Understanding Islamic Finance - Doha Academy of Tertiary Studies

202 Understanding Islamic FinanceTherefore, neither the principal nor a rate of profit (tied up with the principal) can beguaranteed. On the basis of the risk profiles of the investors and the investment strategy ofthe asset management companies, equity funds can be divided into four categories:1. Regular income funds: the objective of these funds is to earn profit through dividends ofinvestee companies. Such funds provide a regular income stream by way of dividends totheir investors who are mostly risk-averse, like old and retired people.2. Capital gain funds: the objective of these funds is to earn profit through capital gain fromfrequent sale and purchase of Sharī´ah-compliant stocks. These funds can provide a betterreturn to moderate risk-taker investors by proper management and risk diversification.3. Aggressive funds: these funds invest in high-risk securities to generate abnormal profitsfor their investors. They do not allow every investor to invest and limit the portfolio tohigh-risk investors as chances of loss are greater.4. Balanced funds: such funds invest in high quality securities with less risk and give tothe investors a regular income stream based on dividends and capital gain. These fundsadopt a “capital proactive” approach.Screening and Purification CriteriaEquity stocks included in the funds need to be compliant with Sharī´ah guidelines. Sharī´ahboards of IFIs develop a tolerance level in respect of investments in stocks. The selectionof stocks goes through a strict screening process decided by the respective Sharī´ah boards.Keeping in mind the scenario in the markets, this tolerance level might be different in differentfinancial institutions and markets. Generally, the screening criteria tend to ensure that:1. Theinvesteecompany’scapitalstructureispredominantlyequitybased(debtlessthan33 %).2. Prohibited activities such as gambling, interest-based financial institutions, alcohol production,etc. are excluded.3. Only a negligible portion of the income of an investee company is derived from intereston securities. (In the case of Al Meezan Islamic funds, for example, the income of aninvestee company from nonpermissible income should not exceed 5 % of total income.)4. The value of share should not be less than the value of the net liquid assets of the company.The most widely known are the Dow Jones Islamic Market Index Criteria, encompassingthe following:1. The basic business of the investee company should be Halal.2. Debt to market capitalization: total debt divided by 12-month average market capitalizationshould be less than 33 %.3. Cash and interest-bearing securities: the sum of the company’s cash and interest-bearingsecurities divided by the trailing 12-month average market capitalization should be lessthan 33 %.4. Accounts receivable: accounts receivable divided by the trailing 12-month average marketcapitalization should be less than 33 %.Further, Islamic asset management companies have to purify their income by deductingfrom the returns on the investments the earnings emanating from any unacceptable sourcefrom the Sharī´ah point of view. It is obligatory to dole away the prohibited income thatis mixed up with the earnings of the company, and this obligation is on the one who isthe owner of the shares or Sukuk – the investor. Purification is not obligatory for the