Halal and Religious Investing
Most religions direct adherents to be socially responsible with their money, yet few financial advisory firms are either knowledgeable about these rules, or equipped to follow them. Often, this leaves religiously observant investors to choose between their faith and their ability to grow their money. This problem is particularly stark for observant Muslims, because certain investments are expressly forbidden without exception, but many of the same rules appear in other Abrahamic faiths and are still followed by some sects.
The morality of charging interest on loans was debated even in Ancient Greece and Rome.
Image: coin depicting Roman Emperor Marcus Aurelius
THE ABRAHAMIC FAITHS AND THE CHARGING OF INTEREST
The most common religious restriction on investment concerns the charging of interest. Non-religious investors may be most familiar with this concept due to William Shakespeare's play, the Merchant of Venice, in which the medieval Christian prohibition against lending money for interest plays a central plot role.
The Torah, the Bible, the Qur'an, and the religious texts of Hinduism and Buddhism all prohibit the charging of interest to some degree. In the Judeo-Christian-Islamic tradition, this stems from a general prohibition against taking advantage of those who need to borrow money to meet their basic necessities. Modern adherence to this and related ethical standards is often referred to as riba-free banking, in reference to riba (ribit in the Old Testament and Torah), the charging of interest.
In all Abrahamic traditions, the act of borrowing or lending money is, in itself, not prohibited. What is prohibited is usury - the predatory lending money for the sole intent of deriving personal profit from it, without consideration for the borrower's needs or the social consequences of making loans that cannot be repaid without great harm to the borrower. This idea of fairness and social responsibility appears in most religiously-informed ethical investing philosophies.
The extent to which a loan can be considered predatory varies by faith, with Islam typically following the strictest definition of what constitutes unacceptable lending. Under Islamic jurisprudence, any interest is expressly forbidden as haram without exception, while other Abrahamic faiths typically limit contemporary prohibitions to the charging of excessive interest. However, some Judeo-Christian denominations which choose to follow their traditional religious teachings that have been abandoned by other modern sects turn first to the jurisprudence on halal investing, because the underlying motivations and reasoning are shared by all of the Abrahamic faiths.
ISLAMIC FINANCIAL LAW
As financial investment instruments have become more complicated, the need for clear rules and standards to guide religiously-observant Muslim investors has increased. In 1993, the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) was set up to establish standards for Islamic financial institutions. Islamic finance law or sharia, as understood under AAOIFI standards, broadly prohibits four types of investments:
- Riba: the charging or receiving of interest, regardless of whether it is at a fixed or floating rate, simple or compounded;
- Haram industries: investment in companies which violate the core tenets of Islam, such as those which specialize in alcohol, pork, tobacco, pornography, and weaponry, as well as corporations which derive much of their income from the other three prohibited types of investments, like traditional Western banks which charge interest on loans and mortgages;
- Maisir: speculation or gambling, any derivation of income from chance instead of productive activity. This includes certain types of trading which are otherwise common, like shorting stocks;
- Gharar: related to maisir, this refers to any business contract in which there is excessive uncertainty, leading to excessive loss to one party and undue gain by another, usually by deceit or fraud.
Determining whether an investment is halal is a very nuanced process, and requires careful examination of a company's entire range of business activities. For this reason, ensuring religious compliance is beyond the abilities of the average investor, leading some investors who want ethical investments to limit themselves to a few investment activities which they know to be halal, like buying stocks which are explicitly listed as halal. The result is a non-diversified and therefore high-risk portfolio. However, using an investment advisor who is well-versed in Islamic finance law can avoid this, providing religiously-motivated investors with a well-balanced portfolio that meets their personal risk profile.
Top Tip: Only about 5% of all stocks meet halal criteria; most companies carry too much debt, a factor which is almost impossible for the average investor to determine without an advisor to look over a company's financial statements.
CREATING AN ISLAMIC PORTFOLIO
Few areas of international finance and banking are as innovative as the halal class of investments. This is because mainstream investment firms are constantly developing new financial instruments, and many of these are extremely complex, presenting problems for the religiously-motivated investor. To meet Islamic investment requirements, these new instruments have to be screened extensively to ensure that they are both riba-free and avoid maisir (speculation) or gharar (excessive risk) - two characteristics which are often present in new mainstream financial innovations. It is for this reason that an IMF working paper in 2010 found that halal banking instruments were particularly resilient during the financial crisis of 2008-2009, and even outperformed conventional investments prior to the crisis (external link).
The ethical constraints upon halal investing also drive innovations which are exclusive to the field, meaning that a halal-compliant advisor is both applying an additional layer of scrutiny to innovations from mainstream investments, and is knowledgeable about new techniques and products which have been explicitly designed with your core ethical principles in mind and won't expose you to unnecessary financial risk typical of mainstream financial innovations. Even non-religious investors benefit from this additional scrutiny and enhanced knowledge.
There are some broad criteria, set by sharia boards, that an Islamically-compliant advisor uses to evaluate a potential investment:
- Preference is given to investment in companies which operate locally, meaning that the money from your investments will be used to generate economic growth and new jobs in the community
- Companies which derive more than 5% of income either directly or indirectly from haram business activities (like alcohol, gambling, pork products, weapons, riba, and other unethical practices) are not allowed
- Total debt, total cash and interest bearing securities, and accounts receivable can each be equal to no more than 33% of a company's total market capitalization
- Investing in over-valued stocks is prohibited, to avoid market bubbles that are prone to crashing
The underlying tenets of halal investing transcend religious cultures, and are shared by investors who want to make environmentally or socially responsible investments. Halal investing values honesty, fairness, disclosure, and transparency in business practices, while eschewing misrepresentation, hoarding, profiting from harmful activities, and taking advantage of a seller's helplessness. The core value is that you should not seek to benefit from harm done to others, but making money in socially beneficial ways is not only permissible but encouraged because of the positive effects that ethical investments can have on the community. Islamic belief that humans should be responsible stewards of the earth is a value shared by many other religious and non-religious groups, meaning that halal investing has value for all types of investors who care about the consequences of their investments.