In today’s global financial markets, Muslim investors are faced with a multitude of investment options. One of the questions often asked is whether it is halal, permissible under Islamic law, to invest in Exchange-Traded Funds (ETFs). The answer is not straightforward and requires a nuanced understanding of both Islamic finance principles and the structure of ETFs.
What are ETFs?
ETFs are investment funds that trade on stock exchanges, much like individual stocks. They offer investors an opportunity to buy a diverse portfolio of assets, including equities, commodities, and bonds. ETFs generally charge lower management fees than other types of managed funds, with fees typically ranging from as low as 0.5-1% per annum. However, they may come with lower dividend yields and potentially high costs in certain situations.
What Makes an Investment Halal?
Islamic finance is governed by principles derived from the Shariah, or Islamic law. These principles prohibit certain types of economic activity, such as interest-based lending (riba), gambling (maisir), ambiguity or uncertainty in contracts (gharar), and unlawful activities. Investments compliant with these principles are considered halal. Therefore, whether an ETF is halal or not depends on the nature of the assets it holds and the manner in which it operates.
Islamic principles guide the design of Halal ETFs. Halal ETFs comprise assets that comply with Islamic law and often track an Islamic benchmark index. Companies that are not involved in activities prohibited by Islam, as mentioned earlier, constitute these indexes. The Shariah committees are appointed to conduct regular reviews to ensure strict adherence of the ETFs to Islamic principles.
Several Sharia-certified ETFs have emerged in recent years. For example, the Wahed FTSE USA Sharia ETF and the S&P 500 Sharia Industry Exclusions ETF are some of the popular choices. These funds invest in large-cap and mid-cap stocks that comply with Islamic law, and their performance tracks respective Sharia-compliant indexes.
Investing in Halal ETFs
Platforms like Musaffa offer users the chance to invest in Sharia-screened stocks and ETFs, saving investors the trouble of assessing whether a particular ETF is halal or not. However, it is important to note that different views exist on Sharia compliance, and investors should consult a Sharia advisor if they have any doubts or questions. Furthermore, investing in any form of security comes with risks, and past performance does not guarantee future results.
How to find Halal ETFs?
- Understand Shariah Principles: Gain a thorough understanding of the basic principles of Shariah-compliant investing. Islamic finance prohibits investments in industries such as alcohol, gambling, pork-related products, and interest-based financial services. Avoiding companies with high debt levels or involvement in unethical practices is also important.
- Utilize Screening Tools: Make use of specialized screening tools designed for Halal investing to ensure compliance with Islamic principles. These tools help filter out companies engaged in non-compliant activities by assessing financial ratios, revenue sources, debt levels, and business practices.
Musaffa offers a user-friendly screening tool specifically for halal stocks and ETFs.
It provides convenient access to information and comprehensive reports on the compliance status of these investments. Musaffa’s methodology has undergone meticulous development, rigorous vetting, and approval by a team of knowledgeable Shariah advisors, prioritizing a safe and secure investment environment.
By using Musaffa’s stock screener, anyone can easily find which ETFs and stocks are halal and which are not.
- Review Company Filings: Conduct thorough research on individual companies before making investments. Analyze their financial reports, annual statements, and disclosures to gain insights into their operations, revenue sources, and compliance with Shariah principles. This step ensures that the selected stocks or ETFs align with your Halal investment goals.
- Monitor Performance and Reassess: Regularly monitor the performance of your Halal investments and reassess their compliance with Islamic principles. Companies may change their business practices over time, so staying updated on any developments that may impact the Halal status of your investments is crucial. Signing up for the Musaffa Halal stock & ETF screener can provide notifications on compliance status changes, keeping you informed.
Pros of Exchange-Traded Funds (ETFs):
- Diversification: ETFs offer instant diversification by providing exposure to a basket of securities, such as stocks, bonds, or commodities. This helps to spread the risk and reduce the impact of individual company or industry performance on the overall investment.
- Trading flexibility: Investors can buy and sell ETFs throughout the trading day at market prices, similar to individual stocks, as ETFs actively trade on stock exchanges. This allows investors to take advantage of intraday price movements and implement various trading strategies.
- Lower fees: ETFs generally have lower expense ratios than other managed funds, such as mutual funds. This is because ETFs passively track an underlying index instead of actively selecting and managing securities, allowing investors to benefit from their passive management approach. Lower fees can have a positive impact on long-term returns.
- Transparency: ETFs disclose their holdings on a daily basis, allowing investors to know exactly what assets they own. This transparency helps investors make informed decisions and evaluate the risks and potential returns associated with the ETF.
- Tax efficiency: ETFs are structured in a way that can minimize capital gains taxes. Since ETFs are primarily based on an index, they tend to have lower turnover, resulting in fewer taxable events than actively managed funds.
Cons of Exchange-Traded Funds (ETFs):
- Lower dividend yields: While some ETFs pay dividends, the yields may not be as high as owning individual stocks or high-yield equity funds. This can be a disadvantage for investors seeking regular income.
- Potential high costs: Although ETFs generally have lower expense ratios, investors may still incur brokerage commissions when buying or selling ETF shares. Frequent trading can lead to higher transaction costs, potentially eroding overall returns.
- Intraday pricing and trading noise: For long-term investors with a time horizon of several years, the intraday price fluctuations of ETFs may not be relevant. Focusing on short-term price movements can lead to unnecessary trading and potentially hinder long-term investment goals.
In conclusion, it is indeed possible to invest in ETFs in a halal manner. However, this requires careful selection of the ETFs in question to ensure they comply with Islamic principles. As the market for Islamic finance continues to grow, more options will likely become available for Muslim investors seeking to balance their financial goals with their religious commitments.
To read more about Islamic Finance related topics, please click here and visit our academy.