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Equity Market: An investment option the Islamic way

Monday July 04, 2011 06:20:26 PM, Ziaulla Namani

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In order to remain in the main stream of the economy and have equitable investment opportunity, equity stock market (The Islamic way) provides the most cost effective investment solution for the Muslims. Hence they should take advantage of the boom in the equity market of the country so that they are not left behind in the economic growth that is being witnessed throughout. Equity market has proved that they are not only the most effective, transparent, liquid and conducive to small and big size investors as a means of investment, but it outperforms all other asset classes where return on investments is the parameter considered. In the long term equity market always goes up.

On the onset investment in equity market is Islamically a permissible activity since it is based on Musharakah (Partnership) and the profit is earned with risk of loss. However there are some issues for a Muslim to invest in equity market (explained later). With the guidance and approval from Ulama (Islamic scholar) it is now possible to invest in equity market the Islamic way, and this perhaps is the best option available for the Muslim.

We first look in to the inherent advantage investments in equities have over other forms of structured investments.

Fixed Interest (Riba) based investments
Fixed interest (Riba) based investments like the saving bank deposits, Bank FDR, Postal savings, Debentures, Bonds etc are prohibited in Islam.


“O those who believe, do not eat Riba (usury or interest) multiplied many times. And fear Allah, so that you may be successful.” (Al-Imran verse 130)


Islam has discouraged fixed saving and withholding wealth but it has encouraged investments. Profit is only with the risk of losses. In equity investment, the profit and loss is shared in proportion to the investments made. Thus, investment in equity market is in accordance to the Quran and Hadeeth injunctions.

Investment in Real Estate
Investment in Real estate/properties, is though permissible but it has certain disadvantages over equities. First, because of the unit size, it is not possible for every individual to buy a property since the cost involved is huge whereas, one can invest in equity for an amount as low as one thousand and there are no upper limits.


Secondly, property is subject to a lot of legal paper work and one has to go through a very cumbersome procedure to acquire properties. However, it is very easy to buy and sell shares by being a member of a SEBI registered broker. So buying and selling shares is as easy as snapping your fingers.


Finally, there is often a threat of encroachment of the property which involves costly litigation. Equity shares have a big advantage here since the stocks purchased get directly deposited in the investor's Demat account where it is in the safe custody and one can sell them whenever and as much as he wants to sell. And in terms of returns in the long term, equity investment has outperformed this asset class.

Investments in Conventional Mutual Funds
Investments in Conventional Mutual Funds are not permissible from the view point that these mutual funds don't follow Shariah rules, thus they do invest in 'Haram' or prohibited companies like liquor, banks, hotels , entertainment etc that is strictly prohibited in Islam, hence profit earned from these mutual funds is impure and tainted. Investment done by mutual funds does not take in to account the companies huge interest based debt and high interest earning. However, Muslims can invest in Shariah compliant Mutual fund / Shariah compliant PMS / Shariah ETFs.

One more point that goes in favour of equity stock market is the Capital gains tax. There is no capital gains tax for long term investors i.e. if the investment is held for more than one year. And for the short term investments of less than a year, investors have to pay only fifteen percent tax on its gains. Muslims must take advantage of this benefit and invest in equities that would help them create wealth in the long term in the Shariah way.

The concerning part in the equities investment is the market risk and volatility. There is a way out to overcome this, investors should take guidance from Equity Research advisors and Fund managers who can guide and advice them on their investments. But the best way is to invest in equity market through structured SEBI approved Shariah compliant investment products like the PMS, Mutual Funds, ETFs etc.

Role of Shariah Scholars
Islam makes 'Lawful Earning' (Halal) mandatory, and in Islam, the spiritual and material aspects are one and the same. This implies that Islam emphasizes the need to make a living by means that are permissible under it.

After many decades of debate and discussions and upon understanding the need of Muslims to invest in equity market, Islamic scholars globally gave their consent to Muslim to invest in equity markets, but with certain strict conditions. As explained earlier that fundamentally investments in equity shares is Halal on the basis of Musharakah (partnership) on profit and loss sharing basis. But one cannot partner in the businesses that are not permitted in Islam (e.g. liquor, pork, banking, entertainment etc) moreover the conventional companies are prone to take interest based debt and earn interest. And these are the reasons for which the Muslim community kept themselves away from the equity market.

Shariah scholars have imposed investment restriction and conditions and only upon fulfilling these conditions Muslims can invest in equity markets the halal way.

The conditions laid down are as follows:
1. Restriction Based on the Type of Securities: Investment should only be done in Shariah compliant stocks as defined. Securities trading in derivatives and day trading in stocks are strictly not permitted. Short selling is completely prohibited. Securities should only be sold upon having its complete possession.

2. Restriction on Business Activity: No investment shall be made in stocks of the companies whose business activity is prohibited (Haram)
a. Conventional interest based banks and other financial institutions like banks, NBFC, Insurance companies, stock brokers etc.
b. Alcoholic beverages like wine and other liquor related products and services.
c. Pork and non- Halal food products
d.Entertainment includes film production companies, cinema, Cable TV, music etc.

3. Restriction Based on Financial ratios: Apart from the above restriction on business activity, Islamic scholars from different part of the world have set certain financial criteria based on the need. In India Islamic Investment & Finance Board (IIFB) comprising of eminent scholars have approved the following financial criteria:
a. Interest bearing debt of the companies should not exceed 33 percent of its twelve months average market capitalization.
b. Cash plus interest bearing securities of the companies should not exceed 33 percent of its twelve months average market capitalization.
c. Trade receivable and other debtors of the companies to its twelve months average market capitalization should not exceed 33 percent.
d. Interest Income plus prohibited activity (impure) income of the companies to the company's total income should not exceed 5 percent.

4. Shariah Screening Process: Shariah screening is conducted for all the listed equities as prescribed and mandated by Shariah scholars. This process is done every quarterly. Those stocks that successfully pass the Shariah screens are thus called Shariah compliant universe. This process is done under the supervisor and audit of Shariah committee of Aalims and Muftis.

5. Purification of Impure Income: The income thus derived from trading and investments in shares do have some portion of impure or prohibited income. This income can be in form of interest received by the companies or some prohibited activity carried on by the company that earns impure or tainted income needs to be cleansed or purged. This is a compulsory process. The impure income consequently cleansed should be given as charity.

Shariah compliant stocks
Though there are more than 5000 companies listed on Bombay Stock Exchange (BSE) but on evaluation it was found that 3400 companies are actively traded. Pragmatic Wealth Management Pvt. Ltd. under supervision of its Shariah committee screened for Shariah stocks and it was found that as on December 2010 out of the 3400 companies 915 are Shariah compliant, it roughly represent 27 percent of total traded stocks. The market capitalization of these stocks as on December 2010 was ` 4,319,087 crore that is approximately 63 percent of the total market capitalization of BSE. This demonstrates the potential for the Muslims to invest in equity markets.

Shariah based equity investment products
1. Direct Investment
Direct investing in equity means that the investor gets registered with a SEBI approved Broker and trades on line directly with the broker. He takes advisory from research analyst and often relies on his own skills. the risk of investing directly is relatively high.

2. Mutual Fund
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed portfolio of stocks at a relatively low cost. Shariah Mutual funds are managed on similar lines, but the stocks selection is done on Shariah principles as explained. Shariah Board comprising Islamic scholars supervises and certifies the funds.

3. Shariah Portfolio Management Services
Shariah Portfolio Management Services (PMS) is an investment portfolio in stocks and other individual securities, managed by a professional money manager that can potentially be tailored to meet specific investment objectives.

The Shariah PMS model is based on Mudarabah (profit-sharing) model where the investor or Rabbul-Mal provides his capital to SEBI approved licensed Financial Institution (Fund Manager or Mudarib). The money is then invested in equity market on Shariah principles (as explained earlier). Profits arising from investments are periodically given back to the investor (rabbul-mal) after deducting the fund manager's fees. This risk is solely borne by the investor the fund manager gives his expertise.

The Shariah board has a vital role to play in portfolio management funds. The Shariah board ensures that the stocks invested in the funds are Shariah compliant and strict trading policy is followed as prescribed by Shariah board.

4. Exchange-Traded Funds (ETFs)
Exchange-Traded Funds (ETFs) is security that tracks an index, a commodity or a basket of assets like an index fund, but trades like any other stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold. Its performance tracks an underlying index, which the ETF is designed to replicate. Exchange-traded funds follow a specific benchmark index as closely as possible. Through an index ETF, investors get exposure to a large number of securities in a single transaction. Shariah Index ETFs comprises stocks that are Shariah compliant. Shariah ETFs provide institutional and retail investors access to investments based on Islamic principles.

Shariah Index
} Islamic Index is an Index of Shariah compliant stocks.
} Index includes stocks that pass the Shariah Screening norms on industry and ratio screens.
} Industry screens filter stocks of companies that into non compliant businesses.
} Ratio screens filter stocks on Cash Compliance, Debt Compliance, and Receivables Compliance.
} By screening stocks for Shariah Compliance, the indices help to reduce research costs and compliance concerns, Muslim investors would otherwise face in constructing Islamic investment portfolios.
} It gives Muslim investors the opportunity of putting faith into finance and thus increases participation of Shariah Compliant investors into the stock market.
} The Islamic index tracks the performance of Shariah compliant stocks and thus acts as benchmark for Islamic investments.

How to Trade and Invest in Equity
The first step required to invest in equity market is the opening of Demat account. A Demat account refers to a dematerialized in which shares and securities are held electronically instead of the investor taking physical possession of certificates.

For Opening an account investor has to approach to a SEBI registered stock broker. After receiving the trading membership forms he needs submit the following:
1. Duly completed account opening form and passport size photos.
2. A copy of PAN card as proof of identity;
3. Personalized cheque /Copy of the bank passbook
4. A copy of passport/voter ID/ ration card as a proof of address.

All applicants should carry original documents for verification by an authorized official of the depository participant, under his signature. Further, the investor has to sign an agreement with DP in a depository prescribed standard format, which details rights and duties of investor and DP. DP should provide the investor with a copy of the agreement and schedule of charges for their future reference. The DP will open the account in the system and give an account number, which is also called BO ID (Beneficiary Owner Identification number).

Islamic investment equity market is one of the fastest-growing sectors within the Islamic financial system. Currently, there are more than 100 Islamic equity funds worldwide. The total assets managed through these funds currently exceed US$4.5 billion (RS. 20,000 crores) and is growing by 1315% per annum. With the continuous interest in the Islamic Investments, there are positive signs that more funds will be launched. Some Western majors have just joined the fray or are thinking to launch similar Islamic equity products. In India more than 15 million Muslim population and absence of any alternate investment avenues, leave a huge gap for Islamic investments. Looking at this potential SEBI recently has given some relaxation to Shariah Based Investments Products.

Uptill now the practitioners and the Institutions have focused on constructing Islamic investment products rather than the marketing the same. “In India Muslims are sleeping giant and they should be woken up”. More focus should be on to create awareness amongst the Muslims on Islamic Finance. Shariah Scholars should come forward and take a greater responsibility not only to create awareness but help Financial Experts to develop Islamic investment products in accordance to Shariah. Muslim social group, credit co-operative societies, businessmen, Muslim Politician and Islamic finance institution should come together to campaign for this much needed Islamic investment options. This ethically sound and socially responsible investments will not only help Muslims get a suitable alternate but would help the entire mankind to get rid of the menace of interest based conventional financial system prevalent today.

In conclusion we believe that equity investment is indeed best option available for Muslims.


Ziaulla Namani is associated with Islami Tijara - India’s only Magazine, which covers Islamic Finance industry.

He can be reached at










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