Equity Investments: Halal Or Haram?

Halal equity investments are those that comply with Islamic principles, also known as Shariah law. These investments channel money into financial ventures that are in accordance with Islamic principles derived from the Quran, Hadith, and Sunnah. Halal equity investments are permissible, whereas haram equity investments are forbidden.

Halal equity investments are an increasingly popular alternative to conventional forms of investing, which often conflict with Islamic values of fairness, moderation, and social well-being. They are considered a form of ethical investing, not only for Muslims but also for non-Muslims who view this approach as a way of generating wealth that benefits both their finances and their communities.

To be considered halal, equity investments must avoid interest (riba), which is prohibited in Islam as it is considered excessive compensation without an appropriate value exchange. Halal equity investments must also avoid prohibited industries, such as those that involve alcohol, gambling, pornography, pork, and interest-bearing financial products.

There are several types of halal equity investments, including stocks, exchange-traded funds (ETFs), mutual funds, real estate, gold and precious metals, and venture capital. These investments provide a way for Muslims to grow their wealth while upholding Islamic principles and promoting a principled, thoughtful approach to building wealth.

Equity investment options: equity shares, equity mutual funds, and private equity

Equity investment options are permissible (halal) under Shariah law, but there are certain conditions that must be met for them to be considered ethical and responsible investments. Here is an overview of three types of equity investment options: equity shares, equity mutual funds, and private equity.

Equity Shares

Equity shares, also known as stocks, are a way of investing in a business by buying a piece of ownership. This entitles the investor to a proportion of the company's assets and profits equal to the number of shares they own. However, for Muslims, it is essential to ensure that the company's activities and structuring are compliant with Shariah norms before investing. Fully Shariah-compliant equities are rare due to the prevalence of interest-based transactions in modern business. Therefore, scholars have developed minimum compliance criteria that provide investors with a reasonably wide choice of Shariah-compliant equities. These criteria involve screening companies based on their business activities and financial ratios to ensure they do not deal with prohibited activities such as alcohol, pork, conventional financial services, gambling, etc.

Equity Mutual Funds

Equity mutual funds are investment funds that pool money from multiple investors to invest in the stock market. A team of professionals carefully selects the stocks to deliver maximum returns while managing risk. Equity mutual funds offer a diversified portfolio, typically holding 40-50 stocks, which reduces risk. These funds can experience short-term volatility, so investors should be prepared to stay invested for at least five years. Equity mutual funds are a good option for those who want to invest in equities but lack the time or expertise to research and track the market.

Private Equity

Private equity involves investing in private companies, often early-stage, high-risk ventures with significant growth potential. These investments typically require a substantial sum of money, with minimum investments usually starting at $250,000 and reaching as high as $25 million. Private equity firms often focus on sectors such as software, healthcare, telecommunications, biotechnology, and more. They aim to add value to the companies they invest in by implementing strategic changes, such as bringing in new management or selling off underperforming parts of the business. Private equity investing is typically only accessible to institutional investors and wealthy individuals due to the high investment requirements.

Equity funds: how they work and their benefits

Equity funds are a type of investment fund that pools money from thousands of investors to buy a portfolio of stocks in a range of companies. They are also known as stock funds or equity mutual funds.

Equity funds are often used in investment portfolios and are a popular choice for investors, especially those who are new to investing or who want to take a more cautious approach.

Equity funds are a form of collective investment, where investors pool their money to be managed by a fund manager. The fund manager's goal is to generate returns for the investors by investing in a diverse range of stocks.

The fund manager will decide which stocks to invest in based on the fund's investment strategy and objectives. Some funds are actively managed, meaning the fund manager will research and analyse stocks to try and outperform a benchmark index. Other funds are passively managed, aiming to replicate the performance of a specific market index.

Equity funds offer several benefits to investors:

• Diversification: By investing in a range of stocks across different sectors and industries, equity funds reduce the risk associated with investing in individual stocks. If one stock performs poorly, the impact on the overall fund is minimised as the losses are offset by gains in other stocks.
• Professional management: Fund managers are experts in the field and use their knowledge and strategies to make investment decisions. They actively monitor the market and can react quickly to changes, helping to maximise returns and minimise losses.
• Potential for superior returns: Historically, stocks have offered higher returns than other asset classes like bonds and cash. Equity funds provide an opportunity for investors to benefit from these returns while also diversifying their portfolio and minimising risk.
• Suitability for long-term investors: Equity funds are suitable for investors with a long-term horizon who can weather short-term market fluctuations and focus on long-term growth.
• Tax benefits: In some cases, investments in equity funds can provide tax advantages, such as tax-deferred growth or tax-free withdrawals.
• Convenience: Equity funds offer a convenient way to gain exposure to a diversified portfolio of stocks without the need for deep research or a large amount of capital.

While equity funds offer many benefits, it's important to consider the risks involved:

• Market risk: Equity funds are subject to market volatility, and economic downturns or changes in investor sentiment can cause stock prices to decline.
• High expense ratios: Due to the constant management required, equity funds tend to have higher expense ratios than other types of funds, which can eat into returns over time.
• Risk of loss: Investing in stocks carries more risk than some other investments, and there is a potential for short-term losses due to market fluctuations.

How to invest in equity funds

There are a few ways to invest in equity funds:

• Through an employer-sponsored retirement account, such as a 401(k) or 403(b).
• Directly through a fund provider, such as Vanguard or Fidelity Investments.
• By opening a brokerage account, which offers more choice but may have an initial minimum deposit requirement.

When investing in equity funds, it's important to consider your financial goals, risk tolerance, and investment horizon. It's also crucial to research the fund's investment strategy, management team, historical performance, and fees.

Risks of equity investments

Equity investments are a risky business, and it is important to be aware of the potential pitfalls before diving in. The biggest risk of equity investments is that you could lose some or all of your money. This is due to the direct impact of market forces on stock prices, which fluctuate constantly and can cause investors to lose some or all of their investment.

There are several other types of risk that can affect equity investments:

• Credit risk: This is where a company is unable to pay its debts.
• Foreign currency risk: A company's value can change due to shifts in international currencies.
• Liquidity risk: This is where a company is unable to meet its short-term debt obligations.
• Political risk: A company's returns can be impacted by political changes or instability in a country.
• Economic concentration risk: A company's value can drop if it is too focused on a single entity, sector, or country.
• Inflation risk: Rising inflation can cause a company's value to drop.

There are also specific risks associated with private equity investments, including the inherently illiquid nature of the investments and the need to lock in capital for several years. Operational risk, funding risk, and market risk are also key considerations for private equity investors.

It is worth noting that mutual funds are generally considered less risky than direct equity investments, as they provide diversification across stocks and sectors, spreading out the risk.

How to lower equity risk

Equity investments are a risky business, and there are many types of risk that can affect them. These include market risk, credit risk, foreign currency risk, liquidity risk, political risk, economic concentration risk, and inflation risk. However, there are ways to lower the risk of equity investments.

Firstly, it is important to develop a dynamic defence strategy. This means that investors should be aware that every downturn is different and that defensive strategies must change accordingly. For example, the world experienced a two-step correction in 2022, with a revaluation of stocks that became very expensive, and a tricky risk tied to economic sensitivity. These developments differed from the COVID-19 crash of 2020, so investors should be aware of current market behaviours and new forces that could impact the market.

Secondly, investors should cast a wider net for stable companies. While companies such as utilities, consumer staples, and healthcare have typically provided stability in volatile markets, broadening the sources of stability can help diversify risk and return potential. Investors should look for high-quality companies with less market or economic sensitivity, and consistent cash flows. These can often be found in business models that underpin consistent cash flows, even when many businesses are facing macroeconomic pressures.

Thirdly, it is important to steer clear of unpredictable forces. Geopolitical risk and macroeconomic developments are unpredictable, so it is not prudent to take a directional bet on them as part of a defensive equity investing strategy. For example, while energy stocks may seem tempting, energy stock prices are driven primarily by oil and gas prices, which are extremely erratic as they are determined by geopolitical events and decisions.

Finally, investors should not lose their nerve. Selling equity positions in a falling market means locking in losses and forfeiting recovery potential. It is almost impossible to time market inflection points, so investors who sell risk missing the best days of a rebound, which can impair long-term returns. Lower-volatility equity strategies can help reduce risk and make it easier to stay in equities.

Equity accounting: how to calculate it and its applications

Equity accounting is a vital concept in finance, reflecting the ownership interest in a company's assets after deducting liabilities. It is calculated by subtracting total liabilities from total assets, as shown in the formula below:

Shareholder's Equity = Total Assets – Total Liabilities

This calculation is essential for understanding a company's financial health and can be found on its balance sheet. Current assets, such as cash and inventory, and non-current assets, like property and equipment, are included in total assets. In contrast, total liabilities consist of current liabilities (due within a year) and long-term liabilities (due over a year).

Equity accounting has several applications. Firstly, it helps analysts and investors assess a company's financial health and stability. A positive shareholder's equity indicates that a company has sufficient assets to cover its liabilities, while negative equity suggests the company's liabilities exceed its assets, which investors may view as risky. Secondly, equity accounting is used in financial ratios like Return on Equity (ROE), measuring financial performance and management's effectiveness in using assets to generate profits. Thirdly, equity accounting is crucial for shareholders, as it represents their residual claim on a company's profits and their voting rights. Finally, it is used in private equity investments, where investors purchase shares in private companies, often through direct investments or venture capital funding.

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