these monkeys in the big cage that the manhas collected. I will sell them to you at $35 and when he returns from the city, you can sell them back to him for Rs 50.'
The villagers squeezed together their savings and bought all the monkeys.
Then they never saw the man or his assistant again, only now the monkeys were everywhere!
The villagers seeing there were many monkeys around, went out to the forest and started catching them.The man bought thousands at $10, but, as the supply started to diminish, the villagers stopped their efforts.The man further announced that he would now buy at $20. This renewed the efforts of the villagers and theystarted catching monkeys again.
Soon the supply diminished even further and people started going back to their farms. The offer rate increasedto Rs 25 and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it!
The man now announced that he would buy monkeys at Rs 50! However, since he had to go to the city on somebusiness, his assistant would now act as buyer, on his behalf.
In the absence of the man, the assistant told the villagers: 'Look at all these monkeys in the big cage that the manhas collected. I will sell them to you at $35 and when he returns from the city, you can sell them back to him for Rs 50.'
The villagers squeezed together their savings and bought all the monkeys.
Then they never saw the man or his assistant again, only now the monkeys were everywhere!
Rakesh Jhunjhunwala : The Magician from Dalal Street
INDIA'S answer to Warren Buffet. The stock market’s ‘big bull’.: Rakesh Jhunjhunwala.He made a fortune by investing in the stock market. From an initial amount of Rs 5,000, as it is rumoured, he has made Rs 5,000 crore in just over two decades!
For a man who purchased Tata Tea for Rs 5000 when he was only fifteen years old, Rakesh Jhunjhunwala has a total net worth of approximately Rs 6000 crore along with his wife Rekha Jhunjhunwala. The exact value of the portfolio is something he doesn’t like to talk about.
He doesn’t have any rules for his science of investing. But his approach is fundamental and takes a long-term view thus he is also referred as the Warren Buffet of India. Jhunjhunwala has never met Warren Buffet but admires and even follows his style of investment.
“Don’t insult the great man by comparing me to him. I am young and I’m constantly learning. There is so much to learn from others. But at the end of the day I want to be only Rakesh Jhunjhunwala and nobody else”, he says.
Retail investors, analysts and fund managers always want to know what he is buying. Everybody wants to be a part of Rakesh’s stocks. He knows that. He leans back and looks at you and tells you that he is not an advisor or a fund manager.
He and his wife came into the limelight with Crisil Limited. At the end of April 2005 he was holding 14.26% of the company, accounting for Rs 70 crore. In the same year the couple made Rs 27 crore after they sold out to the S&P open offer at Rs 775 per share. Today his investment in Crisil is worth more than 200 crore and the holding accounts for 7.63% of the entire company. In all the companies that he has invested, it is this investment that has given him his famed moments.
In India, bull runs have been associated with certain individuals. In the nineties it was Harshad Mehta and in early 2000 it was Ketan Parekh. But Jhunjhunwala does not like to be associated with any booms. He believes that the market is above individuals. Individuals can be associated to excesses in the markets, but not to the phase of the markets itself, he believes. It is like if the market is at a P/E multiple of 20, an individual might just make investors believe that the P/E should be 22. He thinks that individuals who believe that they are bigger than the markets do not last for a long time.
Jhunjhunwala once said humorously, "Markets are like women; always commanding, mysterious, unpredictable and volatile." And yet he lorded them. There is a lot I learnt from his investing quotes, and there's something in it for you too. The market is rational. An individual can never be smarter than the market”.
“The market is about greed and fear. Sometimes there is too much greed and sometimes there is too much fear. It has a lot to do with the psychology of the market. You have to sometimes read the market like you read an individual”, he adds.
But Mr Jhunjhunwala has not taken any courses in psychology or behavioral finance to understand the psychology of the market. He has always believed that psychology cannot be learnt in classrooms. He has learnt his lessons in finance by practicing them and never believed in borrowed wisdom. He has liked his experience first hand. “I have experienced the markets from its core. You know I was there during the day of the bomb blasts when it happened. I have seen ups and downs so my understanding of the market is from being in there”.
That is probably why international fund managers like to spend time with him to understand the Indian equity market. He meets at least two international fund managers a week. Probably that is where he markets or tries to sell the India story to the global equity fund managers. He doesn’t like it when he is referred in this context.
“How can you sell the Indian equity to the global fund manager? Is it an FMCG product like toothpaste or a shampoo? These fund managers are here because they believe in the fundamentals of the country. Not because a Rakesh Jhunjhunwala wants them to buy Indian equity”. He gets slightly excited.Incidentally, foreign investors are selling Indian equity as global markets are facing a liquidity crisis. Those who have purchased the India story are jittery. Highly leveraged funds that invest into global markets based on borrowed money are facing the heat. They have purchased assets that they are not able to value. They don’t even understand the nature of these assets.
As the ground beneath their feet starts to shake, Rakesh Jhunjhunwala sits firm. He was in Lonavala watching movies when the crisis was very severe. He is patient and knows that this shall also pass. The red on the screen will turn to blue. The market will once again be the winner. Mr Jhunjhunwala will remember this. His greatest fear - he might fall prey to his own philosophy. The market will remain above all individuals.At a time when the market is going through volatility and an uncertain phase, Jhunjhunwala has no advice for the investors. “I don’t advice anybody. I don’t manage anybody’s money. I manage my wife’s money because I don’t have a choice.”
In The Smart Manager, Jhunjhunwala have talked about his ten commandments of investing. The top three are:
¡ Be an optimist. It's a necessary quality for investing success
¡ Expect a realistic return. Balance fear and greed
¡ Invest on broad parameters and the larger picture. Make it an act of wisdom, not intelligence
For a man who purchased Tata Tea for Rs 5000 when he was only fifteen years old, Rakesh Jhunjhunwala has a total net worth of approximately Rs 6000 crore along with his wife Rekha Jhunjhunwala. The exact value of the portfolio is something he doesn’t like to talk about.
He doesn’t have any rules for his science of investing. But his approach is fundamental and takes a long-term view thus he is also referred as the Warren Buffet of India. Jhunjhunwala has never met Warren Buffet but admires and even follows his style of investment.
“Don’t insult the great man by comparing me to him. I am young and I’m constantly learning. There is so much to learn from others. But at the end of the day I want to be only Rakesh Jhunjhunwala and nobody else”, he says.
Retail investors, analysts and fund managers always want to know what he is buying. Everybody wants to be a part of Rakesh’s stocks. He knows that. He leans back and looks at you and tells you that he is not an advisor or a fund manager.
He and his wife came into the limelight with Crisil Limited. At the end of April 2005 he was holding 14.26% of the company, accounting for Rs 70 crore. In the same year the couple made Rs 27 crore after they sold out to the S&P open offer at Rs 775 per share. Today his investment in Crisil is worth more than 200 crore and the holding accounts for 7.63% of the entire company. In all the companies that he has invested, it is this investment that has given him his famed moments.
In India, bull runs have been associated with certain individuals. In the nineties it was Harshad Mehta and in early 2000 it was Ketan Parekh. But Jhunjhunwala does not like to be associated with any booms. He believes that the market is above individuals. Individuals can be associated to excesses in the markets, but not to the phase of the markets itself, he believes. It is like if the market is at a P/E multiple of 20, an individual might just make investors believe that the P/E should be 22. He thinks that individuals who believe that they are bigger than the markets do not last for a long time.
Jhunjhunwala once said humorously, "Markets are like women; always commanding, mysterious, unpredictable and volatile." And yet he lorded them. There is a lot I learnt from his investing quotes, and there's something in it for you too. The market is rational. An individual can never be smarter than the market”.
“The market is about greed and fear. Sometimes there is too much greed and sometimes there is too much fear. It has a lot to do with the psychology of the market. You have to sometimes read the market like you read an individual”, he adds.
But Mr Jhunjhunwala has not taken any courses in psychology or behavioral finance to understand the psychology of the market. He has always believed that psychology cannot be learnt in classrooms. He has learnt his lessons in finance by practicing them and never believed in borrowed wisdom. He has liked his experience first hand. “I have experienced the markets from its core. You know I was there during the day of the bomb blasts when it happened. I have seen ups and downs so my understanding of the market is from being in there”.
That is probably why international fund managers like to spend time with him to understand the Indian equity market. He meets at least two international fund managers a week. Probably that is where he markets or tries to sell the India story to the global equity fund managers. He doesn’t like it when he is referred in this context.
“How can you sell the Indian equity to the global fund manager? Is it an FMCG product like toothpaste or a shampoo? These fund managers are here because they believe in the fundamentals of the country. Not because a Rakesh Jhunjhunwala wants them to buy Indian equity”. He gets slightly excited.Incidentally, foreign investors are selling Indian equity as global markets are facing a liquidity crisis. Those who have purchased the India story are jittery. Highly leveraged funds that invest into global markets based on borrowed money are facing the heat. They have purchased assets that they are not able to value. They don’t even understand the nature of these assets.
As the ground beneath their feet starts to shake, Rakesh Jhunjhunwala sits firm. He was in Lonavala watching movies when the crisis was very severe. He is patient and knows that this shall also pass. The red on the screen will turn to blue. The market will once again be the winner. Mr Jhunjhunwala will remember this. His greatest fear - he might fall prey to his own philosophy. The market will remain above all individuals.At a time when the market is going through volatility and an uncertain phase, Jhunjhunwala has no advice for the investors. “I don’t advice anybody. I don’t manage anybody’s money. I manage my wife’s money because I don’t have a choice.”
In The Smart Manager, Jhunjhunwala have talked about his ten commandments of investing. The top three are:
¡ Be an optimist. It's a necessary quality for investing success
¡ Expect a realistic return. Balance fear and greed
¡ Invest on broad parameters and the larger picture. Make it an act of wisdom, not intelligence
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