What Is an Islamic Investment Policy?

What Is an Islamic Investment Policy?

Islamic investments are a unique form of socially responsible investments because Islam makes no division between the spiritual and the secular. This means there is much more scrutiny applied to investment practices because religion is factored into all financial decisions. Investments that wish to be in accordance with Islamic Investment Policy need to follow a specific set of guidelines.

Understanding Islamic Investment Policy

The establishment of an Islamic investment policy, be it for the institutional or individual investor, starts with the Sharia Board, a group of Islamic scholars (jurists) that vests investment products for compliance with Islamic Law and conducts ongoing due diligence of them.

Sources for interpretation follow a hierarchy of authority: the Quran, believed by Muslims to be the words of Allah verbatim as revealed to his prophet Muhammad in the seventh century; the Sunnah, which are rules from the prophet's sayings (Hadiths) and actions; Qiyas, which are scholarly legal deductions; and Ijma, the consensus of scholars on a particular issue.

Difficulties in Islamic Investing

The challenges a Sharia-compliant portfolio faces are similar to those that any other portfolio manager would come up against for any other client, in that the manager must formulate an investment thesis which drives portfolio selection criteria, and then decide on the appropriate benchmark against which to measure performance.

Because borrowing and setting aside excess funds in short-term, low-risk, interest-bearing instruments are integral to corporate finance, the application of Islamic law to corporate finance poses some interesting questions.

Remaining Sharia-compliant to Islamic law in the stock selection when the realities of corporate finance dictate the need for companies—even those not engaged in prohibited businesses—to borrow and to find a principal-protected repository for excess cash makes compliance a difficult and omnipresent struggle.

Achieving Sharia Compliance

From a private client portfolio management perspective, once armed with Sharia-permissible products, an investment committee at an Islamic private wealth firm would face the same issues as any other: namely, how to develop, implement and monitor an investment policy consistent with a client's objectives. Additional challenges exist, though, namely the lack of both a deep secondary market for these products and the lack of uniformity regarding vetting processes across the Muslim world.

Due to the intricacies involved and the potential capital loss of falling out of compliance, companies who are not based in Islamic countries but who still rely heavily on Islamic investment often hire either in-house Sharia counsel, or outsource the compliance-checking to a third party firm.