A:

Islamic investments are a unique form of socially responsible investments because Islam makes no division between the spiritual and the secular.

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.

The challenges a Sharia-compliant portfolio faces are similar to those that any other portfolio manager would come up against 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. However, managing assets in accordance with Islamic precepts is a bit more complicated because there is the unique specification of avoiding interest-bearing investments of any kind.

Because borrowing and setting aside excess funds in short-term, low-risk, interest-bearing instruments is integral to corporate finance, the application of Islamic law to corporate finance poses some interesting questions. For example, is it feasible for a portfolio manager to be completely invested at all times? May one remain faithful 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, both to borrow and to find a principal-protected repository for excess cash?

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 uniform standards in the vetting process across the Muslim world.

To read more on this subject, see Working With Islamic Finance.

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