Sharia is the religious legal system governing members of the Islamic faith. It is derived from the religious precepts of Islam, particularly the Quran and Hadith. Sharia deals with wide range of topics like religious prescriptions, trade regulations, politics, economics, marriage contracts, personal hygiene etc.
Sharia prescribes a ban on certain types of economic activities. The important ones are as below:
- Receipt and payment of interest
- Entering into any transaction which is structured ambiguously like options, futures or swaps
- Speculative activities such as gambling, wagering etc.
- Any economic and business activity related to pork products, tobacco, alcohol, armaments, drugs and pornography
Since receipt of interest is banned according to Sharia, the preferred Islamic investment format is equity.
Sharia permits investing in equity shares of a company and receiving dividends. Sharia also prescribes that investors should not trade in equity shares of a new company raising initial capital till the company invests a substantial portion of the funds in buying assets required for its operations. Trading in shares of a company which is in the process of liquidation is also prohibited.
It is also not permissible to invest in companies that deal in adult entertainment, alcohol, cinema/broadcasting, insurance companies, tobacco, financial services, investment services, gambling, hotels, defence, music, mortgage/lease, interest income and pork.
Equity shares of companies whose nature of business is in compliance with Sharia also need to meet certain financial parameters:
- Interest bearing debt divided by total assets is less than or equal to 33%
- Sum of cash and short-term investments divided by total assets is less than or equal to 33%
- Sum of cash, short-term investments and receivables divided by total assets is less than or equal to 50%
At regular intervals, the investor is also required to determine the quantum of impure income that the shares/equity portfolio he holds earns and donate it to charity. Impure income is calculated as:
Interest earned * % of total capital of company ( Amount calculated as number of shares held at face value / total paid up capital of the company) * % of period held (period for which shares held / period for which amount is considered)
While Sharia portfolios are built according to Islamic principles, any investor regardless of religious affiliation can invest in these portfolios. Sharia’s insistence on abstinence from investing in certain sectors is appealing to ethical investors. Further, the low leverage allowed facilitates conservative business practice and is of interest to risk-averse investors.
The Halal Street smallcase includes only Shariah compliant stocks — that are both fundamentally sound and have good growth prospects. This smallcase is an equally weighted portfolio of stocks that belong to diverse sectors.