There are a lot of research papers and in-depth commentary on what is halal when it comes to investing, We’re written about the misconceptions around the share market and what aspects of it are not halal.
In this article we go into a little more detail about how we screen for sharia compliance for companies on the Australian Share Market, ASX, before deciding if they are good investment opportunities.
Tabarruk has a partnership with Islamicly, a platform for screening and tracking sharia compliance of stocks.
▪️ 50,000 global users
▪️ Renowned shariah scholars board
▪️ Alerts on compliance changes
▪️ 20+ years of screening experience
Two of the main experts on the Islamicly shariah scholars board are:
Dr. Muhammad Ali El-Gari
▪️ AAOIFI – Accounting and Auditing Organisation for Islamic Finance Institutions: Board of Trustees – Member Shariah Standards Committee (Jeddah Member)
▪️ Director, Centre for Research in Islamic Economics, King Abdulaziz University
▪️ Academic Committee, Islamic Development Bank, Jeddah
▪️ Ph.D in Economics from the University of California, USA
▪️ Also on board for National Commercial Bank (Saudi Arabia), Citi Islamic Investment Bank (Saudi Arabia), Saudi American Bank (UK), Saudi British Bank (UK) and Dow Jones Islamic Index (USA)
Dr. Mohammad Amin Ali Qattan
▪️ Ph.D in Islamic Banking, University of Birmingham, UK
▪️ Shariah matters expert
▪️ Shariah controller for Al-Mal Islamic Investment
▪️ Researcher in Islamic Economics in the Amiri Diwan
▪️ Author of numerous articles and papers at various seminars globally in Islamic Economics, Banking and Finance
Together with Islamicly, we screen companies based on the following rules detailed below.
Main Rule I – Business Sector, What does the company do?
A company has to operate in a field that is ethical and permissible according to Islamic laws. As a Muslim, one is not allowed to partake in investment or business dealing, that would have a detrimental affect on society.
The general way we screen companies is to exclude the following industries:
❌ Conventional Financial Services
❌ Media & Adult entertainment
❌ Gold / Silver trading on deferred basis
Any business that has activities, that could harm people’s health, physical and emotional wellbeing in any manner is also off limits according to Islam.
Main Rule II – Financial Ratio – 5% Tolerance of total income from non permissible sources
The second condition that has to be adhered to is avoiding Riba a.k.a. Interest.
Due to this condition, companies that operate in the conventional banking and financial services are off the table for us.
It has to also be noted that in the current day and age, we live in a world surrounded by interest and it is almost impossible to find a company that is 100% interest free.
Recognising this fact of life and the worrying evolution of modern economics, the Islamic scholars and finance experts agree on a common consensus that a companies total non-permissible income (including riba) must not exceed 5% of it’s total income from permissible activities and sources.
The above two rules are part of our first screening process with every company. The other sub rules are at the bottom of this article.
Halal companies on the ASX vs Global Markets
The US markets make up almost 50% of the world’s markets. The Australian Sharemarket (ASX), is 1.5% of the global markets. A small portion of the ASX is shariah-compliant as of September 2020.
Shariah compliance is not static and correct only for a point in time. Any new announcements, quarterly updates can change the compliance.
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5 key things:
- 📝 Exclusive videos, articles and step-by-step guides on everything you need to know to start investing in the Australian share market / ASX
- 🛒 Live folio access (over 25 companies we own shares in, plus 2-3 we buy monthly) and watchlist (companies we’re screening & researching)
- 📊 In-depth analysis on each of the sharia compliant companies we own, why we bought the company and what makes it a great investment. That’s 4-6 weeks or over 300 hours per company that Fahd and Moin spend researching
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Here’s how we’ve performed this year (up until the end of Nov 2020)
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Sharia Compliance Sub rules checked periodically
There are a few other technical, financial ratios checked periodically for shariah compliance. There is consensus on these rules by reputed shariah scholars, and we check these at least on a quarterly basis for every company we screen, sometimes more often based on company events and financial information being released.
There are compliances with reference to cash holdings a company has.
These are made up of:
1. Accounts Receivables / Market value of Equity (36 month average) < 49 %;
Accounts receivable is measured as a sum of:
- Total accounts receivables
- Other non-business/non-trade related receivables
- Other debit balances
- Murabaha receivables
2. (Cash + Interest Bearing Securities) / Market value of Equity (36 month average) 33%
Cash + Interest-bearing securities are measured as a sum of:
- Cash in hand
- Cash in current accounts
- Cash deposits
- Term deposits
- Short-term interest based securities
- Marketable securities
- Short-term investments held for sale/trading
- Government bonds (if classified as short-term investments)
- Investments in mutual funds, other equity funds held for sale/trading
- Islamic / ethical investments are excluded
This compliance is measured as:
Debt / Market Value of Equity (36month average) < 33 %
Debt is measured as:
- Long-term interest-bearing debt as disclosed by the company’s management
- Short-term interest-bearing debt as disclosed by the company’s management
- Current portion of long-term interest-bearing debt as disclosed by the management
- Interest-bearing short-term liabilities such as overdrafts, bridge loans, etc.
- Short-term non-interest-bearing operational payables/liabilities such as gratuity payable, creditors for goods and services, provisions, etc.
- Long-/short-term Islamic debt
- Long-/short-term non-interest-bearing debt
- Loans from sovereign bodies which are non-interest based (as given by SIDF)
Tabarruk’s Screening Process and application of Main and Sub Rules
- Before any initial investment. we screen for 100% compliance with the above main and sub rules.
- Once invested, we periodically screen for compliance.
- If any of the main rules fail compliance, we close our entire position at the earliest.
- If the company fails the sub rules, we don’t make any further purchases in the company and wait for 12 months from date of failing for it to pass compliance again. If after the time above has elapsed, the company still fails on the sub-rules, we sell the entire position in the company
Average market capitalization of companies used in calculations
The average market capitalization of X over n months is calculated by multiplying the moving average daily closing price of X over n months (must be adjusted for corporate actions) (Pavg) with the total number of shares outstanding for X.
For stocks that have multiple share classes, this is estimated as Pavg/Plast * M, where M is the current market capitalization and Plast is the last closing price of X (for Pavg and Plast, the figures for the main share class are used).
For companies that do not have a sufficiently long price history (e.g., recent IPOs), the figure Pavg is calculated as the moving average daily closing price of X over n days where n is the number of days X has been trading or the number of days that a daily closing price for X has been available.
We check all of the above with our fathers, both Islamic banking experts and also with services that specifically do the research on companies to determine their sharia compliance.
There are times when a company is new or has changed business models, where we carefully go through their reports to work out the adherence to both Rules. This is possible because all Australian companies listed on the ASX publish all their financial reports for the public quarterly and annually.
Technically halal, but ethically a question mark
Sometimes, we come across companies that satisfy both rules above, look like great opportunities even from a fundamental and technical analysis of their reports and history, but we don’t invest in them.
The reason is a subjective one, and not as clear cut as Rule I and II. That’s because we know enough to feel that the company in question, and it’s activities don’t line up with what we think is ethical to a large extent.
An example is a defence technology and space research company that generated most of it’s income form that technology being used in weaponry. For war. To cause death.
Another example could be a mining company that unfairly took land from the native people, or caused excessive harm to the environment by the methods and extent to which they mined the land.
As Muslims, we have to pay extra attention to where the sources of our incomes come from and have to be vigilant in making sure our money is as pure as possible.