Types of Arrangements
As a Company
The fund manager will take on the role of the Board of Directors (BoD), while the investors will act as shareholders that provide instructions to the BoD regarding the management of the invested funds. What governs the fund is the company law stated in the jurisdiction, where the fund has been incorporated.
As a Trust
The fund manager is appointed as a Trustee by the investor, in order to manage and invest the funds from the trust. The Trustee will have a fiduciary responsibility in managing the trust fund and is also governed by the trust law.
As a Partnership
In this arrangement, the fund manager takes on the role of a General Partner who is responsible for managing the funds and providing returns to the investors, while the investors assume the role of an Ordinary Partner.
Structure of an Islamic Investment Fund
Funds Manager (Individual/Company)
Trustee of investors’ surplus money and will act on their behalf in managing it.
Shareholders of the fund who pass on the responsibility of managing and investing their surplus money to the fund manager.
Provides Shariah guidelines to ensure that the investment activities are Shariah-compliant.
Third parties, other mutual funds with whom the fund managers enter into contracts or the distributors who bring the investors into the fund arrangement for a commission.
Islamic Fund Models
- Mudaraba is a partnership-in-profit arrangement where one party (Rab-Al-Maal) supplies the capital and other (Mudarib) provides skill/labour.
- In the case of Islamic funds, the fund manager acts as the Mudarib, whereas the investors are the Rab-Al-Maal (capital providers).
- Any profit/surplus derived from the fund investments are distributed between the fund manager and the investors according to a predetermined ratio.
- Any losses/deficits resulting from operations are borne solely by the investors.
- The profit can either be a fixed percentage or linked to the performance of the Islamic fund, but not a fixed amount or a lump sum.
- Wakala is the assigning of one party (agent) on behalf of another (principal), in a known and permissible dealing.
- In the case of Islamic funds, the fund manager acts as the agent (Wakil) on behalf of the investors to manage the fund for a fee (either a flat fee or linked to the performance of the fund).
- The agent/trustee who has the power of attorney is not liable for anything unless it acts negligently.
- Musharaka is a partnership arrangement where each partner contributes a specific amount of capital which allows them to each have a right to deal with the assets in the partnership.
- Profits are distributed according to the predetermined ratio and losses are shared based on the contributed capital of each partner.
- In the case of Islamic funds, the fund manager and investors form a temporary partnership and contribute a certain amount of capital. The profit ratio is either a fixed percentage or linked to the performance of the Islamic fund. Losses are borne according to the capital contribution.
The Shariah boards of several organisations have devised a mechanism of screening and purification, which relates to protecting a company and its shareholders from illegitimate wealth or income. Shariah screening has two main components:
The core business activity of a company is analysed before determining its permissibility, since investing in companies that are engaged in Haram (forbidden) activities is prohibited. Some of the types of impermissible business activities are mentioned below:
- Interest-based activities
- Conventional assurance-related activities
- Production/distribution of alcohol
- Production/distribution of pork/non-Halal meat
- Manufacture/distribution of arms/weaponry
- Production/distribution of pornographic material
- Other impermissible activities under Shariah law
Comprised of four components:
Impure income earned through interest and other suspect earnings: Islamic scholars have provided a ceiling and stipulated that the ratio between interest and unlawful, unearned income (or both) and the company’s total income should be as negligibly low as possible; most agree that it should not exceed 5% of the total income.
Cash and Debt VS Total Assets or Average Market Cap: Total cash and debts in the company’s balance sheet should not exceed the average market cap; they should be less than 30-50% of the existing assets or average market cap.
Debt VS Equity or Average Market Cap: The ratio between debts and shareholder’s equity should not be more than 30-33%.
Account Receivables: According to the Shariah, account receivables are considered to be debt due to the company and so the purchase/sale of debt is only allowed at par. A company’s share is an undivided portion of its assets and if these assets are primarily cash and receivables, the share must be sold at a different price than the par value. Therefore, from a Shariah perspective, the difference would be considered as interest. The acceptable ratio limit for receivables to total assets or market cap is 33%.
Applying the following criteria, the investment manager will deduce the percentage required for the purification (elimination) of impure income:
- For impure income derived from prohibited (Haram) activities
- For impure income derived from non-operating interest income
- For total impure income
Upon receiving the impure income percentage from the investment manager, the administrator will then calculate the amount of impure income and deduct that amount from the fund assets on the next valuation day. The impure income amount for a company can be calculated by multiplying its respective impure income percentage into its dividends per share, and then by the number of shares owned by the fund.
Types Of Islamic Funds
A fund that allows the fund manager to issue new shares on demand as well as allow investors to redeem the existing shares on the basis of prevailing net asset value (nav).
The number of shares or units must be restricted to the volume of the issue at the fund’s inception. No new shares/units can be issued to the market. They can be listed and traded on an exchange and secondary markets by investors at a premium or discount to nav. Exchange traded fund (etf)
Also known as a listed index-tracked fund, it tracks a particular index and uses it as a benchmark for the fund’s performance. It can be traded on a daily basis.
It is a fund where investors pool in their surplus money which is then invested by the fund manager in the equities and shares of shariah-compliant joint stock companies. The profits are earned through capital gains.
It is a fund where investors pool in their surplus money which is then invested by the fund manager in assets that generate leasing returns.
It is a fund where investors pool in their surplus money which is then invested by the fund manager in different commodities with the purpose of resale. The goods are sold and payments are received on the spot, and profits are earned through capital gains.
It is a fund where investors pool in their surplus money which is then invested by the fund manager in purchasing assets, goods or commodities with the aim of resale or markup. The goods are sold on the spot and payment is deferred and received in installments. Profits are earned through the markup.
It is a fund where investors pool in their surplus money which is then invested by the fund manager in different investment channels such as leasing, equities, commodities and murabaha business.
It is a fund that is invested in islamic fixed-income securities and dividend-generating shariah-compliant shares, with the aim to distribute most of the returns.
Capital growth fund
It is a fund that is invested in shariah-compliant shares in order to maximise long-term capital growth.
Aggressive growth fund
It is a fund that is invested in aggressive, high-risk shariah-compliant shares with the promise of high returns.
It is a fund that invests in islamic fixed-income securities such as short-term money instruments and islamic bonds.