Subject material for course Islamic Investment

1. ISLAMIC INVESTMENT
Mahyuddin Khalid
emkay@salam.uitm.edu.my
The Principles of Islamic Investment
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2. Topic Outline
 Islamic Investment Concept
 Principle of Islamic Investment
 Shariah Supervisory Board
 Shariah Screening
 Principle of Zakat on Investment
 Speculation, Gharar and Gambling
 Time Value of Money
 Purification of Income
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3. Islamic Worldview and Investment
Transcendental accountability to Allah SWT
Hablumminallah
Social accountability to the society
Hablumminan-nass
Individuals as trustees or vicegerents
Khalifah
Success in this world and in the hereafter
Falah
Economic goals beyond purely wealth maximization
Tazkiyah
Personal accountability
Taklif
Justice in relationships, contracts, and activities
Adalah
Public interest is more important than personal interest
Maslahah
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4. Definitions of Islamic Investment
Islamic Investment is
an investment in
financial services and
investment products
that adhere to
Islamic principles
Islamic Investment
can be defined as:
•A joint pool in which the
investors contribute their
money for the purpose of
its investment to earn
permissible (halal) profits
in strict conformity with
the Islamic law
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5. Islamic Investment
 The Islamic financial system broadly refers to financial market
transactions, operations and services that comply with Islamic
rules, principles and codes of practices
 The Islamic financial services industry comprise Islamic banking,
Islamic insurance and Islamic capital market.
 In other words working to earn a halal living is itself a religious
obligation second in importance after the primary religious
obligations like prayers, fasting and hajj.
Narrated by Abdullah ibn Masud r.a., the Prophet Muhammad
(PBUH) said: ‘Seeking halal earning is a duty after the duty.’
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6. Islamic Investment
Modern Islamic
financial
products and
services are
developed using
2 different
approaches.
By identifying the existing
conventional products and
services that are generally
acceptable to Islam, and
modifying, removing any
prohibited elements that are able
to comply with Shariah principles
By involving the application of
various Shariah principles to
facilitate the origination and
innovation of new products and
services
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7. 7
The Principles of Islamic Investment
Shariah
compliant
investment
activities
Prohibition
of riba,
gharar and
maysir
Sanctity of
contracts
Money as
capital
Risk sharing
Prohibition
of
speculative
activities

8. 8
Sources of Islamic Investment
PRIMARY SOURCES
• Al-Quran
• Sunnah
• Ijma’
• Qiyas
SECONDARY SOURCES
• Istihsan (juristic preference of the stronger principles)
• Istishab(Presumption of continuity)
• Maslahah Mursalah (extended analogy/ consideration of
public interest)
• Sadd al-Zarai’ (blocking unlawful means to an unlawful
end)

9. 9
Criteria of Islamic Investment
Investment must be in ethical sectors (profits are not from prohibited activities, and
non-Islamic financial institutions
Investment of property and wealth must be result from a partnership between
the investor and the user of capital in which rewards and risks are share
Investment must be considered the philosophy of Islamic business (e.g: social
justice, equitability, and fairness as well as practicality of transaction
The major prohibited elements are riba (interest), gharar (uncertainty), maisir
(gambling), non-halal (prohibited) food and drinks and immoral activities
When a transaction have a prohibited elements, it’s must first be removed for it to be
Shariah-compliant

10. 10
Benefits for Muslim to involve in investment activities
Children education
Insurance protection
Shelter
Provision for retirement
Source of income

11. 11
Challenges of Islamic Investment
Competition
with the
conventional
system
Efficient and
active Islamic
financial
market
Availability
of a wide
range of
instruments
Human
resource
requirement
Uniformity of
scholarly views

12. 12
Differences between Islamic and conventional investment
Activities
Contractual
Relation
ProfitRisk

13. The Determination of Permissible Activities
 In Islamic perspectives, all activities must be acceptable and not
related to prohibited by Islamic law.
 An examples of the prohibited activities are follow:
 Alcohol
 Gambling
 Pork or a related products
 Pornography
 Conventional financial, banking & insurance services
 Also, an activities such as tobacco, hotels or entertainment are
prohibited
 The decision are depends on the methodology or interpretation
used by Islamic scholars in different jurisdictions
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14. 14
Investment and Financing of Halal Activities
Impermissible to invest and
give financing to related
activities
Financial serviced based on Riba
Gambling and gaming
Manufacture or sale of non-halal products
Manufacture or sale of tobacco-based or
related product
Stockbroking or share trading in Shariah non-
compliant securities
Other activities that conflicts with Shariah
Entertainment activities that conflicts with
Shariah
Conventional insurance that containing of
gharar

15. 15
Profit and Loss Sharing vs. Lender-borrower Relationship
PROFIT LOSS SHARING
• First Tier
• Between bank and depositor
• The depositor are considered to be
provider of the capital (Rabb al mal)
• The bank functions as a working partner or
manager of funds (mudarib or amil)
• Second Tier
• Between bank and entrepreneur
• The entrepreneur is the manager of fund
• The bank functions as provider of capital
LENDER-BORROWER RELATIONSHIP
• The relationship between a lender and a
borrower is governed by a loan contract
between them.
• Such a contract would specify all the
obligations of the two parties in every
possible future contingency.
• With respect to:
• The amount of repayment
• The interest rate on the remaining debt.
• A possible adjustment in the collateral
required by the lender.
• The actions (in particular investment
decisions) to be undertaken by the
borrower.

16. 16
Prohibition of Riba
• Unlawful gain derived from the quantitative
inequality of the counter-values in any
transaction purporting to effect the exchange of
2 or more species which belong to the same
genus(category) and are governed by the same
efficient cause(illah)
Definition of Riba on Trade transaction
• A predetermined excess or surplus over and
above the loan received by the creditor
conditionally in relation to a specified period
Definition of Riba on Loan transaction

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Elements of Riba
Excess or surplus over
and above the loan
capital
Bargain to be
conditional on
the payment
of a
predetermined
surplus
Determination
of this surplus in
relation to time

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Prohibition of Gharar
 Gharar literally means reduction.
 In Fiqh it is ambiguity that carries the risk of reduction.
 It is divided into minor and major Gharar. Major Gharar renders a
contract invalid or impermissible (Haram).
 Gharar is defined by Wahbah al-Zuhayli as a sale of
 (i) that which is not known to exist or not,
 (ii) whose measure is not known to be large or small, or
 (iii) that is undeliverable.
 Professor Zarqa considers gharar as a sale “of probable items whose
existence or characteristics are not certain, due to the risky nature
that makes it similar to gambling.”
 The prohibition of Gharar gets into stronger relevance in regard to
derivatives, which are sometimes referred to belong to the
categories of a Gharar sales and sometimes simply compared to
straight gambling.
 Gharar, however, influences largely the way the insurance business
needs to be done as it renders a conventional contract as not
permissible for Muslims.

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Prohibition of Maysir
 Gambling (Maysir, maisir; ‫ر‬ِ‫س‬ْ‫ي‬َ‫م‬ْ‫ال‬ ) or Qimar, ‫قمار‬) ) as a game to spend
money and expect larger outcomes was widespread practiced in the pre-
Islamic time of the Arabs.
 The Quran prohibited gambling alongside alcoholics:
 “They ask you concerning wine and gambling. Say: ‘In them is great sin, and some
benefit for men, but the sin is greater than the benefit. […]” (Al-Baqarah: 219)
 Gambling differs from trade as what one receives is the other’s loss, it is a
zero sum while trade exchange generates typically a win-win situation.
 There is some concerns among Muslims whether investing in stock market
resembles gambling by nature; while the majority of scholars accepts
trading of company shares as long as the companies are not involved in
forbidden areas or involved in Riba.
 The reservation of some Muslims may remain, especially if they feel
uncomfortable regarding the proper intentions of themselves.
 In stock trading is a grey zone where investing ends and gambling starts
which cannot be drawn precisely, but it is related clearly to the individuals
intention, which is not be judged by legal analysis but by self control.

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Shariah Supervisory Board
 Definition:
 A group of Shariah experts whose responsibility is to monitor and
supervise the operations of Islamic financial institutions in order to
ensure that it does not contravene Shariah principles.
 In theory, the role of SSB involves six areas:
 Provide fatwas that certify permissible financial products;
 Undertake Shariah audit to ensure products comply with guidelines;
 Dispose of non-Shariah compliant income or earnings;
 Provide advice to the bank on the distribution of income to
shareholders or depositors/investment account holders.
 Provide guidance to the bank on its wider social role.

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Shariah Screening
 Definition:
 The process of identifying Shariah-compliant investments. Shariah
clearly defines activities in which Muslims are not to be involved,
such as riba and the consumption of alcohol and pork.
 Consequently, Muslims cannot invest in assets of businesses
earning primarily from such activities.
 2 tier benchmark for screening:
 Business Activity Ratio
 Financial Ratio

22. 64
Non-Shariah Compliant Investment Activities
 Ruling on Non-Shariah compliant investment products which are
advertently/inadvertently bought:
 Must be disposed within a month of knowing the status of the
securities
 Any capital gain or dividend received during or
after the disposal of the securities has to be
channelled to charitable bodies
 Investor has a right to only obtain the original
investment cost
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23. Principle of Zakat on Investment
• Wealth belongs to government, community or Waqf is
not subjected to Zakat
Individual Right of Ownership
• Show the most accurate and relevant value of the assets
• Measure the net worth of the individual / company
The valuation of assets should be based on
current or market value.
• Assets should be owned for one full year (haul).
• Zakat charged only once a year (except for agriculture
produce)
Yearly principle
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24. Principle of Zakat on Investment
• The aim of Nisab (minimum requirement) is to ensure zakatable
wealth is in excess of normal requirements.
Ability to Pay
• Zakat computation must be true and fair
• Zakat payers need to truthfully disclosed all his/her financial
facts.
Full Disclosure
• Measurement must be objective and quantifiable
• Justice to both Zakat payers (who hold the financial obligation)
and Zakat beneficiaries (who are the rightful recipients of
Zakat).
Objectivity (True and Fair View)
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25. Calculation of Zakat on Investment
• Based on zakat on agriculture product.
• The shares are considered as fixed assets if shareholders or
investors acquired the shares:
• for long-term investment
• as a way to gain control over the company's capital (Held to
Maturity)
• as a participation (stake) in the company's capital
• Thus, only its income generated (i.e. dividend) will be
subjected to Zakat at 10% (as for agriculture produce).
Long-term Investment on Stock
• If shareholders acquired the shares for trading activity, it is
considered current assets, and its value and income is subject to
Zakat.
• Thus, Zakat on Shares = (Market Value of Shares x Quantity) x 2.5%.
Short-term Investment on Stock
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26. Calculation of Zakat on Investment
• Zakat on Sukuk has been argued should be charged as a
form of valuable trading commodity.
• Thus, Zakat for Sukuk = (Current Market Value x
Quantity) x 2.5%
Investment on sukuk
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27. 4
Speculation & Gambling
Stock Market provides the avenue for firms to
raise funds, for investor to invest their surplus
funds.
One needs to predict the future value of stock
prior to making any decision to buy or sell the
stocks
The Messenger of Allah (SAW) also forbade us from gambling as illustrated in the
following Hadith
From Abu Hurayrah (RA), that he said, ”The Messenger of God (S) forbade the 'sale of the pebble'
[hasah] [sale of an object chosen or determined by the throwing of a pebble], and the sale of al-
gharar. [Sahih Muslim]
The Quran clearly prohibit us from gambling as illustrated by the following verses
relating to games of chance or gambling. Allah SWT says:
“They will ask thee about intoxicants and games of chance. Say: In both there is great evil as well as
some benefit for man; but the evil which they cause is greater than the benefit which they bring.”
Quran (2: 219)
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28. 5
Speculation & Gambling
 Being given the obvious prohibition of gambling in both the Quran
and the Hadith of the Prophet (SAW), it is of utmost importance to
determine whether speculation in the stock market is similar to
gambling.
 Maysir or gambling is prohibited in Islam because it causes enmity
and hatred and also involves consuming property bi-al-batil, which is
a type of oppression.
 Ibn Taymiyah’s opinion on the above Hadith is that gharar as the
consequence of which is unknown and goes further to claim that
selling it involves maysir, which is gambling.
 Based on the Quranic verses and the Hadith of the Prophet (SAW),
Ibn Taymiyah pointed out that if a sale contains gharar and devours
the property of others, it is the same as gambling, which is clearly
forbidden.
 Therefore, for a transaction to be equated to gambling, it must involve
the devouring and unlawful appropriation of the property of others.
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29. 7
Speculation & Gambling
 Kamali (1996) defines speculation as consisting of "the intelligent
and rational forecasting of future price trends on the basis of
evidence and knowledge of past and present conditions".
 Speculative risk taking in commerce, which involves the
investment of assets, skills and labor is not similar to gambling.
 This is because the buyer is engaged in a transaction aimed at
making profit through trading and not through dishonest
appropriation of the property of others.
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30. 8
Speculation & Gambling
 El-Ashkar (1995) defined speculation as:
 "the practice of:
 using available information to
 anticipate future price movements of securities so that
 an action of buying or selling securities may be taken with a
view to
 buying or selling securities in order to
 realize capital gains and/or maximize the capitalized value of
security-holdings.
 It is a process that relies on the analysis of a lot of
economic and financial data, companies' financial reports,
political decisions, information about management skill and
aptitude and the personal profile of the decision makers.
 That is to say, speculation is an activity that requires a great
deal of knowledge and skills.
 Therefore, speculation in stock markets cannot be equated to
gambling.
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31. 9
Speculation & Gharar
 The sale of gharar is said to lead to maysir (gambling) which
leads to oppression and is therefore prohibited in Islam.
 It is evident that gharar is not present in speculation in stock
markets as each party is clear to the quantity, specification,
price, time and place of delivery of the object.
 Moreover, the object of the transaction, which is the purchased
security, is available in the market at the time of transaction and
is, bound to be available at the time of delivery.
 Therefore, speculation has no element of gharar and, hence,
does not lead to maysir.
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32. 10
Pro and Cons of Speculation
 The above discussion has proved that although speculation in the
stock markets may look like gambling, yet it is by no means
similar to gambling.
 Its positive side is that it can help stabilize prices and
activate a market where there is thin trading.
 It can also provide signals to less-informed investors upon which to
act.
 The negative effect of speculation is that excessive
amount of it may cause volatile price movements in the
market.
 It can thus be concluded that excessive speculation should not be
allowed, but a reasonable degree of it be permitted.
 Quantitative limits on daily trading volume and legislative guidelines
may help contain speculation within healthy bounds.
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33. 33
Time Value of Money from Islamic Perspective
The Time Value of Money (TVM)
• The idea that money available at the present time is
worth more than the same amount in the future due to
its potential earning capacity.
This core principle of finance holds that
• Provided money can earn interest, any amount of
money is worth more the sooner it is received.
TVM is also referred to as present discounted
value.

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Time Value of Money from Islamic Perspective
 Islam recognizes the legitimacy of the TVM emanating from
deferral (ajal) and acceleration (‘ajal) in Islamic financial
transactions such as deferred sale and bilateral
rebate (da‘ wa ta‘ajjal).
 However its application must be in conformity with specific
shariah guidelines to avert unfair economic effects of financial
transactions such as interest (riba).
 The application of TVM in accordance with its fundamental rules
can actually remove riba from the economy and prevent from
making of money out of money.
 Benefits of the knowledge of the time value of money:
 For investment analysis
 To compare investment alternatives
 To analyse how time impacts business activities
 To minimize a risk

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Purification of Income
 Investor/Unit trust fund receives income from invested
companies in the form of dividend and capital gain.
 Not all income are considered “clean”. Some are derived from
non halal sources such as interest income
 Purification of income requires identifying the non halal portion
of income received from invested companies and deducting it
from the total income prior to distribution
 The income net of purification is then distributed to the
investors
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36. 66
Purification of Income
 The “tainted” income cannot be distributed to investors but
instead donated to charities
 It is also possible for the fund to allow discretion to the investor
in deciding the recipient charitable organization
 No consensus among Shariah scholars in implementing
purification
 No standard available from AAOFFI
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37. Summary
In this
chapter
you have
learned
about:
Islamic Investment
Concept
Shariah Screening and
Supervisory Board
Principle of Zakat on
Investment
Speculation, Gharar
and Gambling
Time Value of Money
Purification of Income
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38. Thank you38