Compare Commodity and Equity Funds on the Islamic Market - dummies

Compare Commodity and Equity Funds on the Islamic Market

By Consumer Dummies

If you’re looking to build a sharia-compliant investment portfolio with the potential for significant growth (as opposed to a portfolio focused mostly on safeguarding your funds), chances are good you want to include funds that invest in commodities and/or those that invest in equities. As with conventional funds of this type, the Islamic variety of commodity and equity funds present some risk to the investor because you can’t know with certainty that the price of a certain commodity or a company stock is going to increase. No way around it: You can’t hope for returns without facing some associated risks. That’s just the nature of investing, Islamic and otherwise!

Commodity funds and Islamic finance

Commodity funds may invest in purchases or projects based either on the cost plus murabaha contract or, in the case of construction projects (or other projects to be completed in the future), the leasing (ijara) contract.

In the conventional market, many types of commodity funds are available that allow you to invest in oil, wheat, pork bellies, orange juice, and so on. Conventional investors (who don’t necessarily want to see and touch the commodities in question) look to fund management companies to make savvy trades — often using derivative products — to garner profits from the commodity’s price changes.

Islamic commodity funds also invest in physical commodities but must avoid short selling as well as investment products of a speculative nature, such as commodity futures. In an Islamic commodity fund, the commodities are actually purchased for resale. (The fund management company doesn’t try to short sell a commodity security, for example.) The profit from the sale is distributed among the investors according to the investment contract.

In order to be accepted as sharia-compliant, the commodity fund must meet the following basic criteria:

  • The commodities involved can’t be prohibited in Islam. In other words, no pork, alcohol, or other forbidden items.

  • Short selling isn’t allowed. The seller must actually have possession of the commodities in question.

  • All parties involved must know the price of the commodities to be traded.

  • Forward sales aren’t allowed, except under salam and istisna contracts.

Here are just two examples of existing Islamic commodity funds:

  • Riyad Capital Bank in Saudi Arabia has two Commodity Trading Funds available to investors. One fund deals in U.S. dollars, and the other deals in Saudi Riyals; both are sharia-compliant.

  • Al Rajhi Capital, also in Saudi Arabia, offers three commodity fund products: a U.S. dollar commodity fund, a Saudi Riyal commodity fund, and a Euro commodity fund.

Equity funds and Islamic finance

An equity fund gains profit by buying and selling stocks to achieve capital gains and by receiving corporate dividends. The capital gains and dividends are distributed among investors proportionally according to the size of each person’s investment. The key difference between an Islamic and conventional equity fund is the requirement for an Islamic equity fund to invest in sharia-compliant assets.

Islamic equity funds really opened the door to investing for people seeking to purchase sharia-compliant stocks and to make socially responsible investments. And because these funds avoid investing in companies that are highly leveraged with debt, Islamic equity funds may have a performance advantage over some of their conventional counterparts. The drawback is that the investment criteria for inclusion in an Islamic fund are strict enough to eliminate certain industries altogether, which can negatively affect such funds during economic downturns. (As with all things in the investment world, Islamic equity funds have their pros and cons!)

Here are just three examples of the hundreds of Islamic equity funds currently available:

  • Malaysia’s AmIslamic Funds Management launched the AmASEAN Equity Fund (AMASEQY) in 2011. The fund’s investments focus on the nations of Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.

  • HSBC Amanah GCC Equity Fund (SAMGCCE), launched in 2006 and managed by HSBC Saudia Arabia, strives for medium- and long-term capital growth by making investments in sharia-compliant products and services in Malaysia and Saudi Arabia, and by offering wholesale banking (Islamic financing/Sukuk) globally through those countries.

  • Launched in 2003, the Meezan Islamic Fund (MEZISLM) is a product of Al Meezan Investment Management Limited. The management company’s website states that this fund is “not only Pakistan’s largest Shariah compliant equity fund but also Pakistan’s largest equity fund in the private sector.”