THE
2009 GROSSMAN SENIOR RESEARCH PRIZE:
“Investing the Islamic Way”
A Thesis presented to the Department of Economics at Trinity College
in partial fulfillment of the requirements for the Bachelor of Arts
Degree
May 2009
by
Verdell Walker
This Thesis won the 2009 Kenneth S. Grossman Senior Research Prize for Global Studies,
administered by the Center for Urban and Global Studies. The Kenneth S. Grossman ’78
Global Studies Fund was established in honor of Professor Eugene Leach in support of
student investigations of global issues that will confront mankind collectively in the 21st
century.
2
ABSTRACT
The objective of this thesis is to analyze the performance of Islamic equity funds versus
their conventional, interest-based counterparts. This was accomplished by calculating and
comparing the returns for four Islamic equity funds and two conventional funds for specified
time periods. Chapter one will provide a brief historical background on the evolution of Islamic
law (“Sharia”). Chapter two will provide a quick review of the literature surrounding portfolio
theory, as developed by Markowitz, Tobin, Sharpe and others, and its application to “real world”
portfolios. Chapter three will treat the constraints Sharia imposes on investing, which include
prohibitions on certain lines of business, restrictions on allowable amounts of debt, and
inhibitions to the development of Islamic investment management funds. Chapter four will
examine the performance of Islamic funds. Chapter five will deal with other investment options
for Muslim investors. Chapter six will discuss the dangers of Sharia arbitrage and the prospects
for greater expression of Muslim principles in Islamic finance. The findings presented in chapter
five indicate that Muslims may not necessarily have to pay an opportunity cost for adhering to
their faith in their financial affairs. While of course longer time horizons are needed to make
more certain judgments, the Islamic funds have charted excellent performance over the time
horizons considered and have performed well versus their conventional counterparts. Indeed, the
superior returns of the Amana funds have attracted the attention and funds of non-Muslim
investors as well.
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ACKNOWLEDGEMENTS
This thesis could not have happened without the guidance, support, and expertise of the
following:
Above all, God
My mother
Professors Curran, Antrim, Grossberg, Prashad, Hayes, and Ahmed
Chaplain Marwa Aly
Rachel Barlow
Marlene Barzana
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TABLE OF CONTENTS
I.
Introduction
II.
The History and Evolution of Islamic Law
III.
A Review of Modern Portfolio Theory and Ethical Investment
IV.
Sharia Constraints on Muslim Investors
V.
An Investigation of the Performance of Islamic Funds
VI.
Other Islamic Asset Classes and Investment Alternatives
VII.
Sharia Arbitrage
VIII.
Conclusions
IX.
List of References
X.
Appendices
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LIST OF TABLES
Table 1. The Good Money Industrial Average vs the Dow Jones Industrial Average, 1976-2000
....................................................................................................................................................... 90
Table 2. The Good Money Utility Average vs The Dow Jones Utility Average, 1976-2000 ...... 91
Table 3. AMAGX During Last Stock Market Downturn ........................................................... 109
Table 4. AMANX During the Last Stock Market Downturn ..................................................... 110
Table 5. IMANX During the Last Stock Market Downturn ....................................................... 111
Table 6. Number of Securities - Islamic Portfolios .................................................................... 112
Table 7. Industry Allocation - Highest Percentages ................................................................... 113
LIST OF FIGURES
Figure 1. The Efficient Frontier.................................................................................................... 40
Figure 2. The Capital Market Line ............................................................................................... 42
Figure 3. The Capital Market Line with Lending or Borrowing at the Risk Free Rate ............... 43
Figure 4. The Security Market Line .............................................................................................. 45
Figure 5. Dow Jones Islamic Market Screening Criteria ............................................................ 85
Figure 6. The GMIA vs. DJIA - Cumulative Value Change ......................................................... 91
Figure 7. The GMUA vs. DJUA - Cumulative Value Change ...................................................... 92
Figure 8. The AEIFX and VEIPX Compared.............................................................................. 102
Figure 9....................................................................................................................................... 103
Figure 10. AMANX and VEIPX Compared ................................................................................ 104
Figure 11..................................................................................................................................... 105
Figure 12. IMANX and VWUSX Compared ............................................................................... 106
Figure 13..................................................................................................................................... 106
Figure 14. AMAGX and VWUSX Compared .............................................................................. 107
Figure 15..................................................................................................................................... 108
Figure 16................................................................................................................................................... 114
Figure 17.................................................................................................................................................. 115
Figure 18................................................................................................................................................... 116
Figure 19................................................................................................................................................... 128
Special Note: References to individual hadith and/or hadith collections in this thesis will be
found in footnotes.
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CHAPTER I.
INTRODUCTION
Since 2001, the Islamic finance industry has grown by an astonishing 20% to 30%,
making it the fastest growing segment of the global financial industry (Carruthers and Colangelo,
2008). Islamic finance has long had a foothold in the Middle East and other countries with large
Muslim populations, and now it is expanding in the United States and Europe. The rise of this
industry has tracked the concurrent growth in the western Muslim population. Particularly in the
US and the UK, immigration and conversion to Islam are fueling the growth of the Muslim
demographic. These Muslims tend to be well-educated and middle class, and many of them are
demanding more Islamic financial products. Western financial institutions, such as HSBC and
Citibank, have been striving to acquiesce to this new source of customers. The growing demand
for Islamic financial products and services as well as the recent increased focus upon the Islamic
world highlights the rising influence of Islam and Muslims in global political, economic, and
social arenas.
Contemporary Islamic finance is the product of centuries of development of Islamic law.
The contracts used today in the industry are based on the intellectual and juristic efforts of some
of Islam’s greatest scholars and jurists. Taking the contracts those jurists devised as a foundation,
industry practitioners construct contracts and instruments to meet the financial needs of Muslims
seeking liquidity and financing, as well as enabling them to conform to the letter and spirit of
their religious obligations. Contrary to popular belief, Islamic law is not a rigid system of rules
and regulations devised in the 8th Century C.E. In practice, Sharia is dynamic, fluid, and open to
interpretations by Muslim jurists who strive constantly to adapt Islamic law to meet new
challenges to the Muslim way of life. Guided by the Quran, Muhammad’s example, these jurists
exercise a certain degree of independent reason but always do so within the boundaries set down
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by their faith. Their objective is to refine and expand the law and, by extension, Islam itself, as a
means to adaptation in a changing world.
The development of the Islamic financial industry holds great promise for Muslims and
non-Muslims alike. Muslims will gain an industry dedicated to meeting their business and
financial needs while at the same time affording them the opportunity to adhere to their religious
beliefs if they so choose. And since Islamic finance and investment shares many of the same
standards and principles as the modern ethical investment movement, non-Muslim investors will
gain an avenue through which they can find expression for their ethical and social values while
also pursuing and protecting their own financial wealth and gain. Moreover, it seems that
Muslims may not necessarily have to sacrifice financial gain for their principles. One of the
central aims of this thesis is to investigate and analyze the performance of Islamic equity
portfolios relative to conventional (i.e. not subject to the restrictions and guidelines of Islamic
law) equity portfolios. The results indicate that Islamic funds perform better or at least as well as
conventional funds. This is a positive validation for the Islamic financial industry in particular
and ethical investment in general.
However, in order to move forward, the Islamic financial industry must overcome
significant challenges. The most serious obstacle the industry currently faces is its present
reliance on prohibitions, the most famous of which is the prohibition on paying and receiving
interest. The Islamic financial industry is now a prohibition driven industry. Unfortunately, many
Islamic financial institutions focus on crafting products and services that simply mimic
conventional financial products. These “Islamic” products differ from their conventional
counterparts only in name. The mechanisms through which they are created, such as adding
degrees of separation and incorporating special purpose entities, only impose added costs and
8
economic inefficiencies on a captive market of Muslims who wish to follow the precepts of their
faith. This phenomenon is known as Sharia arbitrage, and as we shall see in the following
chapters it has the potential to cause serious and lasting damage to the nascent Islamic financial
industry before it even has the chance to mature.
The prohibition-focused nature of the industry as it currently is poses the danger that
practitioners will become more focused on adhering to religio-legal form rather than on
promoting the moral substance of the Sharia. Helping Muslims avoid those actions that are
impermissible in Islam is only half the battle. The industry should also strive to allow Muslims to
further the aim of Islam itself: to promote and protect the welfare of humankind while bringing it
closer to God. Furthermore, the same intellectual vitality that characterizes other spheres of
Islamic law must be applied with the same vigor in Islamic finance. While there is nothing
wrong with using medieval contracts as a starting point for formulating new financial
instruments – indeed, modern Islamic bankers would be remiss if they did not take advantage of
the rich legacy and achievements left behind by the brilliant scholar-jurists of old – the industry
should endeavor to reduce their reliance on religious forms and instead find new ways to meet
contemporary financial challenges. This is precisely how jurists of the classical and medieval
periods of Islamic history formulated these contracts in the first place! If the industry continues
along its current path, it risks losing the innovative quality so characteristic of Islamic
jurisprudence itself, falling into stagnation, and worst of all, failing to realize its full potential.
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CHAPTER II.
THE HISTORY AND EVOLUTION OF ISLAMIC LAW
The main purpose of this work is to examine a subset of Islamic finance, namely Islamic
investing. However, Islamic investing and finance cannot be fully understood without a working
knowledge of the broader canopy under which it rests – Islamic law. The rules that govern
Islamic finance and contractual obligations as they relate to business and commerce are an
important component of the wider body of Islamic law. Muslims believe that in order to direct
their business and financial dealings God has laid down guidelines to which they must adhere.
Some are explicit, while others require elucidation from qualified religio-legal specialists. To
help the reader better understand these religious requirements, this chapter is devoted to offering
a brief sketch of the history and evolution of this body of legal thought.
What is Islamic Law?
Joseph Schacht (1964) describes Islamic law as the “epitome of Islamic thought, the most
typical manifestation of the Islamic way of life, the core and kernel of Islam itself” (p. 1). Islamic
law is aimed at guiding the footsteps of Muslims in this world and the next, regulating their
religious and secular conduct. One of its key goals is to educate humans in how to maintain the
correct relationship with both God and other human beings. Islamic law is often equated with the
Arabic word “Sharia.” In its narrowest sense, Islamic law comprises legal rules. But the term
Sharia connotes more than legal rules; it refers to the method of conduct that Muslims must
employ in their lives, religiously, ethically, and legally (Zahraa, 2000, p. 169; Mahmassani, 1961,
pp.10-11). Many Muslims believe that the Sharia has a defined set of objectives, known as the
maqasid al-Sharia. These objectives center on protecting and preserving a set of key elements:
1. Life, human and otherwise (within reason)
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2. Religion
3. Wealth
4. Intellect
5. Progeny/lineage (taking care of widows, orphans, and the elderly falls into this
category) (Haneef, 2002, p. 254)
6. Honor (debated by scholars) (Marwa Aly, personal communication, January 29, 2009;
Llewellyn, 2003, pp. 193-194)
Anything that promotes or protects these elements should be supported and/or allowed. The
Islamic legal system that can be seen as the articulation of the Sharia and its aforementioned
goals can be divided into two main spheres: ibadat and muamalat. Ibadat, which means
“rituals,” refers to matters of religion, such as prayers, the hajj (pilgrimage to Mecca), paying
zakat (charitable donations), and other obligations incumbent upon Muslims. Muamalat, which
means “transactions,” describes social, political, and economic practices and issues that are most
akin to the subject matter of other legal systems. This second part is further divided into three
spheres: criminal law, family law, and transactions (the purview of Islamic finance) (Badr, 1978,
p. 188).
So how do Muslim jurists (the fuqaha) derive the rules and regulations that make up the
Sharia? This is achieved through the science of fiqh, or Islamic jurisprudence. Meaning
“knowledge,” fiqh is the methodological process through which qualified individuals have
shaped the development, interpretation and derivation of the Sharia throughout history. Islamic
law is not static, even in this present age. Through the methodologies of fiqh, jurists continue to
respond to the legal questions that arise and shape daily life for Muslims. The Sharia and its
attendant legal rules are based upon a set of both primary (i.e. divine and passed from God to
11
humankind through the prophets) and secondary sources, discussed in the next chapter.
The Sources of the Law: The Primary Sources
To deduce the substance of Islamic law, Muslim jurists rely on two primary sources: the
Quran and the Sunna. The Quran is the holy book of Islam, while the Sunna can best be
described as the example of Muhammad to which Muslims can look for guidance as to how to
live the most pious and authentically Islamic life possible. Whenever a jurist is trying to find the
answer to some religious or legal question, it is to these sources that he looks first.
The Quran
Without a doubt, the Quran is the most important source of Islamic law. For all Muslim
jurists past and present, regardless of their differences in opinion on innumerable legal issues, the
Quran is the backbone of Islamic law. Muslims believe that the Quran was revealed to
Muhammad by God over a period of approximately twenty years in the cities of Mecca and
Medina. The Meccan chapters, or suras as they are known in Arabic, are typically shorter,
emotionally powerful, and deal with matters of religion and faith. The Medinan suras are usually
longer and provide the most detailed legal guidelines. The Quran was not written down during
Muhammad’s lifetime. After his death his companions began the process of transcribing the holy
book. During his reign from 644 to 656, the third caliph Uthman ordered that the Quran be
compiled into one definitive version and distributed to the provinces of the growing Muslim
empire (Mahmassani, 1961, pp.66-67).
The subject matter of Islamic law is ubiquitously Quranic in origin; all works of fiqh
throughout Islamic history touch on the same subjects – such as prayer, divorce, making alms,
the hajj, etc. – because these subjects were initially raised in the Quran. If a subject is not
12
directly dealt with in the Quran, it usually has some Quranic inspiration. For instance, the Quran
makes no mention of many of the various business contracts used in Islamic finance. However,
when formulating these contracts, jurists were expressly concerned with structuring the contract
in such a way that Muslims could avoid riba and gharar, both expressly forbidden in the Quran
(and discussed in the next chapter). 1 The verses that deal with licit and illicit acts and behaviors,
as opposed to those concerned with ritual duties, are few in number in proportion to the Quran’s
total verses, usually 6236 in most modern editions. However, as opposed to other verses, the
legal verses are often longer in length and rarely repeated (Dutton, 1999, pp.157-161). The
Quran offers the most comprehensive legal rulings in personal law, such as issues of divorce,
marriage, inheritance, and the treatment of slaves (Schacht, 1964, p. 12).
Muslim jurists are convinced of the primacy of the holy book, especially in light of such
verses as Quran 6:38 (“…Nothing have we omitted from the book….,” )and Quran 16:89 (“…We
have sent down to thee a Book explaining all things, a guide, a mercy and glad tidings to
Muslims”). These verses led many Muslim jurists to believe that the Quran is a complete guide
to the proper Islamic life and the answer to every possible question, and thus it was up to them to
research the Quran and identify the answers contained therein, the real intentions of God, and the
proof to support their legal arguments. Yet as mentioned above the Quran contains very few
explicit legal rulings, so many scholars divide the Quran’s verses into two classes. First, there are
verses which have clear meanings, and second, there are verses whose subtle nuances of meaning
and connotation must be extracted by rational deduction and subject to interpretation (Zahraa,
2000, p.190). For this reason, jurists rely on the second most important source for the Sharia: the
Sunna.
1
Riba is unjustified enrichment through the exploitation of others or through the appropriation of other’s property
for one’s own use without a legitimate reason. It is dealt with numerous times in the Quran. Gharar is excessive risk
and uncertainty in business and finance. Riba and gharar will be treated extensively in chapter III.
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The Sunna
To the adherents of Islam, Muhammad is considered the perfect Muslim, the embodiment
of all that is good in man and an infallible example. Muslims attach great importance to his
words, deeds, and personal attributes, as well his acceptance of others’ actions, both tacit and
explicit. The sayings and actions of Muhammad are collectively known as the Sunna of the
Prophet (Mahmassani, 1961, pp. 71-73). The Sunna can be viewed as a natural extension of the
Quran; the dictates contained within the Book, according to early jurists, were personified and
put into action by Muhammad. Muhammad created a model for living the proper Muslim
lifestyle by demonstrating to his disciples, through his own life, how to fulfill the obligations laid
down in the Quran, such as prayer, paying zakat, and so forth. Symbolically the Sunna will never
usurp the primacy of the Quran, but it is undoubtedly a necessary complement to the Book itself
(Dutton, 1999, pp. 161-164). In practice, it is referred to much more often than the Quran in fiqh.
Throughout the centuries, the prophetic Sunna has been recorded in collections of the
traditions of Muhammad, the Hadith. A hadith is essentially a report from one or more of the
Companions of what Muhammad said or did. The Companions were those early Muslims who
saw or spoke with Muhammad, the most prominent of which were his close associates. The
reports of the Companion(s) were passed down through time through a chain of narrators, or
isnad. The credibility of the isnad was of vital importance, as only the reports of the most
trustworthy narrators were accepted by Muslims. In the eighth century, hadiths began to be
collected, authenticated, and compiled into complete collections. Thus hadiths can be considered
the textual building blocks of the Sunna. There have been numerous compilations of hadith
throughout Islamic history, but the two best known collections are referred to as the Sahih
(Arabic for ‘authentic’) books, written by Abu Abdullah Muhammad ibn Ismail al-Bukhari (d.
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870) and Abu al-Husayn Muslim al-Nisaburi (d. 875). Both Bukhari and Muslim searched
throughout the Muslim provinces for their traditions, painstakingly asserting the accuracy and
authenticity of the narratives and their isnads (Mahmassani, 1961, pp. 71-72).
The Secondary Sources
As mentioned earlier, the revealed sources of the Quran and the Sunna are the foundation
of Islamic law. While they do provide specific rulings on some legal issues, for the most part,
jurists must engage in the processes of deduction to derive the law from these sources. This is
done using the two secondary sources: ijma (consensus of opinion) and ijtihad (deductive
reasoning).
Ijma
Ijma, the consensus of the Muslim community on a hukm (regulation of God), is regarded
as the third most important source of Islamic law. In practice it is often thought of as the
unanimous opinion of jurists at a specific time about a particular legal question. Its primary
function was to determine whether a jurist’s opinion was valid or weak. This doctrine is based on
the well known prophetic hadith, “My people shall not agree in error” (Saleh, 1998, p. 260). In
the early days of Islam, consensus referred to the unanimous agreement of the Muslim
community. Later, as Islam spread from the Hijaz across the Near East and the Mediterranean,
consensus came to be thought of as the agreement in opinion of Muslim jurists in any particular
point in time, which represented the Muslim public, or those who were involved in the
discussion of a particular legal issue. Consensus may be an explicit corroboration of opinion or a
tacit acquiescence on the part of jurists. Shiite jurists held different views on ijma than Sunnis.
Shiites only accept the consensus of Muhammad’s family, Ahl al-Bayt, or an endorsement by one
15
of Shiite Islam’s infallible Imams, instead of the mere consensus of the ulama (the community of
legal/religious scholars who were well versed in Islam and the Sharia) (Kamali, 1996, p. 24;
Mahmassani, 1961, p. 77-78).
Despite a vast treatment in works of fiqh, as yet there is no generally accepted view about
what ijma truly is. Scholars have debated the scope, form, and proper application of ijma since
the 8th century, when it became formalized along with the other methodologies of fiqh. Some
scholars, like Hanafis (adherents to one of the major schools of Islamic law discussed later), felt
that ijma should include all Muslims in order to be valid, while others, such as eleventh century
scholar Ibn Hazm, believed that only the consensus of the Companions mattered. In addition,
there is wide disagreement on the authority of tacit ijma. Some schools of law (again the Hanafis)
allowed tacit ijma, other schools did not (like the now extinct Zahiri school), and still others trod
a middle road like the Shafiis, who only allowed tacit ijma if certain guidelines were met (for
example, there must be indications of approval by the silent parties). Scholars even disagreed on
what types of questions ijma could answer. The great Islamic scholar al-Ghazzali (d. 1111) felt
ijma could answer all questions, while others felt that ijma could only be used for questions that
had not already been answered in the Quran (“Idjma,” 1971, pp. 1023-1026).
In addition to ijma, a lesser degree of consensus known as al-jamhur, or the majority of
jurists, also exists. Al-jamhur is attained when a majority of jurists agrees on a specific ruling,
thus lending the ruling a higher degree of probability of being truly Islamic. The individual
opinion of a jurist is challengeable until it is supported by other jurists, through either ijma or
jamhur (Zahraa, 2000, p. 183). Before this occurs, a ruling is considered to be probable. The
approval of other jurists transforms the ruling into one of certainty. Furthermore, the case
establishes a precedent that can be followed by later jurists in similar cases. In its capacity as a
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precedent-forming process, consensus has been a powerful force in the development of Islamic
law, and it has important implications for the rise of taqlid, or imitation, which will be discussed
in greater detail below (Hallaq, 1986, pp. 427-450).
On a practical level, the possibilities for ascertaining consensus on a particular issue
dramatically waned as the Muslim world grew. If it exists at all today, it is usually on minor
points of legal detail. Some have even gone so far as to suggest that in modern times ijma should
not be limited to Muslim jurists but should consist of all Muslims (Weiss, 1978, p. 209; Kamali,
1996, pp. 23-24). This is obviously impractical in modern times where Muslims reside in every
corner of the inhabited world and obtaining the opinion of each one of them is at the height of
infeasibility.
Ijtihad
Ijtihad is perhaps one of the most – if not the most – important concepts in the study of
Islamic jurisprudence. Simply put, ijtihad is the process in which a mujtahid (one who practices
ijtihad) uses his own reasoning to deduce the answer to a legal question; he extracts this answer
from the Quran and Sunna, his source material. Ijtihad, which literally means “endeavor” or
“self-exertion,” is the opposite of taqlid, or imitation. Taqlid is the acceptance of a rule based on
the authority of past jurists and/or previously settled legal cases. In general, Muslims do not
believe that a mujtahid creates Islamic law; rather he “discovers” that which was already
implicitly present in the Quran and the Sunna (Weiss, 1978, pp. 200-206).
Muslims generally regard ijtihad with great reverence. A tradition attributed to
Muhammad describes the rewards awaiting the jurist who practices ijtihad in the next life. Even
if his judgment is incorrect, he would still receive a reward. If the jurist had reasoned correctly
he would be doubly rewarded. In ijtihad, the jurist must apply himself to the utmost and
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sincerely seek God’s pleasure to receive the favor; if not, he is doomed to burn in hellfire
(Zahraa, 2000, pp. 192-193; Makdisi, 1979, p.1). Theoretically the opinions of a jurist should be
objective, not subjective. If personal preferences or other subjective whims infiltrate a juristic
decision, it is rejected as bida, or improper innovation (Weiss, 1978, p. 206). Keep in mind bida
does not mean innovation in the sense that we now know it; indeed ijtihad is used precisely to
innovate in an appropriate way and find new solutions to problems!
Ijtihad has numerous sub-varieties, each geared toward applying the general guidelines of
Islamic law to new legal cases (Kamali, 1996, p. 21). One of the most widely used modes of
ijtihad is qiyas (analogy). Qiyas is used to discover the solution to a new legal quandary, except
if that case has already been addressed in the Quran and the Sunna. Analogy consists of two
types: the analogy of similarities and the analogy of opposites.
The more prevalent of the two, the analogy of similarities, is used when a case in
question bears marked similarities to a case that has already been decided. Muslim jurists
developed this doctrine on the premise that rules are made to fulfill various objectives and
interests. These objectives and interests are the impetus for the rules. Thus, they could apply the
same rule to another problem which shared the same cause (illa) (Mahmassani, 1961, p. 79;
Hallaq, 1986, p. 427). Once a new case is found to share the same illa with a previous case, the
judgment of the original case is transferred to the new, ensuring consistency and continuity in
Islamic law. Scholars of fiqh have laid down strict parameters for the isolation of the illa, since
the illa was the key factor in analogies of similarities. Misusing the illa was tantamount to
flouting God’s law (Hallaq, 1984, p. 680).
The analogy of opposites was slightly more straightforward, if not used so often as its
counterpart. Jurists simply did not apply a rule that had been established in an earlier case to a
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new case if it was determined that the new case did not share the same illa with the old. Hence, a
new rule would have to be developed through some other mode of ijtihad (Mahmassani, 1961, p.
79).
The Requirements of a Mujtahid and the Process of Ijtihad
In order to qualify as a mujtahid, a Muslim jurist first had to acquire a lofty set of
prerequisites and qualifications. Besides a deep understanding of the Quran and the Sunna, a
mujtahid must also have a firm grasp of Quranic Arabic language and grammar, the
circumstances of the revelation of the Quran (asbab al-nuzul), the wording of verses, the
multiple meanings of different words, and al-naskh, the doctrine of abrogation (discussed briefly
later in the chapter) (Zahraa, 2000, p. 190). These rigorous standards have led some to believe
that not everyone is qualified to perform ijtihad. Therefore, most Muslims are simply taught to
follow the guidelines set by mujtahids.
The authority of the results of a jurist’s ijtihad rests only in the fact that what he has
derived is based upon the Quran and the Sunna, not on his personal merit, however great it may
be. Even if the ruling is issued by a learned and talented jurist, it is still an opinion (unless of
course it is corroborated by ijma or jamhur) (Weiss, 1978, p. 203). It is the pursuit of this ilm, or
knowledge, in which jurists are so entangled. Since each ruling is by nature fallible opinion
created by humans, Sunni jurists acknowledge the possibility of error, which is evidenced in the
occurrence of ikhtilaf (disagreement among jurists). However, it is incumbent upon Muslims to
obey even erroneous rulings, provided that jurists derived them from the texts in good faith and
sincerity.
The Dynamism of the Law
The Quran, Sunna, ijma, and ijtihad are the four main sources of Islamic law. They are
19
widely accepted and applied by nearly all Muslim jurists. While disputes over the authenticity of
hadith, the conditions for ijma, and the methods of qiyas did arise, greater differences also arose
among groups of jurists who favored other strategies for adapting Islamic law to new situations.
Some jurists accepted new methods while others rejected them. These controversies were some
of the main points of division among the madhhabs, or “schools” of Islamic law, which emerged
in the tenth and eleventh centuries. This chapter will deal with a few of these principles.
Maslaha and Istislah
Maslaha is the Islamic concept of public interest or welfare. It is the direct opposite of
madarra and mafsada, which both denote “injury.” Anything which prevents or mitigates
mafsada and promotes the overall welfare of humanity can be termed maslaha. Legally, maslaha
is to be distinguished from istislah, which is a mode of legal reasoning that uses maslaha as
grounds for making a legal decision. The great eighth- century scholar Malik ibn Anas is
traditionally thought to be the first jurist to have used maslaha as a basis for legal reasoning, and
it is accepted as a valid legal source by the madhhab, or school of jurisprudence, that bears his
name. Other jurists and madhhabs typically reject it. 2 Istislah was developed by later jurists who
claimed Malik had been first to use the method. Before Malik, the concept of public welfare had
been used to decide numerous legal matters during the time of the seventh century even though
the term maslaha had yet to be coined.
It was not until the time of the esteemed eleventh century scholar Abd al-Hamid alGhazzali that maslaha emerged as a mature principle. Al-Ghazzali insisted that maslaha was
about more than just averting mafsada; instead, it was actually the ultimate purpose of the Sharia
itself. Al-Ghazzali reasoned that maslaha was anything that furthered the aims of the Sharia,
2
However, no indisputable evidence has demonstrated that Malik ever used maslaha as a basis of reasoning, and
other jurists have also been said to be the first to consider it.
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namely the maqasid al-Sharia. Anything that hampered this goal was mafsada. According to alGhazzali, the achievement of maslaha was paramount and necessary, and qiyas was the
appropriate tool to use to reach that end. To al-Ghazzali, maslaha is divided into al-darurat
(necessities), al-hajiyyat (needs), and al-tahsinat (improvements). The second and third
categories require a textual reference from the Quran, the Sunna, or the precedent of ijma be
found through qiyas. Alternatively, al-Ghazzali considered the al-darurat to be enough for a
legal decision, even without employing qiyas on the first three sources of the law, because aldarurat constitutes the ultimate aim of the Sharia itself. Essentially al-Ghazzali argued that
maslaha was a source of law unto itself, irrespective of the other sources.
The thirteenth-century jurist Nadim al-Din al-Tawfi took al-Ghazzali’s reasoning a step
further. He believed that if maslaha contradicted one of the primary sources, it should overrule
the source because maslaha was God’s primary goal, and the Sharia was meant to promote it. He
cites passages from the Quran and the prophetic traditions to support his argument, particularly
the hadith la darar wa-la dirar (“no injury should be imposed nor an injury to be inflicted as a
penalty for another injury”). Al-Tawfi thus promoted the principle of maslaha in all aspects of
legal transactions (muamalat) but not in religious matters (ibadat). Underlying both alGhazzali’s and al-Tawfi’s reasoning are the overarching objectives of the maqasid al-Sharia i.e.
the need to promote and protect life, religion, wealth, intellect, and progeny. Today, the principle
of maslaha has been enjoying renewed interest from Muslim jurists, including those involved in
Islamic finance, where it is used to argue that in order to prevent undue hardship Muslims should
be allowed to pursue certain modern financial instruments and processes that may not be strictly
Islamic (Mahmassani, 1961, pp. 87-89; “Maslaha,” n.d., pp.738-739).
21
Al-Naskh
As we have seen, maslaha can be used as a justification for allowing Muslims to engage
in activities that may not have a basis in the Quran, Sunna or precedents of ijma, or that might
even contravene these texts, provided that compelling evidence of the need to do so exists.
Maslaha, as envisioned by al-Tawfi and others, is itself related to al-naskh, the concept of
abrogation. It means that one Sharia rule can supplant an earlier one in order to enable the Sharia
to adapt to changing times. There are several brands of naskh, the primary three being the Quran
being supplanted by itself, the Sunna being superseded by it, and the supplanting of the Quran by
the Sunna (Schacht, 1964, p. 115). Needless to say, naskh has always been a controversial
subject in Islamic jurisprudence. While the majority of jurists recognized the supersession of the
Quran by itself (e.g. a later verse of the Quran superseding an earlier one), it was usually only
accepted in regards to those Medinan verses which discussed transactions and not the Meccan
verses which tended to deal with matters of religion. In addition, instances of the Sunna
supplanting the Sunna occurred often, i.e. a later hadith contradicted an earlier one.
However, it was the supersession of the Quran by the Sunna that raised the most
disagreement among jurists. While jurists generally agreed on the authority of a prophetic
tradition when it supported the Quran or elucidated it, many jurists found it impossible to accept
that the Sunna could contradict and overrule the holy book of Islam. The foremost among these
were al-Shafii and Ahmad ibn Hanbal, the revered eponyms of two of the extant madhhabs,
active in the eighth and ninth centuries respectively. They cited several Quranic verses and
prophetic traditions which affirm the primacy of the Quran.
Some jurists who felt that the Sunna could supersede the Quran, including Malik, some
jurists from the extinct Zahiri madhhab, and the disciples of Abu Hanifa, another great jurist and
22
madhhab namesake. They reached this conclusion through reason and actual historical precedent.
Quran 2:180 says:
“It is prescribed for you when one of you approacheth death, if he leaves wealth, that he
bequeath unto parents and near relatives in kindness. This is the duty of the devout.”
However, these jurists felt that this verse was supplanted by a saying attributed to Muhammad:
“No bequest is to be made to an heir.”
Today, most jurists fall into the camp of Ibn Hanbal and al-Shafii and hold that a law can
only be repealed by the authority that made it (Mahmassani, 1961, pp. 64-66). Essentially, only
Muhammad can repeal himself, and even Muhammad cannot repeal God.
Classification of Human Deeds
The rulings of the Sharia, drawn from the primary sources using the methods described
above, are intended to guide the behavior of Muslims in the temporal world. They are divided
into five categories, based on whether performing an action or not performing it are rewarded,
not rewarded, punished, or not punished.
1. Deeds that are incumbent upon Muslims to perform are wajib. Making the hajj,
performing prayers (salat), and paying alms (zakat) fall into this category.
2. Deeds that are recommended but not mandatory are mandub. The remembrance of
God (zikr) is an example.
3. Deeds that are permissible but neither rewarded nor punished are mubah.
4. Deeds that are frowned upon but not expressly prohibited and punished are makruh.
A Muslim is rewarded if he or she refrains for committing makruh deeds.
5. Deeds that are expressly forbidden are considered to be haram. Like makruh deeds, a
Muslim is rewarded if he or she refrains for committing haram actions. Charging or
23
paying interest is considered haram under the prohibition of riba. Engaging in
something that is haram is subject to divine penalty (Saleh, 1998, p. 262).
Another important term is halal, which simply refers to something that is permissible under
Islamic law. The system above is a perfect example of the flexibility of Islamic law. Jurists can
and do disagree about the nuances between each of the categories. Furthermore, Muslim jurists
recognize the broad range of human behavior and the complexities of the human condition. Thus,
we see yet again that different human actions seldom can be classified as unequivocally bad or
unequivocally good in Islamic law.
Historical Foundations of the Sharia and Islamic Law
Jahiliyya
Muslim historians refer to the period before the advent of Islam as Jahiliyya, or the Time
of Ignorance, meaning that humankind was ignorant of God’s true religion and His law before
Muhammad’s revelations. Despite this designation, the legal institutions, traditions, and
structures of pre-Islamic Arabia had a profound influence on the development of Islamic law.
The early inhabitants of the Arabian Peninsula, the Bedouin, had a very complex system of law
that was rigorous in the application of its rules. The cities of Mecca and Medina, which were
destined to play a key role in the coming religion, were already bustling centers of commerce
and trade, as were other cities and towns in the area. The people of this region, therefore, had a
well developed system of commercial law with which Muhammad was no doubt familiar in his
position as a caravan leader for his wife Khadija’s Mecca-based mercantile business.
Family law, criminal law, and laws of personal status were also well developed in the
Arabian Peninsula before the advent of Islam. These laws were dominated by the tribal system,
24
a social force that still wields much power and influence in the Arab world today. The individual
was only understood in terms of his or her tribe; the tribe provided legitimacy and protection to
its members. The features of tribal law were affected in no small way by Islam, but they have
still left indelible fingerprints on Islamic law.
The Arabs of this period relied extensively on mediation through arbitrators known as
hakam. The importance of the hakams lied in the fact that whatever judgments they issued in
legal disputes became an authoritative explanation of what the law was or ought to be. Thus, the
hakam’s role as arbitrator also developed into that of a lawmaker. Through his statements, the
hakam explained what constituted the sunna, or normative custom (to be distinguished from the
prophetic Sunna of Muhammad). The hakams applied and developed this sunna, which became
one of the most important concepts in what would become Islamic law (Schacht, 1964, pp. 6-8).
Due to his status as the Messenger of God and a man of unblemished character,
Muhammad was considered by his followers to be a hakam. Moreover, his military and political
successes extended his influence beyond that of a mere arbitrator. As a prophet, Muhammad was
concerned with laying down a moral code by which man could lead a life that was most pleasing
to God. Nevertheless, Muhammad had to work within and apply Islam’s religious and ethical
guidelines to the legal institutions of his day. The legal rules and prohibitions that are found in
the Quran and the Sunna do not exist solely for their own sake. Instead, they can be seen as
establishing, upholding and maintaining the moral norms that characterize a proper Islamic
lifestyle. For instance, the Quranic prohibitions of riba and gharar were meant to further the
ends of Islamic justice, such as preventing the exploitation of the poor. Though these
prohibitions concern certain kinds of commercial and legal transactions, the Quran does not
25
concern itself with regulating the form and substance of these transactions (Schacht, 1964, pp.
11-12).
The Formative Era of Islamic Jurisprudence
The Umayyad and Abbasid Caliphates
After the death of Muhammad in 632 and the reign of the Medinan caliphs between 632
and 661, the rule of the Muslim community was transferred into the hands of the Damascusbased Umayyad dynasty. While the Umayyads tended to focus more on temporal matters of state
and administration, Islamic law, justice, and jurisprudence began to solidify and emerge during
their rule. As the Umayyads concentrated on the territorial expansion of the Muslim empire,
Umayyad governors also took steps that advanced the development of Islamic fiqh. As the
empire grew, the system of arbitration that prevailed in the era of Jahiliyya and the first decades
of Islam no longer met the legal needs of Muslims. The governors met these needs by appointing
qadis, Islamic judges. The qadis used their own reasoning to reach their decisions, thus forming
the base from which Islamic law would spring. Under the qadis, a trend toward greater
Islamization of local laws began in earnest.
Toward the beginning of the eighth century, more and more ‘specialists’ were appointed
to the post of qadi. A specialist was not someone who was trained in a dedicated educational
institution. Rather he was one who spent time studying the injunctions and legal directives of the
Quran. These individuals were not merely concerned with legal points, but with the wider
application and implementation of Islam in the lives of Muslims. Thus it is during the Umayyad
period that we see the emergence of the ulama, the body of religious/legal scholars which
responded to the prevailing practice of adopting local laws in the acquired territories of the
26
Islamic empire. The ulama came to dominate the qadis and coalesced into a separate,
independent group (Z. Antrim, personal communication, February 2, 2009).
After the Abbasid dynasty overthrew the Umayyads in the middle of the eighth century,
the Islamicization of the law proceeded even further. The Abbasids maintained that Islamic law
was the only legitimate law and elevated the status of the ulama, with whom they consulted on a
variety of issues. The early Abbasid rulers sought to shape the articulation of Islamic law from
theory into practice, but later rulers were less assiduous in their commitment to this goal and
were more concerned with preserving and extending their own power.
Thus, gradually during the Abbasid period, the Sharia and its interpretation became the
exclusive domain of the ulama. Although in theory the ulama operated outside of the influence
of the government, in practice they were far less independent, especially those employed as qadis
who were subject to dismissal and dependent upon executive power to enforce their rulings
(Schacht, 1964, pp. 49-56).
The Rise of the Madhhabs
Thanks to their newfound independence, the ulama were free to immerse themselves in
the articulation of Islamic law, and jurists actively began to develop a rich corpus of legal
thought. During the 9th-11th centuries, fiqh reached its apex, as did so many other sciences in the
capable hands of Muslim scholars. It was also during this time that one of the most important
features of Islamic law began to emerge – the madhhabs, or ‘schools’ of law (Mahmassani, 1961,
p. 17). These madhhabs and the scholars who inspired them hold great significance in the history
of Islamic law in particular and Islam in general.
The term “school” is often used in the literature for the lack of a better word. Throughout
the history of Islamic law, there were numerous such schools, only four of which survive to the
27
present day. The madhhabs were not formal educational institutions. They were merely groups
of jurists who adhered to certain legal doctrines that can be traced back to a pioneer in Muslim
law for which the school was named. Even so, a strict conformity to said doctrines did not exist
in each madhhab, as jurists who belonged to the school were free to differ in opinion from the
‘official’ line. Many often did. Even though a jurist may identify himself as belonging to a
specific madhhab, he is by no means bound by that school’s doctrines. He is free to pick and
choose the doctrines that he feels are best in formulating his legal opinion. It is highly likely that
this freedom of choice has always existed for jurists (Hallaq, 2001, p. 21).
There were hundreds of schools that did not survive the test of time. Only four madhhabs
survive to this day in Sunni Islam: the Hanafi school, the Maliki school, the Hanbali school, and
the Shafii school. The scholars for whom these madhhabs were named did not “found” a school
in any sense of the word; rather their followers and students retroactively applied their names to
the madhhabs that were established around their teachings and doctrines (Hallaq, 2001, p. 25).
The Maliki School
In the Arabian Peninsula, the city of Medina became a seat of Islamic jurisprudence. As
Medina was the destination of Muhammad’s flight from Mecca in 622 and the site from where
he regulated the affairs of the community for the last decade of his life, it is no small wonder
then that the school of Medina came to be associated with those who placed great importance on
the traditions of Muhammad. A number of jurists emerged in Medina who received renown
across the Muslim world for their brilliance. The most famous is Malik ibn Anas al-Asbahi (b.
711 – d. 795). Malik was considered to be a leading authority on prophetic traditions because of
the meticulous diligence he displayed in finding and authenticating hadith. Malik was also a
major proponent of ijma; he relied extensively on the consensus of the scholar-jurists of Medina
28
when he could find no answer to a legal question in the Quran or the Sunna (Dutton, 1999, p. 13;
Mahmassani, 1961, pp. 24-25). Malik was clear in his assertion of the superiority of the Medinan
rulings over those of other cities’ ulama. He cites the Medinese jurists’ greater experience and
knowledge of Islam due to their city being the City of the Prophet (Dutton, 1999, p. 38). Only in
the absence of the Quran, Sunna, and the ijma of the Medinan jurists did Malik employ his
formidable intellect in ijtihad.
From its home in Medina, the Maliki madhhab spread through the rest of the Hijaz, the
Maghrib (North Africa), and Andalusia (Muslim Spain). The school also reached Upper Egypt,
Sudan, Bahrain, Kuwait, and other Islamic nations. It also spread across Muslim Central and
West Africa (Mahmassani, 1961, pp.26-27; Schacht, 1964, p. 65).
The Hanafi School
The eponym of the Hanafi school, Abu Hanifa Numan ibn Thabit of Kufa, Iraq, was
known for his scholarly and legal brilliance. His school was established around 805, at the time
of the death of his famous student al-Shaybani, approximately forty years after Abu Hanifa’s
death. A significant characteristic of Abu Hanifa’s juristic work is his willingness to develop and
extend the Sharia through personal reasoning. Along with the Quran, Sunna, and the opinions of
the Companions, Abu Hanifa considered personal opinion, obtained through the rigorous use of
ijtihad, an important source of the law. This confidence in personal opinion characterized his
school and his followers. Abu Hanifa was also a diligent analyst of the hadith (Mahmassani,
1961, pp. 19-20).
From its home in Iraq, the Hanafi school spread wide across the Muslim world. One
third of the world’s Muslims are adherents of the Hanafi school. Hanafi jurisprudence was the
basis for the Majallah, the official legal code of the Ottoman Empire. Besides being the official
29
school of Lebanon, Syria, and Egypt, it is also widely accepted in Turkey, the Balkans, the
Caucasus, China, India, Pakistan, and Afghanistan (Schacht, 1964, p. 65; Mahmassani, 1961, p.
24).
The Shafii School
The Shafii school revolves around the teachings of the great jurist Muhammad ibn Idris
al-Shafii. Al-Shafii was well traveled, and his sophistication, intellect, oral and written eloquence,
and proficiency in jurisprudence made him a scholar of exceptional ability. These personal
qualities allowed him to create the foundations of his own madhhab, which synchronized the
Maliki school and the Hanafi school. Al-Shafii was heavily influenced by Abu Hanifa and his
teacher Malik; thus his madhhab is an effective melding of the characteristics of these two
influences: reliance on opinion and reliance on tradition, respectively. Thus, the importance of
al-Shafii’s synthesis in the history and evolution of Islamic law cannot be overestimated
(Mahmassani, 1961, p. 27). Because of his articulation of such a synthesis, al-Shafii is
traditionally regarded as the founder of fiqh. Other scholars had contemplated issues of
jurisprudence long before his time, but al-Shafii laid the foundations for the basic structures of a
methodology.
Egypt is home to many adherents of the madhhab, especially in rural areas. Palestine,
Jordan, Syria, Lebanon, Iraq, Pakistan, and India have many adherents as well. Nearly all the
Muslims of Southeast Asia, including Indonesia and Malaysia, follow the Shafii madhhab. The
school also has followers among the Sunni Muslims of Iran and Yemen (Mahmassani, 1961, p.
29; Schacht, 1964, p. 66).
The Hanbali School
30
The smallest of the madhhabs, the Hanbali school began around 855, the date of the
death of its namesake, the Baghdadi jurist Ahmad ibn Hanbal. Ibn Hanbal disliked the use of
personal reasoning even more so than Malik. He advocated the strict adherence to a literal
understanding of the primary sources of the Quran and the Sunna. Ibn Hanbal was said to be
unyielding in his own personal faith and his unwillingness to compromise on his views of true
Islam often led to his persecution and punishment.
Throughout its history, the Hanbali madhhab has seen two periods of rejuvenation. The
first came during the thirteenth and fourteenth centuries with the advent of Ibn Taymiyya and his
student Ibn Qayyim ibn Jawziyya. Ibn Taymiyya consistently denounced what he considered to
be bida, or improper innovation, such as cults of saints, some prevalent Sufi doctrines such as
esotericism, and certain rituals he observed during his pilgrimage to Mecca in 1292. Like Ibn
Hanbal, Ibn Taymiyya was totally committed to the primacy of the textual sources of the Quran
and Hadith. Ibn Taymiyya, and indeed most if not all Hanbalis, attached relatively little
importance to ijma. Also like most Hanbalis, qiyas never took precedence over the text for him.
Nevertheless, he supported the disciplined use of ijtihad, believing that ijtihad was an integral
component of the continual interpretation of the Law (“Ibn Taymiyya,” 1971, pp.951-955).
Ibn Taymiyya’s teachings and legacy directly inspired the second renewal of Hanbalism
that occurred during the eighteenth century in the person of Muhammad ibn Abd al-Wahhab. His
fiery, puritanical form of reformism, today known as Wahhabism, swept through the central
Arabian Peninsula. Ibn Abd al-Wahhab rejected the blind imitation of ancestors and argued for a
return to the pure Islam of the time of Muhammad. By the same token, he too rejected what he
considered to be religious deviations such as the worship of tombs and saints.
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The Hanbali school is the official madhhab of Saudi Arabia and has adherents in other
parts of the Arabian Peninsula, Palestine, Syria, Iraq, and other Islamic nations (Mahmassani,
1964, pp. 30-33).The school is often called the most conservative of the madhhabs. However,
this is erroneous. For one, the Hanbalis reject ijma; the schools which accept and rely extensively
on ijma tend to be the most conservative since they are thus more prone to adhere to the
precedents set by earlier scholars. In addition, Hanbali jurists have been some of the most
frequent users of ijtihad, such as Ibn Taymiyya (whose work on gharar has important
implications for modern Islamic finance, as we shall see) (Z. Antrim, personal communication,
February 2, 2009).
The Evolution of the Madhhabs
The madhhabs can be seen as the intellectual and structural basis of Islamic law. But it
would be a mistake to think that the madhhabs became rigid entities after the deaths of their
eponyms. The madhhabs evolved and changed to respond to the needs of Muslims in each and
every age. Indeed, although the disciples of the four scholars preserved their work and legacies
and referred to them often, later jurists also used their own intellect and ijtihad to further refine
and develop fiqh and each madhhab’s legal corpus. In short, at no point in time did Islamic law
become stagnant.
In 1950, Joseph Schacht published his landmark work The Origins of Muhammadan
Jurisprudence. One of the key points of this book is that the madhhabs began their existence in
the eighth century when jurists began to cluster around geographical centers. Jurists were thus
identified by their regional affiliations. Schacht called these geographical centers the ‘ancient
schools of law’ (Hallaq, 2001, p.1), the most important of which were Kufa and Basra (the Iraqi
school), Mecca and Medina (the Hijaz school), and Syria. In the early Abbasid period, these
32
geographical schools transformed themselves into personal schools that focused on the doctrine
of an individual master-jurist, whose work and teachings disciples carried forward. According to
Schacht, this process was completed by the middle of the ninth century. Schacht maintains that
this transformation was largely due to the efforts of al-Shafii. Since al-Shafii’s teachings and
rulings were an amalgamation of Maliki and Hanafi doctrine, al-Shafii thus created a new
personal doctrine all his own. Thus, Schacht asserts, anyone who adhered to al-Shafii’s teachings
became a follower of al-Shafii. Because of this, Schacht contends that al-Shafii was the founder
of the first truly personal school, and his actions were the catalyst that led to the creation of other
personal schools, including the other three orthodox madhhabs and those which eventually died
out (Schacht, 1964, p. 57-59).
The historian Wael Hallaq disagrees with this thesis, however. According to his theory,
the madhhabs did undergo a transformation, but they evolved from personal schools based on
individual doctrines to doctrinal schools; the geographical schools never existed. Hallaq (2001)
argues that all madhhabs in Islamic history developed a regional character, but this regional
variation was due to the environment in which a particular corpus of law developed, and was not
representative of a distinct geographical doctrine (p. 19). He cites examples in works of fiqh and
history of certain jurists having followings of their own during the period of the geographical
schools, as well as instances of jurists being classified as members of geographical schools even
after 870 CE, the date which Schacht specified as the end of the transformation from
geographical to personal schools (Hallaq, 2001, p.15). Hallaq also finds instances of
geographically defined schools from much later periods of Islamic history, even as late as the
thirteenth century. In addition, there is evidence that the later schools also developed a distinctive
regional character for their doctrine; Hallaq cites Andalusian Malikism, Transoxanian Hanafism,
33
and Syrian Shafiism as examples (Hallaq, 2001, p.18). Furthermore, Hallaq maintains that jurists
who worked in the same geographical area, such as Iraq, did not necessarily share a uniform
doctrine; it was merely convenient for historians to designate jurists by their location (Hallaq,
2001, p.16). Hallaq points to the schools of al-Shafii and the Damascene scholar al-Awzai (d.
774) as examples of scholars considered to be jurists of their own accord and with their own
personal madhhabs that had no association with a particular geographic location before the end
of the eighth century (Hallaq, 2001, p. 17).
As for the transformation from personal to doctrinal schools, Hallaq cites the emergence
of taqlid in the latter half of the ninth century and the tenth century. Taqlid, meaning “imitation,”
is characteristic of a madhhab reaching the final stages of its evolutional maturity. It refers to the
fact that jurists of each madhhab looked to past jurists, especially the four eponyms, for guidance
as to their legal decisions. The prevalence of taqlid, according to Hallaq’s theory, allowed
madhhab jurists to develop a cohesive and substantive body of doctrine and legal theory for their
particular school. Thus, on the macro-level, the later madhhabs were well-integrated entities, and
possessed an organized unity in their doctrinal orientation. Due to the highly individualistic
nature of ijtihad, each jurist within a madhhab had the right to form his own opinions. So on the
micro level, jurists had to control the vast assortment of opinions. To address this need, jurists
developed what Hallaq calls the madhhab-opinion, which was the authoritative doctrine of a
particular school, announced by fatwa (a non-binding religious opinion issued by a religious
scholar or scholars), and determined by the agreement of the madhhab’s jurists. The madhhabopinion also need not be that of the eponym of the school (Hallaq, 2001, pp. 21-24).
Due to the many instances that Hallaq presents of madhhabs not following the trajectory
espoused by Schacht, Hallaq’s arguments are more compelling than the Schachtian theory. The
34
importance of the madhhabs in the history and evolution of Islamic law is undeniable. In its final
form, the madhhab is the representative of a corpus of legal doctrine of its founder. Later jurists
both refined and elaborated that doctrine through their own reasoning. From the very beginning,
Islamic law has been a highly individualistic discipline. The madhhab at its developmental
height was intended to control this individualistic spirit, not curb it. Ijtihad is highly revered in
Islam for a reason. Islamic law owes its dynamic character, and indeed its very development, to
those efforts.
The Gate of Ijtihad
Ijtihad is the lifeblood and catalyst of Islamic law. For centuries, Muslim jurists have
developed the law and addressed the issues that affected the temporal and spiritual lives of
Muslims. A long held theory, again advanced by Joseph Schacht, was that the so-called “gate of
ijtihad” closed forever in the tenth century. Schacht and other scholars hold that during the early
Abbasid period, scholars began to feel that Islamic law had reached its ultimate maturity; all the
questions that mankind could ever raise had been answered through the Quran, Sunna, and the
ijtihad of brilliant jurists of old. Furthermore, the infallibility of ijma also led to the solidification
of doctrine and later to the restriction of jurists’ ability to exercise ijtihad. The question arose as
to who was qualified to practice ijtihad and who was not qualified to do so. Schacht posited that
jurists of the ninth century began to feel that no contemporary jurist had the qualifications that
the earlier scholars had possessed, and thus were not fit to exercise independent reasoning. From
that point on, scholars felt that jurists should limit themselves to the explanation and
interpretation of the doctrine laid down by their forebears. In short, this was a call for the era of
taqlid to begin. After this point, Schacht argues that Islamic law became rigid and extremely
conservative, and despite the opposition of a number of independent jurists and collective
35
movements, taqlid became the guiding principle of the law (Schacht, 1964, pp. 69-75; Weiss,
1978, p. 208).
However, later scholars have challenged Schacht’s theory and argued that no such
closure of the gate of ijtihad ever occurred. Bernard Weiss points out that there was never a point
in time in which a permanent barrier to ijtihad was formally erected, and disagrees with
Schacht’s proposition that ijma is the primary reason behind the conservatism of Islamic law
(Weiss, 1978, p. 208).
Again, it is Wael Hallaq who offers a compelling argument against the prevailing
Schachtian theory. Hallaq (1986) contends that scholars did not debate the necessity of ijtihad;
rather they raised questions about whether or not any era could persist without mujtahids. On one
side, the Hanbalis and a significant number of Shafiis held that mujtahids must exist at all times.
The Hanafis and other Shafiis believed that the mujtahids would eventually cease to exist
(pp.129-130). Hallaq bolsters his argument by pointing out that the search for ilm, or knowledge,
is a fundamental concept of Islamic culture. To Sunni jurists, ilm signified the knowledge of
what would please God. Ilm and fiqh are often equated by Muslim jurists in that fiqh is the
knowledge of God’s law. Ijtihad, along with other methods treated in works on fiqh, is meant to
extract and interpret God’s law from the primary sources. Consequently, it is only through ijtihad
that the Sharia can survive and flourish; closing the gate of ijtihad would prevent the continual
search for ilm and thus render the Sharia and Islam incomplete (Hallaq, 1986, pp. 131-132).
Thus jurists did not question whether the gate of ijtihad should be closed; rather they
were concerned with the existence or nonexistence of mujtahids. The ulama played a key role in
Islamic society, and the mujtahids were at the pinnacle of ulama hierarchy, regarded as the
guardians and expounders of the Sharia. Nevertheless around the tenth and eleventh centuries,
36
the dearth of highly gifted mujtahids like al-Shafii and Abu Hanifa led many Muslims to believe
that mujtahids were a dying breed and were being replaced by lesser mujtahids who could only
operate within the confines of the madhhabs. This belief led many to consider the possible future
extinction of the mujtahids (Hallaq (1986) pp. 135-136). The debate over the existence and
possible extinction of the mujtahids carried eschatological significance. In Islamic eschatology,
the disappearance of ilm is a sign of the Day of Judgment. Ilm could only disappear if the
mujtahids did as well. Thus, the decreasing number of mujtahids was a sign of the coming Day
(Hallaq, 1986, pp. 137-139).
Conclusion
Islamic law is a product of both revelation and reason. These two forces have had a
complex relationship throughout the entirety of Islamic history. After reading this chapter, it
should be clear to the reader that Islamic law is not a static thing. Rather, it is a dynamic, mutable
entity that benefits from and encourages the active participation of Muslim jurists and scholars. It
is further characterized by a wide range of disagreement and variance of opinion on innumerable
legal issues. What is halal (permissible) for one jurist is not necessarily so for others. This point
is especially relevant for the study of modern Islamic finance. One will find a wide range of
opinions on what is Islamic or un-Islamic. However, the same kind of debate and rigorous
intellectual grappling that has shaped, defined, and developed Islamic law over the centuries is
still very much at work in modern Islamic finance, and will continue to be so far into the future.
Furthermore, it is important to study the medieval era of Islamic history because it was in this
37
epoch that the contracts on which modern Islamic finance is based were first created and
developed. 3
3
This chapter has dealt with the dominant Sunni tradition. While much of the material also applies to the Shiite
tradition, there are many differences and a full study of Shiite law is beyond the scope of this thesis. Indeed, even a
broad study of Shiite legal traditions would constitute a thesis on its own. For those interested in Shiite law, the
writer recommends that they should start with pages 35-39 of the Mahmassani’s Falsafat al-Tashri fi al-Islam, cited
in this chapter. For an excellent summary of the Shiite traditions of ijtihad, see Weiss pp. 210-212.
38
CHAPTER III.
A REVIEW OF MODERN PORTFOLIO THEORY AND ETHICAL
INVESTMENT
Introduction
We have just explored the history and evolution of Islamic fiqh, or jurisprudence. The
reader should now have a clear picture of how Islamic legal theory has developed, and how it
continues to be employed to this day. Later we will discuss how the contracts developed in the
classical and medieval periods of Islamic history provided the foundation for modern Islamic
finance. We will also examine the unique considerations that confront Muslim investors as they
make their investment decisions. But it is important to remember that Muslims, like all investors,
must make those decisions based on their individual risk profiles and expected/desired rates of
return. The purpose of this chapter is to provide a brief review of modern portfolio theory as it
has developed in the United States and the Western world.
The Pioneering Work of Harry Markowitz
Portfolio theory as we know it began with the work of Harry Markowitz, who developed
the basic portfolio model during the 1950s. Markowitz derived a model that could yield the
expected holding period return for a portfolio. He also identified an appropriate measure of risk
for the holding period by showing that the standard deviation/variance, a well known statistical
measure, was an excellent way to quantify the measure of risk for a portfolio. At the same time,
his portfolio variance formula demonstrated the importance of diversification in order to reduce
the total risk of a portfolio. By diversification, it is meant that an investor can invest in a number
of asset classes, from stocks and bonds to art and real estate. Markowitz also stressed that
diversification could not eliminate all variance from a portfolio, and that a portfolio with the
maximum expected return will not always be the one with minimum variance. In terms of the
39
variance and standard deviation, it is important to remember that investors do not want
variability - whether it is above or if it is below - about the mean expected return.
Markowitz argued that having a high number of securities in a portfolio does not imply
adequate diversification. Rather, it is important for investors to diversify their asset holdings
across a wide range of industries, simply because firms in the same industry are more likely to
post concurrent poor performances than are firms in different industries. Investing in many
securities also is not guaranteed to ensure a small variance. The standard deviation/variance of
portfolio is a function of the standard deviations of individual securities and of the covariance of
rates of return for all pairs of assets in the portfolio. It is this covariance that is the most
significant determinant of adequate diversification and management of risk. The returns of two
firms in different industries will have a lower covariance than two firms that are in the same
industry. The concept of covariance applies equally to all asset classes, be they stocks, bonds,
real estate, etc. These simple yet profound observations form the basis of modern portfolio
theory, and are employed by portfolio managers and knowledgeable individual investors to this
day (Markowitz, 1952, pp. 77-91; Reilly and Brown, 2006, p. 202).
If one examined all of the two asset combinations that exist in a typical portfolio, we
would derive a multitude of curves that represent those combinations. The envelope curve that
contains the best of those possible combinations is referred to as the efficient frontier. Every
portfolio that has the maximum rate of return for a given level of risk or the minimum amount of
risk for every return is represented along the efficient frontier (see Figure 1). Every portfolio on
the frontier has higher return for equal risk than some portfolio beneath the frontier, or it can
have equal return for lower risk. For example, both portfolio A and B dominate portfolio C
because they lie on the efficient frontier. Portfolio A is preferable to portfolio C because it offers
40
the same rate of return as portfolio C but contains less risk. Portfolio B is preferable to C because
it offers a higher rate of return for the same level of risk. Risk and return are intimately related;
an investor can be rewarded with a higher return for accepting higher risk.
E(R)
B
A
C
E(σport)
Figure 1. The Efficient Frontier
It is important to keep in mind that neither portfolio A nor B is better than the other is. An
investor will choose either portfolio A or B based on their individual risk/reward preference. All
investors seek to find a suitable location on the efficient frontier based on their utility function,
which captures their risk tolerance. For instance, an investor that has an appetite for risk will
choose portfolio B over portfolio A. Conversely, a risk-averse investor will choose A. Based on
his or her utility function, an investor will seek to find the optimal portfolio, a combination of
investments that matches the investor’s risk-return profile.
In summary, the Markowitz model is based on five key assumptions:
41
1. Investors believe each investment is represented by a probability distribution of
expected returns over a defined holding period.
2. Investors seek to maximize their expected utility. Their individual utility curves show
diminishing marginal utility of wealth.
3. Investors estimate the risk of a portfolio based on the variability of expected returns,
as measured by standard deviation/variance.
4. Investors’ investment decisions are solely a function of expected return and expected
risk, as measured by standard deviation/variance.
5. For a given level of risk, investors expect higher returns. For a given rate of expected
return, investors prefer less risk to more risk.
Keeping these assumptions in mind, the optimal portfolio for any investor is one that offers the
maximum expected rate of return for the same or lower level of risk, or one that offers lower risk
for the same or higher expected rate of return, relative to another portfolio(s) (Reilly and Brown,
2006, pp. 202-223).
The Development of Capital Market Theory
Building on Markowitz’s portfolio theory, capital market theory emerged in order to
tackle the issue of valuing risky assets. Two major theories developed for this purpose are the
capital asset pricing model (CAPM) and the arbitrage pricing theory (APT).
A major innovation in the development of capital market theory is the concept of a risk
free asset. Such an asset would have zero variance, as well as zero correlation with other assets
in the portfolio. Thus, the risk free asset provides the pivotal risk free rate of return. It also
allows us to see how capital assets can be priced under conditions of uncertainty. Thanks to the
development of the risk free asset, James Tobin was able to take Markowitz’s work one step
42
further and derive the capital market line. The riskless asset’s expected rate of return was the
pure interest rate.
E(Rport)
CML
Point of
Tangency
Efficient
Frontier
M
RFR
σport
Figure 2. The Capital Market Line
At this pure rate of interest, investors can either lend or borrow. At point M in Figure 2,
the capital market line is tangent to the efficient frontier. Point M represents the risky market
portfolio. Below point M, an investor will be investing in the market portfolio and lending at the
risk free rate (i.e. investing part of your portfolio in the risk free asset). In addition to investing in
a portfolio beyond M on the efficient frontier, an investor may also add leverage to his or her
portfolio under the assumption that one can borrow money at the RFR and invest in risky
securities. 4 As seen in Figure 2, both risk and return increase in a linear fashion along the capital
market line. This simple linear relationship between the expected return and the standard
deviation of the portfolio represents equilibrium (Sharpe, 1964, pp.425-442). It was Tobin who
4
It should be noted by the reader that the lending and borrowing rates may differ, which would lead to a
discontinuity in the capital market line.
43
carried the CML to the market portfolio; others, especially John Lintner, extended the concept to
distinguish between the lending and borrowing portfolios, as seen in Figure 3.
Another important development in the evolution of capital market theory is James
Tobin’s separation theorem, which describes the separation of the investment decision from the
financing decision. Since the market portfolio represents the best investment opportunity, all
investors will want to invest their money in it. Investors differ only in the position that they
desire on the capital market line, which depends on their risk preferences. How an investor
obtains the desired position on the CML is a function of their investment decision based on their
risk tolerance, i.e. whether they want to lend (for more risk averse investors) or borrow (for more
risk tolerant investors) at the risk free rate (Tobin, 1958, pp. 65-86).
E(Rport)
Borrowing
Point of
Tangency
CML
Lending
M
RFR
σport
Figure 3. The Capital Market Line with Lending or Borrowing at the Risk Free Rate
44
The market portfolio includes all risky assets, such as stocks, bonds, foreign securities,
art, real estate, antiques, etc. Because of the tremendous diversity of its holdings, the market
portfolio is regarded as completely diversified, meaning that all of its diversifiable risk is no
longer present. Specifically, this diversifiable risk is unique to each individual asset; it is known
as unsystematic risk. The unsystematic risk of each asset is offset by the variability of all other
assets in the market portfolio. After all the unsystematic risk has been diversified away, only
systematic risk is left. Systematic or market risk, measured by the standard deviation of a
portfolio’s returns, is influenced by macroeconomic variables such as changes in interest rates,
inflation, the money supply, and variability in factors like industrial production. To eliminate
unsystematic risk through diversification, one must add securities to the portfolio. A study by
Statman (1987) showed that a well diversified stock portfolio should contain at least 30 stocks
for a borrowing investor and 40 for a lending investor, after transactions costs. While adding
stocks with low correlations to each other will diversify away the unsystematic risk in a portfolio,
it will not eliminate the systematic risk (Reilly and Brown, 2006, pp.236-237).
The Capital Asset Pricing Model and Arbitrage Pricing Theory
The Capital Asset Pricing Model (CAPM)
Developed by William Sharpe, John Lintner, and Jack Treynor, the traditional capital
asset pricing model (CAPM) determines what should be the expected rate of return on a risky
asset. The formula for the model is usually given as follows:
E(Ri) = RFR + βi (RM – RFR)
In the equation,
E(Ri) = the expected return on asset i
45
RFR = risk free rate
βi = the beta (a measure of standardized risk) of asset i
RM = the return on the market
RM – RFR = market risk premium
In addition, if an analyst or investor has already determined the expected rate of return on an
asset, he/she can use the CAPM to calculate a required rate of return. By comparing the expected
rate of return to the rate indicated by the CAPM, one can determine if an asset is properly valued,
overvalued, or undervalued.
Determining if an asset is properly valued or not requires the derivation of a security
market line (SML) for that asset, which represents the relationship between an asset’s expected
or required rate of return and its systematic risk.
E(Ri)
SML
RM
RFR
σ2 M
Figure 4. The Security Market Line
CoviM
46
Figure 4 presents a security market line for an asset i, depicting its risk/return profile. In terms of
the CAPM and the SML, the most important variable is the beta, which measures systematic risk
(the type that cannot be diversified away). The beta measures a risky asset’s covariance with the
market portfolio as it relates to the variance of the market portfolio:
βi = CoviM/ σ
2
M
Here,
CoviM = covariance of asset i with the market portfolio
σ2M = variance of the market portfolio
The market portfolio’s beta is 1. If an asset has a beta that is higher than 1, this signifies that the
asset has a higher systematic risk than the market. In other words, it is more volatile than the
market portfolio. Conversely, if an asset has a beta less than 1, this signifies that it has lower
systematic risk than the market and is thus less volatile.
As shown in the equation for the CAPM, the expected rate of return for a risky asset is
calculated by adding the RFR and the risk premium. The risk premium itself is calculated by
multiplying the beta and the market risk premium (Reilly and Brown, 2006, pp. 239-241).
Arbitrage Pricing Theory (APT)
While the CAPM has been one of the most useful and revolutionary concepts developed
in financial economics, it also has a number of shortcomings. Many academicians were not
convinced of a perfectly linear relationship between risk and return. Others questioned the
CAPM’s dependence on a market portfolio not currently available and thus its usefulness in
portfolio evaluation. Anomalies such as the small firm effect – where small capitalization stocks
tended to outperform large capitalization stocks on a risk-adjusted basis – also cast a shadow on
the efficacy of the CAPM and other single factor models. Thus financial economists began to
47
search for a model that overcame these deficiencies and permitted multiple expressions of risk.
Arbitrage pricing theory, developed by Stephen Ross during the 1970s, was the result of this
search. APT is a multifactor model that allows investors and analysts to quantify and identify
risk factors in the valuation of an asset (Reilly and Brown, 2006, pp. 270-271).
The APT is usually represented mathematically as follows:
Ri = E(Ri) + bi1δ1 + bi2δ2 + …+ bikδk + εi (i = 1 to n)
In the equation,
Ri = the actual return on asset i during a specific time period
E(Ri) = expected return on asset i provided risk factors do not change
bij = the reaction in asset i’s returns to movements in risk factor j
δk = common factor or indexes with a zero mean that affect returns on all assets
(macroeconomic variables like interest rates, GDP growth, and political events)
εi = a random error term with a mean of zero and that is completely diversifiable in a
large portfolio
n = number of assets
The bij terms measure the magnitude of how an asset reaches to a specific factor. For instance,
export-oriented firms will be more sensitive to changes in exchange rates than firms who conduct
most or all of their business domestically. So the export-oriented firm may have a bij of 5, while
the domestically oriented firm would have a bij of 1.
In the APT, when unique factors – εi – are diversified away, the return on a zero beta
portfolio is zero. Thus, the expected return on an asset is found through the equation:
E(Ri) = λ0 + λ1b i1 + λ2b i2 + … λkb ik
Where:
48
λ0 = expected return on asset i with zero beta
λ1 = risk premium attached to risk factor j
b ij = the factor beta – measures responsiveness of asset i to changes in risk factor j
Through this equation, the investor can calculate the expected rate of return on a risky asset
using the APT.
The CAPM and APT are both static linear models that attempt to represent the investor’s
investing activity – risking capital to obtain a financial reward. The key difference between the
two models is how they represent systematic risk. The CAPM relies on a single representation of
that systematic risk, namely beta. The APT on the other hand employs multiple factors to express
and capture market-wide systematic risk (Reilly and Brown, 2006, pp. 270-272).
While the ability to choose multiple common risk factors in the valuation of a security is
a definite advantage of the APT, the theory unfortunately does not indicate what those factors are
or how many factors there are. Some financial economists have recommended and employed
with success common macroeconomic variables that affect all securities to be used as factors in
the APT model – inflation rates, interest rates, changes in real GDP, etc. These are generally
known as macroeconomic risk factor models. Others have suggested using microeconomic risk
factor models, which use the characteristics of the securities themselves to define the relationship
between risk and return. An example of this approach is the Fama and French model which used
three different risk factors:
1. excess return to the stock market portfolio
2. the return differential associated with firm size (i.e. large capitalization vs. small
capitalization)
49
3. the return differential associated with book-to-market valuation (i.e. “value” stocks vs.
“growth” stocks) (Reilly and Brown, 2006, p. 292)
Ethical Investment
Ethical investment, also called conscience investing, can be defined as the use of ethical
and social parameters of selecting and managing a portfolio. It has its roots in the efforts of
religious institutions to avoid investing in morally dubious industries. Some of the earliest
examples of ethical investing in the US were church groups that found it morally repugnant to
invest in the so called “sin” stocks of companies that were engaged in producing alcohol and
tobacco and gambling. The Pioneer Fund, launched in 1928, was the first mutual fund created to
serve the social interest of these religious groups. Later, several social movements in the United
States, including the women’s rights movement, the civil rights movement, the environmental
movement, and national/international issues, such as the Vietnam War and apartheid in South
Africa, compelled more investors to combine their moral/ethical beliefs with their investment
strategies. The most visible example of ethical investing came during the 1980s as anti-apartheid
activists led a campaign against investing in South African companies in an effort to show their
displeasure with a racist regime and to encourage the end of apartheid. College endowments and
pension funds (most notably TIAA-CREF and the California Public Employees’ Retirement
System) led the way in divestment of South Africa related investments. The boycott received a
great deal of international publicity and a wave of portfolio managers rushed to accommodate the
wishes of their clients who wished to rid their portfolios of companies that had any South
African operations (Judd, 1990, pp. 9-11). The recent move to divest from Chinese companies
that have operations in the Darfur region of the Sudan is a modern day equivalent of the South
Africa boycott.
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The ethical investing sector can be subdivided into four broad categories: environmental,
political, social, and religious. The demand for ethical investing has grown steadily over the past
few years and the trend is projected to continue (Atta, 2000, p. 10). In their landmark guide,
Ethical Investing, Amy Domini and Peter Kinder (1984) identified three approaches to ethical
investing (here, “institution” can be substituted for “investor” to account for institutional
investors such as pension funds, endowments, mutual funds, banks, etc.):
1. Avoidance – an investor avoids investing in companies that offend his or her
ethical sensibilities (modern Islamic finance most frequently uses this approach).
2. Positive choice – an investor places his or her funds with companies that meet
their social/ethical goals, such as companies that hire and promote minorities,
make products and services that improve the environment, treat their workers well,
etc.
3. Activism – an investor uses his or her clout as a shareholder to induce company
management to policy changes.
Domini, a leader in the field of socially responsible/ethical investment, believes that while
avoidance and positive choice complement each other, activism requires a greater degree of
dedication by an investor (not to mention enough capital to buy and hold blocks of shares large
enough to carry sufficient influence to challenge management) (pp. 2-12).
Key Characteristics of Ethical Funds
There are several key traits that ethical funds 5 share in common. First, most ethical unit
trusts utilize some type of screening criteria to select investments. While these screens can be
positive or negative, negative screens tend to be more widely used due to the ease with which
5
An ethical fund is a fund that consists of investments that are chosen in regard to a specific set of ethical guidelines
and standards established by an investor and/or an asset manager.
51
they can be described and monitored. Negative screens also tend to be less subjective than
positive screens. On the whole, the process of deciding what is an ethical investment is
subjective and by no means universal. The disparity in the ethical definitions of different ethical
funds can make comparison and evaluation difficult to attribute to any common ethical
standard(s).
Ethical investment units have also been found to have a bias toward small capitalization
stocks. Studies conducted on ethical funds in the UK have demonstrated this bias. This may have
important implications for the returns of ethical funds, including Islamic funds. There is a well
documented stock market phenomenon called the small company effect; over long periods of
time, small cap stocks tend to have higher returns than large cap stocks. To be sure, the level of
risk involved in investing in small cap stocks is larger than for large cap stocks. This effect has
been documented in many markets, including US and UK stock markets.
Ethical unit trusts also tend to differ in terms of the international exposures of their
holdings. Choosing ethical companies may lead to the exclusion of certain nations. Global asset
allocation may become more a function of ethical standards than that of evaluations of market
fundamentals. As aforementioned, during the era of apartheid many investors did not invest in
South Africa. 6 More recently, many investors withdrew money from Chinese oil companies that
did business in the Darfur region of the Sudan. International diversification has been shown to
have positive effects for a portfolio’s returns because foreign stocks tend to have historically low
or negative correlations with US stocks. Many foreign securities also offer higher risk-adjusted
6
The impact of this boycott on South African financial markets has been debated. A 1999 study by Teoh, Welch,
and Wazzan found that divestment had little to no significant impact on its targets. The team found that total
corporate participation in South Africa was so limited that in spite of the large number of divesting companies and
pressure from legislators and investors, the boycott had little noticeable effect on South African financial markets or
the valuations of South African firms. (Please see Teoh, Siew Hong, Ivo Welch, & C. Paul Wazzan. (1999). The
Effect of Socially Activist Investment Policies on the Financial Markets: Evidence from the South African Boycotts.
Journal of Business, 72, pp. 35-89.)
52
returns than US securities (Reilly and Brown, 2006, p. 97). If an ethical fund is circumvented
from investing in foreign securities, its returns may be negatively impacted (Atta, 2000, pp.9-13).
Ethical vs. Socially Responsible Investing
In everyday parlance, “ethical investing” and “socially responsible investing” are terms
that are used interchangeably to describe investing money with a conscience. However, ethical
investing is only a subcategory of socially responsible investing (SRI), according to social
responsibility proponent Ritchie P. Lowry. Under the broad umbrella of SRI, Lowry (1991)
identifies three distinct types of SRI. Ethical investing, which is a passive approach to social
responsibility, is the simplest form of SRI; individual and institutional investors make their
investment decisions using their own subjective ethical judgment. Domini’s avoidance and
positive choice approaches are most commonly used in this type of SRI. Social investing
involves using the activist approach; social investors use their position as shareholders in
company to influence and coerce management to change their policies. Alternative investing is
the process of investing in ventures that contribute to the public good, such as land trusts and low
income housing developments.
Ethics and morality are highly subjective issues, open to the interpretation of the
individual. With such divergent views on what constitutes ethical behavior, there is no consensus
on what role, if any, social responsibility should play in investment management (not unlike the
debates over which Islamic financial contracts are permissible under the Sharia and which ones
are not!) (pp. 19-36).
Conclusion
In this chapter, we have reviewed the history and evolution of modern portfolio theory
and, briefly, ethical investing. The question of risk and return is one that every investor,
53
regardless of his or her religious persuasion, must face when making their investment decisions.
But for Muslims who choose to adhere to the Sharia, there are other, spiritual considerations as
well. For these Muslims, the Sharia does not stop at the door of the mosque. As we have seen in
chapter II, the Sharia is a way of life and a code of conduct. It has as much influence on earthly
matters like investing as it does on spiritual and religious obligations. We will now turn our
attention toward one of the most prominent forms of ethical investing – Islamic investment.
54
CHAPTER IV.
SHARIA CONSTRAINTS ON MUSLIM INVESTORS
Introduction
We have just reviewed the history and evolution of modern portfolio theory. As we have
seen, every investor follows (or at least should) the profit maximization-loss minimization rule
taught in every introductory economics course and adapted to portfolio selections. Every investor,
from conservative individuals with low risk appetites who seek to build and protect their wealth
to hedge fund managers who are willing to accept high risk for the possibility of huge return,
wants to achieve the maximum return for the least amount of risk. In other words, investors
optimize between risk and return based on their individual preferences. Muslim investors are no
exception.
However, beyond these considerations some Muslims choose to answer to the strictures
of their faith. Indeed, the investment requirements imposed by the Quran and the Sharia
constitute one of the earliest examples of what is now called socially responsible investing. The
Muslim investor has the same goal as any other investor – to maximize returns relative to risk –
but he or she also has the religious obligation to put his or her money into business ventures and
firms that are compatible with Islam and the Sharia. For the pious, not to do so entails a worse
punishment than losing money – it means disgrace in the eyes of God.
The purpose of this chapter is to examine the restrictions that the Sharia imposes on
Muslim investors. It will detail accepted and prohibited lines of business, as well as the financial
characteristics of a halal (legally sanctioned) investment. The classical prohibitions of riba,
gharar, and maysir will also be examined. The chapter will also look at the development of
Islamic investment funds, and the issues that they face. (Islamic equity funds will be the key
focus of this chapter and the next; other investment alternatives for Muslims will be discussed in
55
a later chapter.) The issues explored in this chapter are integral for understanding the
considerations and obligations that pious Muslim investors face every day, and for understanding
what makes Islamic investing truly Islamic.
The Philosophy of Islamic Investing
Omer Ahmed (2000), president of Crescent Capital Management, detailed five key
components of what he considers the “philosophical mandate” of Islamic finance:
1. Wealth must be deployed productively.
2. The hoarding of wealth is haram (forbidden).
3. Money is not an asset.
4. Islam recognizes a separation between ownership and control.
5. Capitalists cannot take advantage of their position.
These five guidelines provide a useful framework for understanding the philosophy of Islamic
finance and economics.
As referred to in chapter II, Islam, through its sacred text, the Quran, provides, at least in
theory, a comprehensive set of principles and requirements for the daily lives of Muslims. Islam
is thus deeply involved in social, political, cultural, and economic matters. The ideal Islamic
economic and financial system differs markedly from the Western interest-based model. It is
important to appreciate that this system is defined and best understood in the context of an
Islamic society.
Ahmed reminds us that in Islam, justice, equality, and fairness are the ends to which all
Muslims must strive. Those involved in business, trade, and finance are no exception and must
endeavor to reach these goals in addition to making a profit or achieving a high rate of return.
Most Muslims do not regard the presence or absence of wealth as vice or virtue.
56
Muslims believe that all wealth belongs to God, and that man only serves as a steward
over whatsoever portion of wealth that God has allotted to him. The Quran places great
significance on how Muslims create, use, and consume their wealth. According to Ahmed,
wealth in Islam is defined in terms of assets, not monetary value. Money is seen as merely a
medium of exchange, with no intrinsic value of its own. The commoditization of money is not an
accepted concept in Islamic economics. Money is at best a potential asset. It only attains a
nominal sense of value when it is deployed productively.
Islam stresses modesty, the avoidance of wasteful consumption, and self-reliance, and
enjoins Muslims to deploy their wealth productively. The hoarding of wealth is expressly
forbidden (Quran 9:33-34). Taking advantage of one’s wealth is also haram. In the context of
business and financial dealings, wealthy owners of capital should not supersede or enjoy any
advantage over the possessors of other factors of production, such as labor. This would violate
Islam’s insistence upon fairness and equality.
Ahmed stresses that profit and loss sharing, or equity based, financing is the most favored
way to conduct financial and business transactions in Islam. Providers of capital and providers of
labor are considered to be equal partners in any contract or transaction; therefore both have the
right to enjoy the fruits of any venture, in addition to bearing the weight of any losses. Providers
of capital cannot protect their capital or demand forms of guarantees for a pre-specified capital
return. This would be a form of the forbidden riba (discussed below). This condition reflects
Islam’s preoccupation with justice and fairness (“Islamic Investing,” 2000.)
The Three Major Prohibitions of Islamic Finance: Riba, Gharar, and Maysir
Modern Islamic finance is a prohibition driven industry. Namely, there is a great deal of
time spent elucidating what Muslims cannot do, or what is haram. While that list is a long one,
57
three main prohibitions must be highlighted in order for the reader to understand the key
foundations of Islamic finance: riba, gharar, and maysir.
Riba
Those who charge riba are in the same position as those controlled by the devil's
influence. This is because they claim that riba is the same as commerce. However, God permits
commerce, and prohibits riba. Thus, whoever heeds this commandment from his Lord, and
refrains from riba, he may keep his past earnings, and his judgment rests with God. As for those
who persist in riba, they incur Hell, wherein they abide forever.
-Quran 2:275
O you who believe, you shall observe God and refrain from all kinds of riba, if you are
believers. If you do not, then expect a war from God and His messenger. But if you repent, you
may keep your capitals, without inflicting injustice, or incurring injustice. If the debtor is unable
to pay, wait for a better time. If you give up the loan as a charity, it would be better for you, if
you only knew.
-Quran 2:277-280
Every loan (qard) that attracts a benefit is riba. 7
Probably the most distinguishing (or at least the most widely known among non-Muslims)
feature of Islamic finance is the prohibition of the payment and receipt of interest. This
prohibition is known by the Arabic word riba, which literally means “increase.” Generally, riba
constitutes any increase in capital for which no compensation is given. Islam forbids the lending
of credit for profit. The Quran fervently denounces riba, and both it and the Sunna list riba as
one of the most grievous sins. The least of the forms of riba are equated with incest, for instance.
All who take part in riba are accursed, both in this world and in the next, where they are
threatened with hellfire. The Quran regards it as a practice of true unbelievers. Indeed, as a test
of Muslims’ belief, it demands that riba should be abandoned, and threatens dire punishment if it
is not abandoned (Schacht, 1995, pp. 491-493). Despite the rancor with which the Quran regards
riba, it provides little explanation of what the term means. This has led to wide misconceptions
7
See Vogel p. 73, footnote 7.
58
of what riba truly is. In English, riba is most commonly translated as “interest” or “usury,” but
these are simplistic and misleading.
The one explicit example of riba comes from the Quran and is known as riba al-jahiliyya,
so known because it was practiced in pre-Islamic Arabia. When a debtor could not repay a loan
(of money or goods) with the accompanying interest, the creditor granted a time extension.
However, the principal was increased concurrently, often by fifty percent. This practice is
referred to in Quran 3:130 and 30:39. This form of riba also includes assigning a penalty to a
debtor for failing to pay at the loan maturity date (analogous to modern late payment fees)
(Schacht, 1995, pp. 491-493; Vogel and Hayes, 1998, pp. 72-73). However, the Quranic verses
and the hadith mentioned above indicate that the nature of riba is much more expansive than the
“pay or increase” form.
As mentioned earlier, the prohibition of interest is the most famous feature of Islamic
finance. This common conception is an oversimplification of the nature of riba. In general,
jurists have defined riba as “trading two goods of the same kind in different quantities.”
Numerous studies have shown that premodern and contemporary Islamic jurists have expanded
riba’s definition beyond its original demarcations (i.e. riba al-jahiliyya) (El-Gamal, 2006, p. 49).
This is precisely the type of articulation of legal thought described in chapter II. However, no
one can argue that charging interest on a loan is not a form of riba, as shown by the “loan”
hadith above.
There are also forms of modern “interest” in the Western sense that Islamic jurists have
allowed. Take for instance the murabaha contract, or a cost-plus or credit sale. Suppose that a
Muslim landscaper wishes to buy a lawnmower for his business. He does not currently have the
funds to do so, but he wishes to conduct this transaction in the Islamic fashion. He then
59
approaches a Muslim financial institution who buys the lawnmower on his behalf. The institution
then sells the lawnmower to the landscaper; the total (deferred) price that the landscaper will end
up paying is a combination of the retail price of the lawnmower, plus a profit markup for the
Islamic financial institution. Clearly, an implicit interest rate can be calculated in this transaction.
However, this transaction is considered halal because the institution is compensated for the cost
of deferring the landscaper’s payment, the risk of destruction of the good prior to its delivery,
and the risk that the lawnmower may be returned if a defect is found therein, as well as credit
risk. In his research, one scholar, Mahmoud El-Gamal, has defined riba as “the sale of credit”
(El-Gamal, 2006, pp. 67-68; El-Gamal, 1999).
Today, Islamic scholars recognize and prohibit two types of riba. The first is riba alqurud, or interest on loans. The second is riba al-buyu, or interest in trade. For riba al-qurud, no
amount over and above the loan may be given or received by the borrower and lender. Riba aljahiliyya falls into this category. This prohibition is not only limited to giving additional money;
gifts, goods, and services are also included.
Riba al-buyu, interest in trade, is further divided into categories. The first is riba al-nasa,
the interest in forward transactions. If two parties engage in a forward transaction for the delivery
of same type of commodity, neither side can defer delivery of the commodity. The second type is
referred to as riba al-fadl, or the interest in inequality; it occurs when two parties exchange the
same commodity but in different quantities.
It is hard to conceive of such transactions that could lead to either riba al-nasa or riba alfadl occurring in the present day. They can arise quite easily in barter, however. The prohibitions
thus discourage barter and encourage cash transactions, which are more efficient (Hardie and
Rabooy, 1991, p. 58).
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Common Misperceptions concerning Riba
1. Riba is prohibited to prevent the exploitation of the poor.
a. While this assertion is partly true, it does not tell the complete story. Many
scholars insist that the prohibition was put in place to prevent rich creditors from
taking advantage of poor debtors. However the Muslim scholar Ibn Rushd (a
twelfth-century Maliki jurist known in the West as Averroes) demonstrated that
the respective wealth of either party in a transaction is of no consequence as
regards to the prohibition of riba; rather, the focus is on the lent sum. Examine
Quran 2:278-279 (reproduced above). Some Muslim scholars hold that the
meaning of verse 279 (If you do not…incurring injustice) is best explained as “if
you repent, then you should collect your principal, without increase or
diminution.” This refers to the fact that both an increase and a decrease in the sum
of money that is returned to the creditor relative to the amount lent is considered
an injustice.
2. All interest is Riba.
a. This too is a misconception. As seen above in the example of a murabaha
transaction, not all forms of interest constitute the forbidden riba. Jurists maintain
that it is perfectly permissible for a deferred price of an asset to be higher than the
spot price. The “interest” is embedded in the credit price of the sale. Another
example of this phenomenon is ijara (lease) financing. 8
3. All Riba is interest.
8
Ijara means lease, rent or wage. In general, it refers to selling benefit, use, or service for a fixed price or wage. An
Islamic financial institution leases to a customer an asset/piece of equipment for a fixed price and period. The fixed
price generally includes the principal amount plus a profit markup for the Islamic financial institution.
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Abu Sa'id al-Khudri (Allah be pleased with him) reported Allah's Messenger (may peace
be upon him) as saying: Gold is to be paid for by gold, silver by silver, wheat by wheat,
barley by barley, dates by dates, salt by salt, like by like, payment being made hand to
hand. He who made an addition to it, or asked for an addition, in fact dealt in usury. The
receiver and the giver are equally guilty. 9
a. This is one of the most famous and oft-quoted hadiths concerning riba. In
particular, it prohibits riba al-fadl. All sales within a genus with inequality with or
without a time factor constitute riba al-fadl. As per this hadith, it is impermissible
to trade goods of the same genus and kind in different quantities. Jurists have
agreed that prohibition is not limited to the six goods listed in the hadith, called
ribawi goods. Hanafi jurists also include all fungible goods measured by weight
and volume. However, Shafii and Maliki jurists restricted it to monetary
commodities, such as gold and silver, and storable foodstuffs.
4. Riba is return without the risk.
a. The return on a permissible credit sale carries the same risk as the return on a loan
with interest – credit risk. In both transactions, the lender faces the risk that the
borrower cannot repay what is owed at the contract’s maturity.
5. Riba is “usury.”
a. This fallacy is due to the faulty yet unfortunately common translation of riba as
“usury.” The modern understanding of usury is exorbitant interest. In Islam,
charging interest on a loan is forbidden, regardless of the percentage rate, be it 1%
or 20% (Vogel and Hayes, 2006, pp. 72-77; El-Gamal, 1999; El-Gamal, 2000).
Gharar
The Messenger of God forbade the ‘sale of the pebble’ (hasah, the sales of an object
determined by throwing a pebble), and the sale of gharar. 10
9
Muslim. Book 10 – The Book of Transactions (Kitab al-Buyu), Number 3854.
Muslim. Quoted in Vogel and Hayes p. 87
10
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The Messenger of God forbade the sale of the copulation of the stallion. 11
Whoever buys foodstuffs, let him not sell them until he has possession of them. 12
In English, gharar can be translated as “risk” or “uncertainty.” Islamic jurists know that
all financial contracts and transactions entail a certain degree of risk and uncertainty that is
unavoidable. Jurists seek to determine whether the risk present in a contract is major or excessive
gharar, which would invalidate a contract, or minor gharar, which is tolerated. It is important to
keep in mind that risk and uncertainty are not haram in and of themselves. Instead, it is the sale
of gharar (bay al-gharar in Arabic) that has been expressly forbidden by Muhammad. Another
important point is that unbundled risk is also forbidden (El-Gamal, 2000, pp. 148-149). Suppose
that a customer buys an expensive crystal vase for $500. As she is paying for the vase, the
salesperson offers an extended warranty plan at an additional cost of $75. It would be
impermissible for her to buy the plan, because this is the sale of risk through insurance, which is
prohibited. However, if the vase were offered for $575, the price of the vase and the cost of the
warranty plan bundled together, it would be perfectly acceptable for her to purchase the vase.
Jurists allow risk sharing by bundling the insurance cost with the purchase price.
In order for a sale to be valid (i.e. binding on both parties), jurists agree that all parties
must have full knowledge of all aspects of the contract, and that the object of the contract must
be in existence at the time of the contract (however, the Malikis and Hanbalis allow sales of
absent/nonexistent goods provided that they are described in minute detail in the contract). The
absence of one does not compensate for the presence of the other, and price is not considered to
be sufficient for the absence of either knowledge or existence. Generally, gharar is considered to
11
12
Bukhari. Quoted in Vogel and Hayes p. 88
Bukhari. Quoted in Vogel and Hayes p. 88
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be present when there is incomplete information and/or fraud, as well as uncertainty about the
intrinsic nature of the objects in question in a contract (Vogel and Hayes, 2006, p. 90).
There are four instances of transactions that involve unacceptable risk to some extent, all
of which are expressly prohibited in various hadiths.
1. Pure speculation. A few examples of this type of transaction are forms of gambling
that pre-Islamic merchants engaged in, such as selling for a fixed price whatever
unexamined goods that a buyer touched. Little is known of these contracts besides
their names, however.
2. Uncertain outcome. This includes contracts where the object has an uncertain value
and may not be realized at all. Examples include selling fish that have not yet been
caught. The sale of goods not yet in one’s possession also falls into this category.
(Notice the implications that this has for the short selling of stocks, and indeed all
options.)
3. Unknowable future benefit. This encompasses contracts in which the benefits to the
buyer are known, but the future benefits are unknown. An example of this is buying a
pregnant cow. Such transactions can feature considerable gharar, especially if the
buyer paid too much for the object of sale or had false hopes as to its benefits.
4. Inexactitude. These hadiths are concerned with inexactitude, such as selling someone
grain before it is weighed (Vogel and Hayes, 2006, pp. 88-89).
There are four conditions that must be met if gharar is to invalidate a contract:
1. The gharar must be major or excessive to invalidate a contract. Instances of minor
gharar, such as if the exact weight of the object of sale is not known to the nearest
ounce, are not sufficient for invalidating a contract.
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2. The contract must be one in which property changes hands (e.g. a sale). Gifts are
thereby excluded from the rules of gharar. A majority of jurists permit uncertainty in
a gift contract. But selling an item that has major gharar is not permissible.
3. The present gharar must affect the principal components of a contract, namely price
and object of sale. For example, it is permissible to sell a pregnant mare, but it is
haram to sell the unborn foal due to the risk that it may be stillborn.
4. If a contract with major gharar meets a need that cannot otherwise be fulfilled, then it
is tolerated. A perfect example of this condition is the salam contract, where an
advance payment is made for goods to be delivered later. Without this contract,
financing for various agricultural and industrial activities could not be completed.
Thus a salam contract is thus deemed to be expedient, regardless of the level of
gharar (El-Gamal, 2006, pp. 58-59). This is an example of the application of maslaha.
Liberal Voices on Gharar: Ibn Taymiyya
As seen above, the limits on gharar can be quite restrictive on some contracts. The four
major madhhabs feature a number of such restrictions that can hamper some transactions. It is
for this reason that modern practitioners of Islamic finance often turn to the rulings of the
medieval Hanbali jurist Ibn Taymiyya (d. 1328). Ibn Taymiyya sought to return the meaning of
gharar to “risk” and believed that the rules prohibiting lack of knowledge and non-existence
were detrimental to the effective utilization of contracts. As we have seen above, traditional rules
of gharar are antithetical to modern forms of finance, such as short selling. However, even Ibn
Taymiyya’s views would regard modern developments such as derivatives and commercial
insurance as untenable (Vogel and Hayes, 2006, pp. 92-93.)
Maysir
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Maysir is actually the severest form of gharar – gambling. The Quran prohibits maysir in
no uncertain terms in verse 5:90, calling it an “abomination,” and “Satan’s handiwork.” The
verse goes further in claiming that maysir, as well as alcohol, were tools that the Devil uses to
“sow enmity and hatred” among Muslims, and prevent them “from the remembrance of God and
prayer.”
Economic Rationale for the Prohibition of Riba and Gharar
Of the three major prohibitions, riba and gharar are the most frequently encountered.
Mahmoud El-Gamal characterizes riba and gharar as the trading in unbundled credit and risk,
respectively. In their bundled forms, which classical jurists strove to develop, both credit and risk
can be made acceptable under traditional Islamic protocol. El-Gamal offers two economic
explanations for the prohibitions on gharar and riba.
Gharar - Loss Aversion
The prohibition on gharar can be interpreted as Islam’s attempt to protect its followers
from exposure to excessive financial risk and the payment of inefficiently priced premiums to
reduce or eliminate risk. The aforementioned human tendencies drive people to take too much
risk in their financial and commercial dealings, and then pay too much for insurance to protect
them as a result. Return to the previous example of the woman buying a vase who is offered an
extended warranty plan. The salesperson offers the plan at the point of purchase, when the
woman has begun to consider the vase her own. This tactic is used to exploit her tendency for
loss-aversion. If the insurance was bundled into the total price of the vase, she would probably
have thought twice before purchasing. Yet since the warranty was offered after she had bought
the vase (when she considered it her own property) the instinct to protect that property was
triggered. The human tendency of loss aversion compelled her to pay more for insurance than
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she otherwise would have. Thus El-Gamal argues that the Islamic prohibition of gharar can help
insulate consumers from the detrimental effects of this behavior (El-Gamal, 2000, pp. 60-61).
Riba - Market Efficiency and Pre-commitment
The economic substance of the prohibition of riba was first articulated centuries ago by
Ibn Rushd. Even though he was of the Maliki school, Ibn Rushd adopted the Hanafi line of
thought in his discussion of the underlying economic basis of the riba prohibition. Hanafis
generally extend the rules of riba dictated for the six ribawi goods to all fungible commodities.
Ibn Rushd felt that the Hanafis’ reasoning for the prohibition of riba was the most compelling:
It is thus apparent from the law that what is targeted by the prohibition of riba is the
excessive inequity that it entails. In this regard, equity in certain transactions is achieved
through equality. Since the attainment of equality in exchange of items of different kinds is
difficult, we use their values in monetary terms. Thus, equity may be ensured through
proportionality of value for goods that are not measured by weight and volume. Thus, the ratio
of exchanged quantities will be determined by the ratio of the values of the different types of
goods traded. For example, if a person sells a horse in exchange for clothes…if the value of the
horse is fifty, then value of the clothes should be fifty. If the value of each piece of clothing is five,
then the horse should be exchanged for 10 pieces of clothing.
As for fungible goods measured by weight or volume, equity requires equality, since they
are relatively homogenous, and thus have similar benefits. Since it is not necessary for a person
owning one of the those goods to exchange it for goods of the same type, justice in this case is
achieved by equating volume or weight, since the benefits are very similar. 13
It is easy to recognize the conditions for efficiency of exchange in the previous selection.
Even though he wrote centuries before the advent of calculus and modern economic theory, Ibn
13
This is the translation of El-Gamal 2006 pp.52-53
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Rushd articulated one of the key concepts of modern economics. Efficiency in exchange is
achieved when the ratio of the prices are equal to the ratio of marginal utilities. Justice is
achieved by “marking to market.”
Another key example of this notion is found in a well known hadith. One day an
unnamed man whom Muhammad had appointed as governor of Khaybar approached
Muhammad. He had with him some dates he had brought from Khaybar. Muhammad inquired
where the governor had obtained the dates. The governor responded that he had traded two
volumes of lower quality dates for one volume of the high quality variety. Muhammad replied
angrily that his actions constituted the forbidden riba. Instead, Muhammad declared, he should
have sold the lower quality dates and used the proceeds to buy the high quality dates. 14
This too is yet another example of economic efficiency. By selling the low quality dates
(at the highest possible market price) and buying the high quality dates (at the lowest possible
market price), exchange occurs at the ratio dictated by market prices. As the law of diminishing
utility will be at work, buyers and sellers of the dates will trade until the ratio of the marginal
utilities is equated to the ratio of market prices. Efficiency in exchange is then achieved. Thus it
can be argued that the aim of the prohibition of riba is to ensure equity in exchange in markets.
This logic can also be extended to credit sales and leases, the classical contracts used to
avoid riba in financing. Here, the appropriate “price” would be the market determined interest
rate. Ironically, conventional finance does a service to Islamic finance in that it determines the
appropriate interest rate for borrowers based on their creditworthiness and the security of the
collateral. Some argue that benchmarking the implicit interest rate in Islamic credit sales to
conventional interest rate tables is appropriate. Suppose that the market interest rate is 6% for a
particular borrower and his or her collateral, but an Islamic financial institution charges this same
14
Bukhari. Volume 3, Book 34 – Sales and Trade, Number 404.
68
borrower 10% implied interest. This is clearly inefficient and contravenes the Islamic spirit of
equity and fairness, even if it uses an accepted Islamic financial contract (Vogel and Hayes, 2006,
pp. 62-93; El-Gamal, 2006, pp. 46-63).
The Time Value of Money in Islamic Finance
A common misconception about Islamic finance is that Islam does not recognize the time
value of money. This is a falsehood that is no doubt derived from the promulgation of the
improper translation of riba as “interest” or “usury.” Jurists not only accept the concept of the
time value of money, but also consider it to be a natural and completely permissible tendency
among humans, who after all tend to exhibit a positive time preference. We can see this in the
case of murabaha, or credit sales. Nearly all scholars agree that the credit price of a commodity
or good can and should be more than its cash or spot price, so long as the credit price is settled
beforehand in a binding contract between the two parties. Jurists accept that both time and place
have an influence on price. A good that is worth $100 in the morning can be worth $10 at night.
Similarly, a good that is worth $500 in New York can be worth $100 in Hatchechubbee,
Alabama. This is acceptable provided that these differences in price arise due to market forces
(Ayub, 2007, pp. 89-90).
Islamic Investment Funds: Development and Practice
Islamic equity investment funds began as simple mutual funds that invested in a limited
universe of stocks, applying standard portfolio management techniques as well as Sharia
guidelines. Islamic investment funds generally revolve around equity investment. The reason for
this is obvious; since Islam forbids the payment and receipt of interest, Muslim investors cannot
buy the conventional bonds and other debt-based securities of companies. Likewise, Muslim
69
investors are prohibited from investing in preferred shares of stock. Preferred shares give holders
priority claims to assets in the event of a bankruptcy, a guaranteed rate of profit, and so on.
Therefore, common stocks are the preferred and permissible way to invest in companies.
Islamic finance values equity partnership as the ideal method of investment. Various jurists have
ruled that it is permissible to invest in and trade common stocks of companies that operate
acceptable primary businesses that conform to Islamic protocol. Owning shares of a company’s
stock is deemed to be equivalent to being a silent partner who has partial ownership of that
company’s assets. Jurists also view mutual funds as permissible modes of investment. The
mutual fund manager is seen as the agent of the fund’s shareholders, who are seen as investors in
the underlying stocks (El-Gamal, 2006, pp.123-124).
Islamic equity funds have experienced tremendous growth. In 1996, there were 29 such
funds with $800 million in assets. By 2000, this number had increased to 98, with nearly $5
billion in assets. Today there are over 100 Islamic equity funds catering to a large variety of
investors.
Asset Management of Equity Funds
Fund management is most often carried out by investment banks and specialized fund
providers in Islamic finance. Most Islamic funds are operated in Saudi Arabia, UAE, Britain, UK,
USA, Canada, Bahrain, Kuwait, Pakistan, Malaysia, Brunei, and Singapore. The steadily rising
demand for Islamic investing options is now spurring growth across the globe. Managers of
Islamic equity funds select stocks based on their lines of business and their financial
characteristics. An Islamic equity fund must carry a pro rata profit actually earned by the fund.
Based on investor risk profiles and management strategy, these equity funds are divided into four
subcategories:
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1. Regular income funds – objective is to earn profits through steady dividends
2. Capital gain funds – objective is to earn profits from the capital gains
accumulated through the frequent purchase and sale of Sharia compliant equities
3. Aggressive funds – objective is to invest in high risk securities in the hopes of
generating above average returns for investors
4. Balanced funds – objective is to invest in high quality securities and to distribute
profits to investors from dividends and capital gains (Ayub, 2007, p. 201)
Other Asset Classes
Equity investment is the most common form of investment in Islamic finance. However,
there are other Sharia compliant products that are available to Muslim investors. Sheikh
Muhammad Taqi Usmani, a preeminent Hanafi jurist from Pakistan, has identified five
categories of Islamic investment funds:
1. Equity funds
2. Ijara funds (funds from subscribers are used to finance the purchase of assets
through ijara or Islamic leases. Rentals from the user of the asset are distributed
to investors in the fund)
3. Commodity funds (funds are used to purchase commodities that are later resold at
a profit; profits are later distributed among subscribers)
4. Murabaha funds (funds are used to finance murabahas; proceeds from these
credit sales are then distributed to the funds investors)
5. Hybrid, or mixed funds (funds are used in different types of investing, such as in
equities, leasing, or commodities) (Ayub, 2007, pp. 201-203)
Sharia Advisory Boards
71
One of the most distinguishing characteristics of Islamic equity funds are professional
Sharia advisory boards. While not all funds retain such boards, having a Sharia advisory board is
a sign of legitimacy to many investors. The presence of a Sharia board is a comfort for many
Muslim investors; they are assured that their money is being invested in a manner that conforms
to the rigid standards of traditional Islamic business practice; this is all because the board is there
to ensure that outcome. A Sharia board serves many functions. It is primarily responsible for
certifying the permissibility of the stocks that comprise an Islamic equity fund. Besides
monitoring the portfolio, the Sharia board also is responsible for monitoring the management of
the fund to ensure that the managers always act in accordance with the Sharia. This is especially
important when fund managers are not Muslims. The board is also expected to help management
prepare investor reports and SEC filings. Those who serve on Sharia boards must be well versed
in both Islamic law and modern financial instruments and practices.
An important caveat to keep in mind is that Islamic funds have different Sharia boards.
As seen in chapter II, rulings on a given financial topic may differ jurist to jurist and board to
board. Sharia boards are often hired and compensated by the financial institutions for which they
consult. Thus, these boards may suffer from a lack of independence in their rulings. On a wider
scale, the industry currently lacks a broad regulatory framework. While there are a number of
influential bodies in Islamic finance, such as the Fiqh Council of the Organization of the Islamic
Conference, there is no single, universal Sharia supervisory board, nor has there ever been. The
call for such a board has arisen numerous times in the past. It has been argued that a central
Sharia board would be impractical because it could not perform all the functions required for
Sharia supervision for the hundreds of Islamic financial institutions in existence. Another reason
put forward is that since there are a wide variety of Islamic financial institutions, from mutual
72
funds to commercial banks, a central Sharia board could not possibly provide the specialized
consultation and advisory services for each subsector of the Islamic financial industry
(DeLorenzo, 2000). The various schools of law and their different interpretations no doubt also
play a role.
Creating a central body to regulate Islamic finance would be a daunting task. But in order
for the Islamic financial industry to move forward, to attract new customers, and to retain current
customers, it needs some sort of regulatory framework. The credit crisis has demonstrated
unequivocally what can happen when the market is allowed to run freely with inadequate
supervision. While the industry’s built-in adherence to the theoretically fair and equitable system
of Islamic financial law is a definite advantage, this does not exempt the industry from the need
to have cohesive regulations. A centralized Sharia supervisory organization should be created to
enact a standard set of regulations for the industry. To counter the arguments presented above,
the agency could have numerous internal departments dedicated to regulating different sectors of
the industry. To fund its operations, a fee could be charged to Islamic financial institutions who
apply for membership in the organization. Membership in the organization could be seen as a
seal of approval and sign of legitimacy in the eyes of Muslim investors. A conference of Muslim
jurists, scholars, and Islamic finance professionals could be convened to choose the governors
who would run such an organization, as well as hammer out other details. Representation from
each madhhab would be paramount. Such an organization would also be in the best interest of
Muslim investors, who would then have greater assurance that the financial products they use are
in accordance with the Sharia. 15
15
In addition, there would probably have to be another organization for Shiites. While Sunni and Shiite doctrine on
some financial and business issues overlap, many others do not.
73
Fortunately, there have been steps in the right direction. There are a number of different
bodies that attempt to provide regulatory standards for members and the industry. The three most
important are the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI), the Islamic Financial Services Board (IFSB), and the Organization of the Islamic
Conference (OIC) Fiqh Academy.
The AAOIFI, founded February 26, 1990 in Algiers, is a nonprofit organization whose
mission it is to formulate accounting, auditing, governance, ethical, and Sharia guidelines for the
Islamic finance industry. The organization is supported by 155 institutional members, such as
Islamic financial institutions (IFIs) and other players in the Islamic finance industry. The
AAOIFI has also garnered the support of national governments. Some countries, such as Bahrain,
Jordan, and Sudan, have implemented its standards, while others like Pakistan, Saudi Arabia,
Malaysia (the leader in Islamic finance), and Australia have issued regulatory guidelines based
on AAOIFI standards for IFIs in their jurisdiction. Most notably, AAOIFI also issues
professional certifications for participants in Islamic finance; these are the Certified Islamic
Professional Accountant (CIPA) and Certified Sharia Adviser and Auditor (CSAA) designations
(Accounting and Auditing Organization for Islamic Financial Institutions, 2009). The AAOIFI
can effectively be thought of as a combination of the Financial Accounting Standards Board and
the CFA Institute.
Based in Kuala Lumpur, the Islamic Financial Services Board (IFSB) also issues
standards for the Islamic finance industry, including Islamic insurance companies. The IFSB
conducts research and facilitates the discussion of issues that affect the industry as a whole by
organizing conferences and seminars. The IFSB currently has 178 members, including the
74
International Monetary Fund, World Bank, Islamic Development Bank, and Saudi Arabia
(Islamic Financial Services Board, 2009).
The Fiqh Academy is a subsidiary of the Organization of Islamic Conference. Established
September 25, 1969, the OIC, the second largest inter-governmental organization after the
United Nations, is comprised of 57 member nations from across the Muslim world (Organization
of the Islamic Conference, 2009). Muslim scholars from across the world, primarily scholars of
fiqh but also including experts in other fields, constitute the membership of the Fiqh Academy.
The goal of the Academy is to investigate and find solutions to the problems that confront
Muslims in the modern era. To this end, the Academy issues fatwas on a number of subjects,
including questions concerning Islamic finance and the economic lives of Muslims (Islamic Fiqh
Academy, 2009).
Sovereign nations have also made concerted efforts to regulate Islamic finance and
banking within their borders. Bahrain has a detailed set of guidelines for listing, offering, and
issuing debt securities, including Islamic bonds, or sukuk. Malaysia has set forth more stringent
requirements for Islamic bonds, such as mandating more frequent/detailed financial reports and
disclosures and requiring financiers involved in Islamic finance to be Sharia literate. However,
Islamic banks have encountered opposition from some governments, particularly those of North
Africa. The governments of countries like Egypt, Morocco, and Algeria are very leery of Islamic
financial institutions (IFIs), believing them to be linked to Islamic political parties. Some of these
countries allow Islamic banks to exist but provide little regulatory support, while others ban IFIs
outright (Modi, 2007). This is probably due to the history of political struggle between more
secular Middle Eastern governments and Islamist movements that has been waged in the region
for decades. Other nations that have experienced tension and conflict between Muslims and non-
75
Muslims also outlaw IFIs (Modi, 2007). At any rate, the varying levels of governmental support
for IFIs presents a hurdle in the way of greater integration and regulation of the industry.
By the very nature of Islamic law, a wide diversity of opinion concerning the
acceptability of Islamic financial products will always exist. As seen in chapter II, the
geographically decentralized and highly personal nature of fiqh may preclude the establishment
of a single regulatory body which can definitively rule on products’ adherence to Sharia
guidelines. However, it is imperative that regulators ensure that Muslim customers have
unfettered access to full disclosures about the risks of Islamic financial products, and that the
process of determining whether an Islamic investment is Sharia compatible is as transparent as
possible.
Other pressing regulatory challenges also confront the Islamic investment funds and the
Islamic finance industry. First, Islamic financial firms should and must continually monitor their
products for Sharia compliance before and after launch to maintain investor confidence and firm
reputation. Second, the shortage of qualified Sharia scholars often means that scholars hold
positions at multiple firms. This obviously can result in numerous conflicts of interest, plus a
possible decline in quality of oversight as scholars are stretched thin across many firms. Third, a
simultaneous dearth of professionals versed in both finance and the Sharia means that the
industry will lack the qualified personnel it needs to sustain its growth. Education, training and
development programs, and time are all needed to allow a large enough pool of Sharia scholars
and financial professionals to emerge (Carruthers and Colangelo, 2008).
The issue of regulation of the Islamic finance industry will be taken up and further
explored in the context of Sharia arbitrage in chapter VII.
The Dow Jones Islamic Market Index
76
In the development of Islamic funds, particularly equity funds, the problem of finding a
suitable benchmark against which managers and investors could measure performance arose.
Millions of Muslims were determined to adhere to their religious principles in their financial and
economic dealings, and fund managers were eager to acquiesce to this new demand. The Dow
Jones Company, sensing an opportunity, stepped in to create an index that would become the
standard benchmark for Islamic investing.
The Dow Jones Islamic Market (DJIM) Indexes were introduced in 1999 as the first
benchmarks to represent Islamic-compliant portfolios. Today the series encompasses more than
70 indexes and is arguably the most comprehensive family of Islamic market measures. The
company has put together a Sharia board to guide its operations, and to judge the Sharia
compliance of the components of its indexes. The board consists of some of the most respected
and well known names in Islamic finance today, including Yusuf Talal DeLorenzo, Nizam
Yaquby, and Dr. Mohamed Elgari. This board was instrumental in developing the screening
parameters that Dow Jones uses to select stocks for its universe.
Over time, the company has launched several subindexes, such as the DJ Islamic US
Index, which covers US companies only, the DJ Europe Index, which is dedicated solely to
European stocks, and even the DJ Islamic BRIC Index, which features companies from Brazil,
Russia, India, and China. The company expects to launch more subindexes in the future.
The Dow Jones Islamic Market Indexes include only easily accessible, actively traded
stocks. The selection universe for the family is the Dow Jones World Index. The components of
DJIM Indexes represent a broad range of stocks from different countries, regions, market cap
ranges and Sharia-compliant industries. Subindexes allow the individual tracking of these
various market segments. Stocks are only selected for membership in the DJIM Indexes if they
77
pass a rigorous set of quantitative and qualitative measures. These screens are developed and
continuously evaluated by the Sharia board. The composition of each subindex is reviewed
quarterly every March, June, September and December. The indexes also are reviewed on an
ongoing basis to evaluate for corporate actions such as mergers and acquisitions, de-listings or
bankruptcies (Moran, 1999; Dow Jones Indexes, 2008).
Acceptable Lines of Business for Islamic Investing
In the never-ending quest for superior portfolio returns and performance, most
contemporary investors are limited only by their tolerance for risk and supply of personal capital.
Some investors, as mentioned above, choose to place their money into firms whose operations
closely match their own personal guidelines and ethics. However, the only restraint that most
investors face on investment decisions is derived from their own self-imposed constraints.
This is not so for the Muslim investor. Muslim investors who choose to conduct their
business and financial dealings according to their religion not only must consider the expected
return of an investment, but also how that investment affects his or her standing in the eyes of
God.
The Sharia forbids Muslims from participating in several activities; thus it is also
forbidden for Muslims to invest in firms engaged in these activities. Fund managers and
individual investors who are concerned with remaining true to the precepts of Islam steer clear of
providing startup financing to companies whose primary business activities fall within the
forbidden categories and purchasing the equity of such firms. Sharia boards have identified
several lines of prohibited business for Muslim investors. The standards that have been
incorporated into the industry screen of the Dow Jones Islamic Market index are as follows 16:
16
Keep in mind that all Islamic funds may not adhere to these same business screens. However, the screens used in
the DJIM are often referred to and used by Islamic funds.
78
1. Alcohol. Alcohol and other intoxicants are strongly opposed in Islam, just as they are
in the Judeo-Christian tradition. The basis of this is the following verse of the Quran:
They ask you concerning alcohol and gambling. Say: "In them is a great sin, and
some benefits for men, but the sin is far greater than the benefit." (Quran 2:219)
2. Tobacco. There is no explicit ban on tobacco in the Quran. Nevertheless due to the
harmful physical effects of nicotine, many Muslims consider tobacco to be an illicit
good (even though smoking is very popular throughout many nations in the Islamic
world). Muhammad al-Jibaly of the Al-Quran was-Sunna Society of North America
cites Quranic commands against suicide and willfully harming the body (Quran 4:29,
2:195) in his denunciation of tobacco products and smoking (Al-Jibaly, 2008).
3. Pork related products. One of the most well known prohibitions in Islam is the
injunction against the consumption of pork products. This prohibition is based upon
Quran 5:4: Forbidden to you for food are: dead meat, blood, and the flesh of swine….
4. Financial services. Since most financial services companies having dealings with
interest – both paying and receiving – it is forbidden for Muslims to invest in them.
Insurance companies also fall within this category. 17
5. Defense/weapons. Many Muslims are averse to investing in companies that produce
weapons and other equipment used in war and defense.
6. Entertainment. Although entertainment products are widely consumed in the Islamic
world (for example, Egypt has a successful and influential film industry), many
17
Conventional commercial insurance as we know here in the West is deemed haram by many Islamic legal experts.
This stance was formally decided at the second session of the Fiqh Academy of the Organization of Islamic
Conference. The Academy felt that paying a fixed insurance premium contains substantial gharar, invalidating the
contract. Most jurists lean towards the forms of mutual insurance and social (state-organized) insurance. A viable
and Islamically permissible mode of insurance known as takaful has been approved by many jurists in that it is
based on the cooperative insurance model (with variations from mutual insurance as it is known here in the West).
However, there are also scholars who deem commercial insurance to be permissible under the Sharia. The debate on
the permissibility of insurance continues, but it is beyond the scope of this paper.
79
scholars agree that it is haram to invest in companies that produce such products.
These forbidden items include films, music, and other recreational products. Casinos
are also off limits due to the prohibition, noted above, of gambling (which is known
in Arabic as maysir). Hotels also generally fall into this category, as many serve
alcohol and provide various forms of entertainment. Lastly, pornography is also
included in this category.
7. Food wholesalers and retailers. Many such companies offer non-halal foodstuffs,
hence the prohibition on this industry.
In addition to the aforementioned businesses, other companies/industries recommended
against include companies who treat their workers poorly, cause negative environmental effects,
and biotech companies that are involved in projects that use aborted embryos and pursue human
cloning. It is important to keep in mind that not all activities associated with these industries are
unequivocally haram; some jurists may classify them as makruh or even mubah (see chapter II),
but even then some would still argue against investing in companies that engage in them.
If a company is engaged in any of these industries, then Muslim investors tend to shy
away from them. However, for many companies, even though their primary line of business is
acceptable, part of their operations are involved in haram activities. Still more have subsidiaries
or minority interests in companies that are involved in impermissible activities.
Sharia scholars differ in their approaches to investments in these types of companies. The
most conservative scholars hold that investing in the equity of a company that is engaged in a
haram activity in any degree is impermissible. Clearly, this narrow view vastly restricts the
number of equities in which Muslims can invest, especially as regards to companies that pay or
receive interest; debt financing is prevalent among companies in all areas of the world. It is
80
nearly impossible for most firms to maintain and grow their operations without accessing short
term credit at the very least. In the case of such companies, some jurists invoke the Maliki
principle of maslaha, or public interest. In this context, it is held that requiring Muslims to
adhere to the strictest forms of Sharia compliance (i.e. investing in companies that are not
involved in haram activities to any extent and that have no short or long term debt) would cause
undue hardship on the faithful. This is especially true for Muslims living in the West, where few
companies completely fit the stringent guidelines of Islamic jurisprudence. Some scholars permit
Muslims to invest in such companies provided that the illicit ventures are not their main line of
business. Others have relaxed the guidelines on the level of financial leverage that a company
may have (discussed in the next chapter). In general, the principle of maslaha allows some
degree of flexibility in the investment choices of Muslims.
Purification
In a perfect world, Sharia scholars’ ideal publicly traded company would exist; all of its
operations would be halal and it would be free from every questionable source of income,
including borrowing and lending at interest. Since this ideal is rarely encountered in the
contemporary world, the issue of purification of returns (covering both dividends and capital
gains) arises. Generally, purification is deducting from total investment gains earnings obtained
through means that are in violation of the dictates of Islam. For equity earnings, this primarily
includes interest earnings and income from haram operations (other than primary operations
which should of course be halal). While this seems simple in theory, it is rarely so in practice.
While many jurists and Islamic finance professionals agree about the importance of
purification, a number of controversial issues surround the procedure of purification. Scholars
disagree about whether Islamic funds should purify returns for investors, or if investors should
81
be responsible for this function. Another issue is whether interest earnings and impure income
should be attributed to revenue or net income. Yet another issue revolves around what is to be
purified: dividends, capital gains, or assets. Purification can also create a comparison problem
between Islamic funds (purified vs. unpurified returns) or distortion of optimal portfolio
selection (pre-purified vs. post-purified returns).
There are three common methods for Islamic equity fund purification. In all formulas, P
equals the purification factor through which impure income can be estimated. Impure income
encompasses both interest income and income from haram operations.
Method 1
In a portfolio of shares on at time period t1, we have companies (c) earning interest i.
Interest income is equal to ic1 + i c2 …+ i cn = a. If net operating income for any company is y,
then total net operating income for the portfolio is equal to: yc1 + y c2 …+ y cn = b. Net asset value
for the fund at time period t1 is NAVt1. Then we must calculate Z, which is equal to: NAVt2 NAVt1. If H is equal to H = a/b then purification factor P is equal to ZH=P. For every dollar
invested, the investor must multiply by P and donate this amount to charity. So for example, if P
= 0.009 and the investor’s Z is $3000, then she must give $27 to charity.
Method 2
We have a portfolio of n securities. (S1, S2,… Sn). Compute the dividend yield where:
D = dividend / market value
The annual portfolio dividend yield will be D1 + D2…+ Dn. Interest income for each company
will be:
I = interest income / net operating income
82
For the entire portfolio, total interest income will be ic1 + i c2 …+ i cn. The purification factor P
can be calculated as (D)(I) = P. For every dollar invested, $P must be donated to charity.
Method 3
Let us assume the following:
Interest income for each stock in the portfolio is X. X1 …Xn denotes each company.
T = tax rate for each company
A = percentage of total shares of each company owned by the fund
M = number of months a share is held in the portfolio
Interest income of the portfolio is then: ∑ X (1-T) (X) (A) (M) (Elgari, 2000)
Many jurists and Sharia board advisors agree that the funds winnowed away during
purification should be set aside for charitable purposes. Some funds distribute these amounts
among a variety of charities, while others set up a charitable fund or foundation under the
auspices of the fund manager.
It is interesting to note that while these mechanisms are meant for cleansing returns of
interest income, no such requirement is in place for income derived from haram secondary
operations. However, one could easily substitute “haram income” wherever “interest income”
appears in the formulas listed above. It is also not clear how “Islamized” debt (that which is
collected or paid through murabaha or ijara transactions) should be treated.
Acceptable Financial Characteristics
The Sharia lays down specific principles that govern the economic and financial decision
making of the faithful. One of the main tenets of Islamic financial theory is the superiority of
profit-and-loss sharing in ownership rather than debt financing. In other words, equity is looked
upon more favorably than debt in a company’s capital structure. However, debt financing is
83
widely used across the world, as is investing in interest bearing securities. For Muslims who
wish to adhere to the strictest interpretation of this prohibition, the universe of companies in
which they may invest is severely circumscribed.
The financial screens that are used to select halal investments are not clear cut and vary
with each Sharia board. The Dow Jones Sharia board has instituted three financial screens that
are used to winnow out unacceptably leveraged companies. Stocks are considered ineligible for
investment if:
1.
Total debt divided by trailing 12-month average market capitalization is 33% or
more.
a. Total debt = short term debt + long term debt + current portion of long term
debt
2.
Cash plus interest-bearing securities divided by trailing 12-month average market
capitalization is 33% or more.
a. It is an established maxim in the Sharia that debt cannot be sold to a third
party, i.e. securitized. Thus, investing in all types of collateralized debt
obligations (CDOs) is impermissible. Selling cash for cash must comply with
the currency exchange (sarf) rules set forth in the Sharia. Modern scholars
traditionally stipulate that cash and debts cannot exceed real assets on a
company’s balance sheet in order for it to be permissible to invest in that
company’s equity. Scholars differ on the percentage of cash and debt that is
allowable, but most agree that this number cannot exceed 50%.
3.
Accounts receivables divided by 12-month average market capitalization is 33% or
more.
84
a. Accounts receivables = current receivables + long term receivables
Some might wonder what is so significant about the 33% number. It is based on a well known
saying of Muhammad: “One third, and one third is too much.” 18 In consequence, amounts of one
third or less have been the criterion for a small percentage.
In addition to the three screens specifically used by the DJIM indexes, other financial
screens are also vetted by numerous Sharia boards.
1. Companies with debt-to-equity ratios over 30% are often considered impermissible to
invest in. This criterion is also based on the “one-third” hadith.
2. It is impermissible to invest in the equities of companies whose interest income or
unlawful gains exceed 5-15%. However, the opinion that such earnings should not
exceed 5% is now widely accepted and considered the norm. The DJIM index also
follows this stipulation.
18
Bukhari. Volume 4, Book 51 – Wills and Testaments (Wasaayaa), Number 5.
85
Sharia
Compliant
Companies
Primary Business
Screens
Financial Screens
Figure 5. Dow Jones Islamic Market Screening Criteria
Shortcomings of the Dow Jones Islamic Market Index
In terms of the stringency of their guidelines for primary business activities, the DJIM
does a remarkably good job of staying in keeping with the strictures of the Sharia. It is easy to
understand that companies that produce pork or alcohol would be excluded from an Islamic
portfolio, whereas for certain other industries, such as hotels and food providers, it may seem
akin to throwing the wheat out with the chaff. Certainly there are some hotels that do not serve
alcohol. However, for an index provider such as Dow Jones, the cost of scouring prohibited
industries for companies that are indeed Sharia compliant far outweigh the benefits. The
conservatism that the DJIM exhibits is reflective of this fact. It has been suggested that
companies that do not pass the business screen due to their industry but who are themselves
86
Sharia compliant could provide information to Dow Jones that indicates their compliant status. If
index managers and the Sharia board approve, then the company could be included in the index,
provided that they also pass the financial screens. This could possibly be of great benefit to the
DJIM in that it would remove the onus of collecting such information from the provider, would
allow the DJIM to provide a wider snapshot of the broader market, and would provide more
investment choices for Islamic funds and individual Muslim investors. In addition, there is also
an illogical omission from the list of prohibited industries – air and sea transportation. Both
airlines and cruise lines are known to serve alcohol and provide entertainment for their
passengers, in addition to being highly leveraged.
Another shortcoming of the DJIM is that it does not take into account off-balance sheet
liabilities and assets in the computation of the financial ratios. Taking these items into account
will result in a truer picture of the financial status of a company, and be truer to Islamic
principles.
Using market capitalization as the denominator in the financial screens is also
problematic. Sudden large market movements can cause a company to be Sharia compliant one
hour, then out of compliance in the next. Since Islamic investors are more concerned with the
assets and liabilities of a company, total assets or total capitalization is a more appropriate
measure for financial compliance (Dow Jones Indexes, 2008; Khatkhatay and Nisar, 2007, pp. 118; Yaquby, 2000).
Conclusion
Two things should be abundantly clear. First, Islamic finance is just as fluid and dynamic
as Islamic law. While there are some issues that enjoy wide agreement, there are others that do
not. Numerous attempts to create an autonomous regulatory body that can govern Islamic finance
87
across the globe have been made. The individualistic nature of fiqh that was first encountered in
chapter II may make this goal impossible. Nevertheless, the industry should still strive to create
and adopt cohesive regulatory standards that can be applied by Islamic financial institutions from
New York to Dubai to Jakarta, for the good of both customers and the industry’s long term
growth. Second, the Islamic finance industry is currently driven by prohibitions. It is
undoubtedly important to keep these prohibitions in mind during the development of Islamic
financial products and services. But a single minded focus on these prohibitions may at best
drastically limit the potential of the industry and at worst promote inefficiency, creative
stagnation, and the elevation of legal form over religious substance. These dangers will be
elucidated in chapter VII, but now we turn to the performance of Islamic equity funds.
88
CHAPTER V.
AN INVESTIGATION OF THE PERFORMANCE OF ISLAMIC
FUNDS
Introduction
We now turn our attention to the performance of Islamic equity funds. Four mutual funds
that conform to the precepts of the Sharia will be examined. The performance of these funds visà-vis the performance of conventional equity funds will be compared. The ultimate purpose of
the following analysis is to answer the following four questions:
1. How do the returns on an Islamic portfolio compare to those of a conventional fund?
2. How does an Islamic fund perform during a market downturn?
3. Can sufficient diversification be achieved in an Islamic portfolio?
4. How have the Islamic funds performed in the recent market downturn and broader
global financial crisis?
To provide background, we will begin with an examination of the literature surrounding
the performance of socially responsible/ethical investing.
Ethical Investment Performance
Ethical mutual funds have been in existence for a number of years, but only recently has
their performance been seriously analyzed. As more and more investors show a marked interest
in ethical investing, and more funds are channeled into the sector, attempts have been made to
analyze their returns as compared to conventional funds. Wall Street purists have consistently
argued that investors who employ ethical restrictions when making their financial decisions will
suffer from a lack of sufficient diversification and sacrifice returns. Proponents of socially
responsible investing have countered that investors can indeed achieve outstanding returns as
well as follow their conscience.
89
The Good Money Indexes
In the late 1970s, GOOD MONEY Publications created its Good Money Industrial
Average (GMIA) and Good Money Utility Average (GMUA). Both stock indexes, the brainchild
of Ritchie Lowry, were designed to be the ethical equivalents of the Dow Jones Industrial
Average and the Dow Jones Utility Average respectively, and were developed to provide an easy
way for investors to track and compare the performance of SRI versus traditional investment
over time. For the GMIA, the industries of the DJIA were examined to select socially acceptable
companies. While acceptable companies existed in some sectors such as computers and
pharmaceuticals, other sectors had no acceptable companies. Nuclear weaponry production and
other defense related business disqualified companies in the aerospace and defense industry.
Companies with poor track records in particular social indicators, such as environmental
protection and labor relations, were also excluded. Like the GMIA, the GMUA was designed to
replicate its Dow Jones counterpart. The index was comprised of utility companies that did not
produce nuclear power, developed and/or used alternative energy sources, and enacted
conservation programs. Companies that used traditional fossil fuels but nevertheless had good
environmental records were also included. Like the Dow Jones indexes, the Good Money
indexes replaced components if a company went private, declared bankruptcy, or merged with
another company. While no company in either Good Money index was replaced because of
negative performance, companies were dropped if they ceased to meet social guidelines. If
possible, the offending company was then replaced with a socially acceptable alternative from
the same industry.
90
Table 1. The Good Money Industrial Average vs the Dow Jones Industrial Average, 1976-2000
Good Money Industrial Average
Cumulative
Year
Value YOY Change
Change
1976
27.74
----1977
30.16
8.7%
8.7%
1978
33.62
11.5%
21.2%
1979
40.41
20.2%
45.7%
1980
49.01
21.2%
76.7%
1981
57.83
18.0%
108.5%
1982
68.17
17.9%
145.8%
1983
88.20
29.4%
218.0%
1984
84.10
-4.7%
203.2%
1985
127.75
51.9%
360.5%
1986
137.60
7.7%
396.0%
1987
144.04
4.7%
419.3%
1988
161.79
12.3%
483.2%
1989
207.11
28.0%
646.6%
1990
170.20
-17.8%
513.6%
1991
218.84
28.6%
688.9%
1992
227.87
4.1%
721.5%
1993
240.67
5.6%
767.6%
1994
226.95
-5.7%
718.1%
1995
277.36
22.2%
899.8%
1996
328.91
18.6%
1085.7%
1997
443.63
34.9%
1499.2%
1998
559.69
26.2%
1917.6%
1999
595.07
6.3%
2045.2%
2000
586.06
-1.5%
2012.7%
Source: http://www.goodmoney.com/gmiaraw.htm
Dow Jones Industrial Average
YOY
Cumulative
Value
Change
Change
1004.65
----831.17
-17.3%
-17.3%
805.01
-3.2%
-19.9%
838.74
4.2%
-16.5%
963.99
14.9%
-4.1%
875.00
-9.2%
-12.9%
1066.54
21.9%
6.2%
1258.64
18.0%
25.3%
1211.57
-3.7%
20.6%
1546.67
27.7%
54.0%
1895.95
22.6%
88.7%
1938.83
2.3%
93.0%
2168.57
11.9%
115.9%
2753.20
27.0%
174.1%
2633.66
-4.3%
162.2%
3168.83
20.3%
215.4%
3301.11
4.2%
228.6%
3754.09
13.7%
273.7%
3834.44
2.1%
281.7%
5117.12
33.5%
409.3%
6448.27
26.0%
541.8%
7908.25
22.6%
687.2%
9181.40
16.1%
813.9%
11497.12
25.2%
1044.4%
10786.85
-6.2%
973.7%
From its inception in 1976, the GMIA performed admirably. Indeed, the GMIA often
outperformed the DJIA. Over a 25 year period, the GMIA climbed over 2000% in value, while
the DJIA increased 973%. This impressive performance is even more evident in figure 4, which
graphs the cumulative change in both the GMIA and the DJIA from 1977 to 2000. The GMIA
was up 20 years out of the 25 year period, and down four. The DJIA, in contrast, was up 18 years
and down six. The GMIA outperformed the DJIA 14 years during the period, while the DJIA
outperformed the GMIA only 10.
91
Figure 6. The GMIA vs. DJIA - Cumulative Value Change
2500%
2000%
GMIA
1500%
1000%
DJIA
500%
0%
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
-500%
Table 2. The Good Money Utility Average vs The Dow Jones Utility Average, 1976-2000
Good Money Utility Average
Cumulative
Year
Value YOY Change
Change
1976
22.89
------1977
25.33
10.7%
10.7%
1978
21.45
-15.4%
-6.3%
1979
22.36
4.2%
-2.3%
1980
23.46
4.9%
2.5%
1981
24.87
6.0%
8.7%
1982
34.51
38.8%
50.8%
1983
45.34
31.4%
98.1%
1984
43.52
-4.0%
90.1%
1985
51.74
18.9%
126.0%
1986
71.71
38.6%
213.3%
1987
63.44
-11.5%
177.2%
1988
67.87
7.0%
196.5%
1989
74.54
9.8%
225.6%
1990
66.63
-10.6%
191.1%
1991
78.88
18.4%
244.6%
1992
75.70
-4.0%
230.7%
1993
80.60
6.5%
252.1%
1994
70.73
-12.2%
209.0%
1995
84.51
19.5%
269.2%
1996
90.53
7.1%
295.5%
1997
107.35
18.6%
369.0%
1998
114.90
7.0%
402.0%
1999
104.93
-8.7%
358.5%
2000
126.96
21.0%
454.7%
Source: http://www.goodmoney.com/gmuaraw.htm
Dow Jones Utility Average
Cumulative
Value YOY Change
Change
108.38
------111.28
2.7%
2.7%
98.24
-11.7%
-9.4%
106.60
8.5%
-1.6%
114.42
7.3%
5.6%
109.02
-4.7%
0.6%
119.46
9.6%
10.2%
131.80
10.3%
21.6%
149.52
13.5%
38.0%
174.81
16.9%
61.3%
206.01
17.5%
90.1%
175.08
-15.0%
61.5%
186.28
6.4%
71.9%
235.04
26.2%
116.9%
209.70
-10.8%
93.5%
226.15
7.8%
108.7%
221.01
-2.3%
103.9%
229.30
1.4%
111.6%
181.52
-20.8%
67.5%
225.40
24.2%
108.0%
232.53
4.5%
114.6%
273.07
17.4%
152.0%
312.30
14.4%
188.2%
283.36
-9.3%
161.5%
412.16
45.5%
280.3%
92
Likewise, the GMUA also performed well, often outperforming its Dow Jones
counterpart. The GMUA outperformed the DJUA 15 years to nine during the period. The value
of the GMUA rose 454% compared to the DJUA’s 280% rise. In addition, when utility stocks
fell out of favor with equity investors during early 1987, the GMUA lost 11.5% of its value
while the DJUA fell 15%.
Figure 7. The GMUA vs. DJUA - Cumulative Value Change
500%
400%
GMUA
300%
200%
DJUA
100%
0%
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
-100%
GOOD MONEY decided to stop tracking their averages in 2002, citing market volatility
and the increasing difficulty in finding socially acceptable companies in which to invest. On this
latter point, GOOD MONEY referred to a study that found two thirds of CEOs interviewed
revealed that they had felt the need to falsify earnings and performance in an effort to placate
shareholders and analysts (Lowry, 1991, pp. 41-49; Good Money, 2002). In spite of this, the
Good Money averages’ long track record does provide important insight into the performance of
SRI over the time period covered. The GMIA and GMUA both demonstrate that an investor may
not have to sacrifice return and financial gain in order to remain true to their moral principles. At
93
the same time, a few caveats must be kept in mind. While the DJIA tends to focus on large cap
companies and not high growth small firms, the GMIA has a broader representation of the entire
economy. This could explain why it has performed in such an impressive fashion. Likewise,
Grossman and Sharpe once compared the performance of the NYSE to that of a value weighted
NYSE portfolio that screened for companies involved in South Africa. To this portfolio they
added Treasury bills, creating a portfolio whose standard deviation was equivalent to the
NYSE’s. While the risk adjusted South Africa free portfolio outperformed the NYSE from 1960
to 1983, this was due to the fact that the portfolio’s companies were smaller than those of the
NYSE, on average (Hamilton, Hoje, and Statman, 1993, pp. 62-66).
Doing Well While Doing Good
In addition to indexes, several ethically screened funds have also performed well. The
1980s saw many socially managed funds outperform their traditional peers. The Calvert Social
Investment Fund, part of Washington, D.C.’s Calvert Group rose 6.8% in 1984 as many
unscreened funds lost value. That same year, the Pax World Fund 19 gained 6.5%, and the New
Alternatives Fund 20 lost a mere 0.6%. In 1987, 848 mutual funds selected by Lipper Analytical
Services that were at least one year old were ranked in the Financial Services Directory; three of
the most recognizable socially screened funds – New Alternatives, Calvert, and Parnassus 21 –
each handily outperformed the industry average for performance in 1986 of 27.7%. During the
bloodletting of the 1987 stock market crash, Lipper found that nine socially screened mutual
funds had actually outperformed or stayed in line with their unscreened peers. Despite the
19
The Pax World Fund was started by Quakers and Methodists. The fund employed both the avoidance and positive
choice approaches. The fund especially sought out companies with excellent environmental records and those who
were dedicated to being equal opportunity employers. (Lowry, 1991, p. 23)
20
The New Alternatives Fund sought companies that had a positive impact on the environment, especially those that
were involved with alternative and renewable energies. (Ritchie p. 52)
21
Parnassus is a socially screened fund that uses a contrarian approach to selecting companies, i.e. choosing firms
that are currently out of favor with other investors. (Ritchie p. 52)
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damage inflicted by the crash, Lipper also declared the Calvert-managed Ariel Growth Fund as
1987’s top small company growth fund with assets of less than $25 million, and the second best
of all small company growth funds irrespective of size. Ariel screened for companies engaged in
business in South Africa, weapons manufacturing, nuclear energy and/or nuclear equipment
production (Lowry, 1991, pp. 51-53). 22
The Opposing Point of View
As dedicated as the adherents of SRI have and continue to be, there remain many
investing purists and financial professionals who remain unconvinced that socially responsible
investing can yield the same financial rewards as more conventional styles. They believe that
investors should only be focused on risk and return; a person’s subjective set of moral principles
has no place in the investment decision. The arguments against social investing are numerous.
One popularly held belief is that imposing moral/social restrictions on the kinds of companies
that may be invested in unnecessarily limits one’s potential universe of investments, thus
dampening the benefits achieved by diversification. Blanket prohibitions on certain sectors deny
these funds and their investors the opportunity to invest in high performing stocks. In addition,
such funds often have a higher cost of operation due to the extra research needed to identify
investments. In the case of Islamic funds, hiring and maintaining a Sharia board also imposes
added costs.
Just as there have been studies that seem to indicate stronger performance from socially
screened funds vis-à-vis their more traditionally managed counterparts, there have also been
empirical analyses that substantiate the claims of those who oppose using social criteria to make
22
Not discussed in this section is the TIAA-CREF Social Choice Equity Fund. TIAA CREF is one of the largest
defined contribution pension plans in the world. Like many of the ethical funds discussed here, the Social Choice
Equity Fund has offered consistently strong performance, both against other funds of its class and its benchmark
index, the Russell 3000.
95
investment decisions. These analyses find that socially screened portfolios perform worse than or,
at best, in line with conventional portfolios. In a study by Hamilton, Jo, and Statman calculated
the monthly excess returns of 17 socially responsible mutual funds established in or before 1985,
and 15 socially responsible mutual funds established in or after 1986. These returns were
compared to those of two groups of conventional mutual funds from the same time periods. The
returns of the SRI mutual funds were not statistically different from those of the conventional
funds, indicating that investors can expect to neither lose nor gain from investing socially
screened funds. They found that adopting social responsibility principles affect neither expected
stock returns nor firms’ cost of capital (Hamilton et al., 1993, pp. 62-66).
Going a step further, Samuel Mueller of the University of Akron identified in 1991 what
he called the “opportunity cost of discipleship,” a theory which holds that adherents of moral or
ethical systems that are different from the prevalent, mainstream social environment will face
negative consequences as a result of their observance. Mueller’s theory builds upon the work of
sociologists, most notably Dietrich Bonhoeffer, who advanced the concept of costly grace. 23 The
costs experienced by such adherents include both indirect costs such as missed opportunities and
more direct costs such as lower incomes. According to Mueller, sect members’ social networks
often consist primarily of other sect members, reducing the opportunity for networking and other
economic benefits. Also, adhering to a sect’s particular set of ethical guidelines may also prevent
members from participating in and taking advantage of profitable economic enterprises such as
owning a liquor store or operating a casino. Like Hamilton and her colleagues, Mueller also
23
The concept of costly grace was developed by Bonhoeffer in 1963. He posits that adherents to sectarian religions
will experience social costs associated with their belief. In 1988, Laurence Iannaccone took Bonhoeffer’s work a
step farther by developing a formal microeconomic model in which participants in sectarian groups suffer real
economic costs as a result of their actions. See Bonhoeffer, Dietrich. (1963). The Cost of Discipleship. New York:
Macmillan and Iannaccone, Laurence R. (1988). “A formal model of church and sect.” American Journal of
Sociology, 94: S241-68.
96
compared the returns of several ethical funds 24 against relevant fund indices during the 1980s.
He found that the funds yielded lower returns than their unrestricted peers, while also exposing
investors to a somewhat higher level of risk (Mueller, 1991, pp. 111-124).
The examples presented above provide a glimpse into the ongoing controversy
surrounding ethical mutual funds. A definite conclusion about the efficiency and performance of
such funds has not yet been reached. While by no means offering a definitive conclusion as to
ethical funds’ performance, this study will attempt to answer such questions regarding the
Islamic subsector of the ethical investing world.
The Advantage of Social Investing
No matter what one thinks of including social criteria in the investment decision, social
investing has a definite advantage, one that has increasingly been highlighted in the wake of the
financial crisis of 2008. The causes of the financial crisis are manifold, but an important root is
speculation in risky mortgage backed securities and the chase for short term profits (which
existed even before the mortgage crisis). The credit crunch that nearly strangled the global
financial system to death highlighted the dangers of excessive leverage. Socially responsible
investing, including Islamic investing, discourages just this sort of behavior because it can lead
to the volatility and uncertainty witnessed over the course of 2008.
By its very nature, socially responsible investing is conservative. Socially conscious
investors seldom chase after short term gains, instead focusing on long term return and gain.
They favor companies with excellent track records, financial strength, superior valuation, and a
sound business model. Socially responsible investors’ insistence on steering clear of companies
that engage in what they (and others) consider to be morally suspect behavior, such as polluting
24
The funds were: Working Assets, Calvert Money Market fund, Calvert Managed fund, Pax World fund, Pioneer,
Pioneer II, Pioneer Three, Dreyfus Third Century, Parnassus, and New Alternatives.
97
the environment or not doing enough to promote and retain female and minority employees, may
seem overly fastidious to many more traditionally minded investors. But that approach seems
wise, even prescient, when such companies are penalized for their behavior through lawsuits,
punitive legislation, and the like. Islamic funds were spared much of the damage that
conventional funds suffered in the early stages of the financial crisis as they did not own
financial stocks. The Sharia’s ban on interest saved many of these funds from the rapid declines
in value that weakened some conventional funds and felled others.
The Four Islamic Equity Funds
In order to gauge the performance of an Islamic fund, suitable representations of Sharia
compliant funds were necessary. Generally speaking, investors seek either growth or regular
income from equity investments; Islamic funds that focused on these goals were needed. Four
Islamic mutual funds were selected to represent the Islamic equity portfolio in this analysis.
Azzad Ethical Income Fund (AEIFX)
The Azzad Ethical Income Fund is provided by Azzad Asset Management, a Virginia
based asset management firm that specializes in ethical investing. Benchmarked to the S&P 500,
the fund’s managers seek to obtain current income for investors by investing at least 80% of its
assets in dividend paying companies, as well as achieving long term capital appreciation. The
fund’s holdings are primarily distributed across a number of large cap dividend yielding
companies. Though the fund’s focus is on large cap companies, the fund may invest up to 25%
of its assets in small and midcap companies. The fund does not invest more than 5% of its assets
in one company, nor does it devote more than 25% of assets to a single sector. Managers also
employ business and financial screens to select securities for inclusion in the fund. Like most
Islamic funds, this fund does not invest in companies that deal with alcohol, tobacco, financial
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services, and unethical entertainment like pornography and gambling. The fund uses proprietary
software, which uses financial data provided by sources such as Thomson Financial, to screen for
companies that meet its ethical criteria (Manal Fouz, personal communication, December 9,
2008). Interestingly, the fund also does not invest in companies that are primarily involved in
the production of all meat products, and not solely pork products, citing the fact that many
people are vegetarians or abstain from eating meat due to religious reasons. The fund also
employs the following financial screens to select permissible securities for inclusion:
A. Debt Screen
i. Total debt = short term debt + current portion of long-term debt + long-term
debt
ii. Total debt/trailing 12-month average market capitalization ≤ 33%
iii. Total debt/assets ≤ 33%
B. Accounts Receivable Screen
i. Accounts receivables = current receivables + long-term receivables
ii. Accounts receivables/total assets ≤ 45%
C. Interest Income Screen
i. Interest income/total sales ≤ 5%
The fund also does not invest in interest based securities, assets that are deemed interestequivalent securities, and derivative and hybrid securities (i.e. swaps and futures contracts) (The
Azzad Funds 2008 Prospectus).
Amana Income Fund (AMANX) and Amana Growth Fund (AMAGX)
Like the Azzad Ethical Income Fund, the Amana Income Fund is dedicated to generating
current income for investors by investing only in dividend paying stocks, as well as preserving
capital. This fund is managed by the Amana Mutual Funds Trust, which is part of Saturna
Capital. Also like the Azzad fund, the Amana Income Fund is benchmarked to the S&P 500. The
fund does not invest in instruments that pay interest, nor does it invest in companies whose
primary lines of business are inconsistent with Sharia guidelines. At least 80% of the fund’s
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assets are invested in income producing equity securities, and the fund is biased toward large cap
companies.
Also managed by Saturna’s Amana Mutual Funds Trust, the Amana Growth Fund is
focused on providing shareholders with long term capital appreciation. Benchmarked to the
Russell 2000, the Growth Fund is biased toward large cap growth stocks. At least 80% of the
assets of the Growth Fund are invested in common stock. Along with Sharia guidelines, stocks
are selected for inclusion in the fund based on past earnings and growth rates, as well as
managers’ expectations of future share price appreciation.
The funds’ managers are true long term value investors; they tend to seek out companies
with strong balance sheets, established and sound business models, and attractive valuation. In
keeping with many mutual funds, managers actively strive to limit the amount of income taxes
paid by shareholders by infrequently trading securities and selling high tax cost lots first (The
Amana Funds 2008 Prospectus).
The Iman Fund (IMANX)
The fourth Islamic fund is the Iman Fund, distributed by Quasar Distributors and advised
by Allied Asset Advisors, a subsidiary of the North American Islamic Trust (NAIT), which also
owns approximately 72% of the outstanding shares of the fund. The Iman Fund is benchmarked
to the S&P 500, the Russell 3000, and the Dow Jones Islamic Market US Index. The fund’s
managers refrain from investing in interest bearing securities, companies that generate large
amounts of interest income, and companies that have impermissible lines of business. The fund
is advised by a three member Board of Trustees – Shaykh Abdalla Idris Ali, Mohammed
Kaiseruddin, PhD., and Bassam Osman, MD – none of whom receive compensation from the
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fund. These trustees meet throughout the year to discuss and decide upon issues of policy and to
supervise the operations of the Fund (The Iman Fund, 2008).
The “Conventional” Comparison Funds
In order to effectively judge the performance of Islamic funds, funds that do not face
Sharia guidelines are needed for comparison. Two conventional mutual funds were chosen for
comparison to the Islamic funds, both provided by Vanguard. “Conventional” funds are those
which do not face restrictions in the types of companies they may invest in. Unlike Islamic funds,
which cannot deploy their uninvested cash in interest bearing accounts, these conventional equity
funds may place their excess capital in interest bearing accounts and instruments.
Vanguard Equity Income Fund (VEIPX)
Due to its focus on obtaining current income for investors, this fund was selected for
comparison to the Azzad Ethical Income Fund and the Amana Income Fund. The fund primarily
invests in large cap stocks with high dividend yields. The fund, which maintains a number of
advisors, looks for companies that have demonstrated a commitment to consistently paying
dividends. Normally the fund invests at least 80% of its assets in stocks. Though the fund may
invest up to 20% of its assets in foreign securities, its primary focus is on U.S. equity securities.
The fund also invests a small portion of its assets in exchange traded funds (ETFs), including
those of Vanguard. The fund can participate in futures contracts, but avoids utilizing more than
20% of its assets for this purpose. The fund does not use futures or any other derivative
instrument to speculate (The Vanguard Group, 2008, Vanguard Equity Income Fund Investor
Shares – VEIPX).
Vanguard U.S. Growth Fund (VWUSX)
The Vanguard U.S. Growth Fund is dedicated to providing investors with long term
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capital appreciation, making it a suitable conventional comparison to the Amana Growth Fund
and the Iman Fund. The fund’s portfolio holdings typically include large cap U.S. companies that
have experienced and are expected to continue to experience high rates of growth. In addition to
focusing on firms that have above average expected rates of growth, the fund’s managers also
search for companies that maintain positions of strength within their particular industry, and are
financially sound. Unlike the Vanguard Equity Income Fund, this fund may use futures, options
contracts, or other derivative instruments. However it too does not use such contracts for
speculative purposes (The Vanguard Group, 2008, Vanguard U.S. Growth Fund - VWUSX).
The Vanguard 500 Index Fund (VFINX)
The Vanguard 500 Index Fund was created to track the S&P 500. Generally, it contains
the 500 stocks included in the S&P 500. The fund also maintains approximately the same levels
of sector diversification as the S&P 500. Naturally, the fund has a beta of 1.00 (meaning that it is
as volatile as the market) (The Vanguard Group, 2009, Vanguard 500 Index Fund – VFINX). The
VFINX makes a perfect benchmark to measure the performance of the Islamic funds and the
conventional funds because it is basically a cost-adjusted version of the real S&P 500. With the
fund, management costs and fees are taken into account, making for a more realistic comparison
of returns.
The Islamic Funds versus Their Conventional Counterparts
How does an Islamic fund compare to a conventional fund? Can Muslim investors expect
the same or better levels of performance? Or are they penalized for adhering to their religious
beliefs, as theorized by Dietrich Bonhoeffer and Samuel Mueller? To conduct this analysis, the
quarterly holding period returns for each portfolio were calculated for its entire time span, from
date of inception to December 2008. The Islamic income funds, AEIFX and AMANX, were
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compared to the VEIPX. Likewise, the Islamic growth funds, IMANX and AMAGX, were
compared to the VWUSX.
Figure 8. The AEIFX and VEIPX Compared
During most of its history, the AEIFX has been outperformed by its conventional
counterpart, the VEIPX. Roughly from 2002 to 2007, the AEIFX only outperformed the VEIPX
four times. However, beginning in last 2007, we can observe an interesting reversal. The Islamic
fund began to consistently outperform its conventional rival over the five quarter ranging from
December 2007 to December 2008. This can be seen even more clearly in the Figure 9, which
depicts the basis point difference between the returns of AEIFX and VEIPX; anything above the
reference line at 0% represents a quarter when the AEIFX outperformed the VEIPX.
103
Figure 9.
The timing of this reversal is most likely no coincidence. This time period coincides with
the emergence of the global liquidity crisis and the resulting upheaval in the broader economy.
Financial stocks, which represented nearly 20% of the VEIPX’s holdings at the end of 2008,
suffered tremendous declines. AEIFX’s Islamic restrictions no doubt helped spare the fund from
the same level of pain experienced by its conventional counterpart.
AMANX, the other Islamic income fund, tells nearly the same story. AMANX has often
outperformed the VEIPX, even in its earlier years. And it too also posted superior performance
relative to the conventional fund (with the exception of the quarter ended September 30, 2008).
104
Figure 10. AMANX and VEIPX Compared
105
Figure 11
The Islamic growth funds have also fared well against their conventional
counterpart, the VWUSX. Throughout its eight year history, IMANX has often outperformed the
conventional growth fund, as seen in Figures 12 and 13. And until the end of the third quarter of
2008, IMANX maintained strong performance in the midst of the fallout from the financial crisis.
AMAGX, the second of the Islamic growth funds, delivered a strong performance during
the difficult second half of 2008, as well as an admirable overall performance throughout its
history, as seen in Figures 14 and 15.
106
Figure 12. IMANX and VWUSX Compared
Figure 13
107
Figure 14. AMAGX and VWUSX Compared
Like the other Islamic funds, AMAGX offered investors a welcome measure of relief
from the dizzying downward spiral in the financial markets in the last months of 2008.
On the whole, the Sharia restrictions of the four Islamic funds protected investors from
the more overwhelming declines faced by conventional funds as the credit crunch deepened. The
ban on interest-based financial companies was a major part of the funds’ consistency and
resilience. As the financial crisis began to punish those companies that had accumulated large
and onerous debt loads, the Islamic funds were largely spared the fallout from the credit crunch
during the latter half of 2008. In addition, Muslim investors
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Figure 15
should be comforted by the fact that the Islamic funds also charted great performance during
good times as well. These results suggest that Muslims may not suffer from “costly grace” if
they choose to adhere to their religious beliefs in their financial dealings and investments.
The Islamic Funds’ Bear Market Performance
In recent years, there have been three bear markets (aside from the current and ongoing
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market downturn precipitated by the financial crisis): the 1987 bear market, which lasted from
July 1987 to December 1987, the 1990 bear market, which lasted from June 1990 to November
1990, and the stock market downturn of 2002, which actually really began in February 2000 and
lasted until October 2002. This downturn is generally associated with the “Internet bubble”
bursting 25, and was exacerbated by the September 11, 2001 terrorist attacks. The oldest of the
Islamic funds, the Amana Funds, were incepted in 1996, whereas the Iman Fund and the Azzad
Ethical Income Fund were incepted in 2000 and 2002, respectively. Therefore, three of the
Islamic funds’ strength and performance have only been tested by the stock market downturn of
2002. The Azzad Ethical Income Fund missed the brunt of the downturn, which came prior to its
inception.
Table 3. AMAGX During Last Stock Market Downturn
Date
March 2000
June 2000
September 2000
December 2000
March 2001
June 2001
September 2001
December 2001
March 2002
June 2002
September 2002
Mean Quarterly
HPY
AMAGX
7.76%
-11.29%
-2.21%
-6.34%
-13.29%
8.61%
-17.28%
21.14%
0.08%
-16.78%
-16.60%
-4.20%
VWUSX
5.09%
1.42%
0.70%
-24.62%
-25.37%
10.37%
-23.76%
20.21%
-8.45%
-21.08%
-13.66%
-7.20%
VFINX
3.24%
-3.11%
-1.95%
-7.78%
-9.36%
7.14%
-15.57%
10.91%
-0.35%
-13.38%
-15.42%
-4.15%
*Bold - outperformed VFINX; Italics - outperformed conventional fund
25
The Internet, or dot-com, bubble was a nearly six year speculative bubble that occurred when Western stock
markets saw their valuations increase exponentially. The bubble’s growth was led by Internet and technology
companies. The rise of the dot-com stocks was accompanied by rapidly increasing stock prices, a rush of venture
capital, speculation, and Malkielian “irrational exuberance.” This environment led many tech ventures to abandon
standard business models and focus more on stock price appreciation. But like all bubbles before it, the tech bubble
also proved untenable and resulted in a devastating stock market crash in 2001 and many tech and Internet
companies went bankrupt.
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Table 3 compares the quarterly returns of AMAGX, VWUSX, and the benchmark VFINX
during the stock market downturn of 2002. AMAGX often outperformed the VFINX and
actually nearly always outperformed the conventional VWUSX. Its average quarterly holding
period return of -4.20% also outperformed that of the VWUSX.
Table 4. AMANX During the Last Stock Market Downturn
Date
March 2000
June 2000
September 2000
December 2000
March 2001
June 2001
September 2001
December 2001
March 2002
June 2002
September 2002
Mean Quarterly
HPY
AMANX
2.42%
0.06%
0.00%
0.34%
-7.28%
3.14%
-8.05%
4.33%
2.06%
-8.76%
-15.63%
-2.49%
VEIPX
0.38%
-2.26%
5.12%
6.94%
-3.87%
4.40%
-6.99%
5.91%
3.31%
-8.42%
-16.92%
-1.13%
VFINX
3.24%
-3.11%
-1.95%
-7.78%
-9.36%
7.14%
-15.57%
10.91%
-0.35%
-13.38%
-15.42%
-4.15%
*Bold - outperformed VFINX; Italics - outperformed conventional fund
In contrast, AMAGX’s sister fund performed slightly worse, as seen in Table 4. While it often
outperformed the benchmark fund, it seldom did better than its conventional rival VEIPX did.
The reason for this was that AMANX was heavily weighted with utility and energy companies
during much of the period; weakness in those industries overcame the relatively good
performance of other sectors.
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Table 5. IMANX During the Last Stock Market Downturn
Date
December 2000
March 2001
June 2001
September 2001
December 2001
March 2002
June 2002
September 2002
Mean Quarterly
HPY
IMANX
-10.12%
-15.21%
7.85%
-17.87%
15.50%
-2.44%
-16.52%
-15.11%
-6.74%
VWUSX
-24.62%
-25.37%
10.37%
-23.76%
20.21%
-8.45%
-21.08%
-13.66%
-10.80%
VFINX
-7.78%
-9.36%
7.14%
-15.57%
10.91%
-0.35%
-13.38%
-15.42%
-5.48%
*Bold - outperformed VFINX; Italics - outperformed conventional fund
The Iman Fund rarely outperformed the benchmark fund VFINX during this period, but nearly
always outperformed its conventional counterpart VWUSX, much like the other Islamic growth
fund AMAGX.
The Question of Diversification
One of the most common charges against Islamic portfolios – and ethical funds in general
– is that by reducing the number of sectors in which an individual may invest, the investor will
pay a price for losing the benefits of diversification. Diversification has been an important tenet
of portfolio selection ever since Markowitz introduced the idea in the 1950s (see chapter III).
According to theory, an investor can virtually eliminate all unsystematic risk in a portfolio
through diversification. This depends on reducing the covariances between assets in the portfolio
to their minimum level. While investing in many securities does not guarantee the smallest
variance for a portfolio, it is generally accepted that adequate diversification can be achieved by
investing in a large number of securities across different industries. The question lies in how
many stocks are necessary to reach an adequate level of diversification (i.e. when unsystematic
risk in the portfolio has been reduced to the lowest possible level).
112
In 1968, John Evans and Stephen Archer investigated how many securities were
necessary to achieve diversification in a portfolio. Through their analysis, Evans and Archer
found that the marginal benefits (i.e. risk reduction) of adding securities to a portfolio declined
rapidly as more and more securities were added, or in technical terms displayed a diminishing
marginal effect. Their study indicated that only eight to ten securities were needed to attain the
full economic benefits of diversification; adding any more was not economically justified due to
marginal costs (primarily transactions costs) outweighing marginal benefit (Evans and Archer,
1968, pp. 761-767). However, this position was refuted by the work of Meir Statman in the late
1980s. Statman’s analysis yielded surprising and substantially different results from the Evans
and Archer study. Statman demonstrated that no less than 30 stocks are needed for a well
diversified portfolio. Specifically, Statman showed that a well diversified equity portfolio must
contain at least 30 stocks for a borrowing investor, and no less than 40 stocks for a lending
investor (Statman, 1987, pp. 353-363).
Even with Statman’s drastically larger required number of stocks, Islamic equity
portfolios are in no danger of not meeting his criteria, as can be seen in the table below:
Table 6. Number of Securities - Islamic Portfolios
Islamic Portfolio
# of Securities
IMANX
158
AEIFX
48
AMANX
82
AMAGX
84
Source: Latest SEC filing
The sector weights in each portfolio are just as important as the total number of securities.
The sector weight represents the portfolio’s exposure to a specific industry. After a thorough
113
analysis of each of the Islamic funds’ SEC filings, the Islamic funds demonstrated good sector
diversification. The figures in the right hand column of Table 7 represent the highest industry
allocations throughout each fund’s history. None exceeds a quarter of the portfolio’s value. The
Islamic portfolios have thus maintained sufficient industry diversification, overweighting sectors
which the managers have been “bullish” on at different points in time.
Table 7. Industry Allocation - Highest Percentages
Fund
Highest Percentage
AEIFX
19.61%
IMANX
17.70%
AMAGX
21.60%
AMANX
22.10%
Source: Historic N-CSRs and N-CSRSs
Recent Market Turmoil – The Role of Financial Stocks
In the midst of the recent turmoil in the US stock market, nearly every stock has suffered
declines as this global financial and economic crisis has proved that no industry is recession
proof. The financial industry was the worst hit. After the global liquidity crisis emerged in late
2007, one financial institution after another fell in a staggering domino-like fashion. Bear Stearns,
Fannie Mae, Freddie Mac, and Lehman Brothers were all felled by the crisis sweeping the
financial markets and enveloping the broader economy. Portfolios that held significant amounts
of financial stocks were pummeled. In light of their lack of financial stocks, 26 a significant
question about the recent performance of Islamic funds immediately emerges. Did Islamic
26
The reader should keep in mind that when we say “financial stocks”, this is not just limited to banks and other
lending institutions. This generally includes all companies that are involved in the financial industry. The companies
that are excluded are: insurance companies, credit services companies, banks (commercial and investment),
brokerages, savings and loans, non-Islamic mortgage companies, asset management companies, and REITS that
invest in conventional interest-based mortgages and/or properties used for non-halal enterprises such as casinos.
114
restrictions on investing in financial companies and companies with high debt loads actually
shield the Islamic funds somewhat from the carnage in the markets? The answer is a qualified
yes.
In the current global financial crisis, there have been three important watermarks for US
markets. The first occurred around August/September 2007 when the liquidity crisis began to
emerge. The “credit crunch”, as it came to be called, was marked by financial and debt markets
seizing up, blocking off lifelines of credit and funding for large and small businesses alike.
Turmoil in the home-loan and mortgage markets gradually began to seep out into the rest of the
lending world. Stock markets across the world were sent into a tailspin, dragging the returns and
value of many portfolios down with them.
Figure 16. Holding Period Return, Post September 2007
10%
0%
AEIFX
IMANX
VFINX
VWUSX
VEIPX
AMAGX
AMANX
-10%
-20%
-24.16%
-30%
-31.15%
-34.68%
-40%
-41.08%
-39.66%
-39.55%
-44.21%
-50%
Source:
Author's Calculations
Figure 16 depicts the holding period returns of all seven portfolios after September 2007
(the holding period is September 2007 to December 2008). VFINX, shaded purple, represents the
benchmark for comparison. The results of this analysis are very interesting. Two of the Islamic
portfolios, AEIFX and IMANX, underperformed the benchmark fund, down 44% and 41%
115
respectively. At the other end of the spectrum, the other two Islamic portfolios, AMANX and
AMAGX, performed relatively well during the holding period.
The first quarter of 2008 was another watershed moment in the current crisis. The quarter
began with extremely high market volatility, both in the US and abroad. The pain did not stop
there; March 2008 saw both the collapse of fabled investment bank Bear Stearns and the
government takeover of Fannie Mae and Freddie Mac. These events sent further shockwaves
through the markets and financial stocks were among the most severely affected. The pattern
shown above again plays out below in Figure 17. AMANX and AMAGX performed well against
their peers during 2008, despite the unprecedented upheaval in the financial markets and the
broader economy.
Figure 17. Holding Period Return, 2008
10%
0%
AEIFX
IMANX
VWUSX
VFINX
VEIPX
AMAGX
AMANX
-10%
-20%
-23.14%
-30%
-31.20%
-40%
-37.58%
-43.63%
-29.31%
-36.66%
-41.52%
-50%
Source: Author's Calculations
The third shoe to drop in the course of the crisis came in September 2008, which
witnessed the fall of another Wall Street pillar, Lehman Brothers. Unlike Bear Stearns, which
was acquired in the eleventh hour by rival JP Morgan Chase with the backing of the federal
government, Lehman Brothers was forced into bankruptcy. The bankruptcy filing sent already
fragile markets into a vicious, breakneck freefall, which eventually led Congress to enact the
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Troubled Asset Relief Program (TARP), administered by then Secretary of the Treasury Henry
Paulson.
Figure 18 shows the holding period returns for each of the portfolios from September
2008 to December 2008. After this third shock, AMAGX and AMANX yet again displayed good
performance. No portfolio was spared in the carnage that ensued after the fall of Lehman
Brothers, but these two funds performed arguably well and caused their shareholders much less
anxiety that most other funds.
In this recent environment, a lack of financial stocks was a definite advantage for the
Islamic funds. In the midst of fears about mortgage related securities and other toxic assets,
shares of banks, brokerages, and other financial companies were hit hard. The restrictions of the
Sharia did provide a degree of insulation from the market turmoil.
Figure 18. Holding Period Return, Post September 2008
10%
0%
IMANX
AEIFX
VFINX
VWUSX
VEIPX
AMAGX
AMANX
-10%
-12.67%
-20%
-19.42%
-22.61%
-30%
-27.22%
-18.68%
-22.45%
-25.92%
Source: Author's Calculations
However, only the Amana funds seemed to be the beneficiaries of this protection, while
the Iman Fund and the Azzad Ethical Income Fund suffered even worse than the conventional
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funds. So while the lack of financial companies does seem to explain a part of the Amana Funds
excellent performance, it does not tell the whole story.
The other factor that probably helped the Amana funds perform so well was the fact that
their managers began to build strong cash positions in August 2007. New investors’ funds were
not placed into equities, and cash levels subsequently rose to around 30% of assets (obviously
these were not held in interest bearing securities) (Mamudi, 2009). These cash positions helped
to mitigate the impact of the havoc raging in the markets on the funds’ performance. In contrast,
the other two Islamic funds kept the majority of their assets in equities.
The Strength of the Amana Funds
The strong and consistent performance of the Amana Funds comes as no surprise. While
the funds are not widely known to most investors, both have consistently been top performers
and their managers at Saturna Capital are also well regarded. Most importantly, the funds belie
the criticisms leveled against socially conscious and faith based funds discussed earlier in the
chapter. Both funds have been continually ranked among the best performing funds in their
respective categories for years.
The Amana funds’ Islamic restrictions and investment rules have also contributed to their
performance, even before the current crisis hit. The low debt requirement has led managers to
some profitable investments. Nicholas Kaiser, the funds’ manager, bought shares of construction
company Washington Group International after research revealed that it had zero debt. The firm
bought the shares at $55; they later sold the position at $91.50 after a takeover offer caused the
stock to rise. The restriction on investing in companies whose debt levels exceed 33% also
helped the funds escape from some potentially disastrous choices. For example, Enron
Corporation met the other criteria for inclusion in AMAGX, but its debt level prevented the fund
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from investing. In addition, the Amana funds’ low turnover rate (which measures how often
stocks are bought and sold) is around the very low level of 10% annually; this strengthens
performance and cuts costs associated with frequent trading, such as capital gains taxes and
trading fees (the frequent trading of stocks is seen as a form of maysir). On the whole, these
guidelines also make the Amana funds appealing choices for long term minded investors, both
Muslim and non-Muslim (Cui, 2007, pp. C1-C2). The performance of the Amana funds within
the period studied provide strong evidence that investors in socially conscious funds need not
fear being penalized for adhering to their beliefs.
Conclusion
Islamic investment is, at its core, a subset of ethical investment in that it is guided by a set
of essential, intrinsic beliefs, values, and social standards. Both Islamic investment and ethical
investment in general have faced a barrage of criticism from “traditionalists” who cling steadfast
to the principle that emotions and other subjective criteria should be divorced from the
investment decision. Indeed, some studies have pointed to the existence of an opportunity cost
associated with investing according to one’s ethical or religious principles. It is true that ethical
investment and Islamic investment in particular can result in a very restricted investment
universe, as well additional costs of operation. At the same time there have been numerous other
studies, including this one, that suggest positive benefits. A key advantage of social investing is
that it tends to be conservative, favoring a value oriented strategy that focuses on long term
return and gain. Furthermore, the restrictions maintained by some social funds have helped their
investors steer clear from stocks that eventually came to be severely punished in the market, as
we have seen in the case of Islamic stocks and their fortunate exclusion of financial firms and
debt laden companies in the wake of the credit crunch. The results of the foregoing analysis offer
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compelling evidence that Muslims need not necessarily fear being penalized for attempting to
adhere to the precepts of the Sharia. Indeed, the Islamic funds, especially the Amana Funds,
often offered superior performance relative to their conventional rivals.
One should not think that equity portfolios are the only investment vehicles available to
Muslims who choose to adhere to the Sharia in their financial decisions. There are several other
Islamic asset classes and investment alternatives that they may choose from, as we shall see.
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CHAPTER VI.
OTHER ISLAMIC ASSET CLASSES AND INVESTMENT
ALTERNATIVES
Introduction
With all the restrictions imposed by the Sharia, it would seem that Muslim investors are
limited to investing in equities and not much else. However, this is not the case. The focus of this
work may be on equity portfolios, but there are a number of different Sharia compliant asset
classes that are available to Muslims. In addition to other special classes of valuable assets that
can comprise a portfolio, such as fine art, jewelry, antiques, and the like, there are many new
types of Islamic securities and financial vehicles that are being developed to suit the needs of
Muslims. Depending on their level of individual wealth, Muslims can deploy their financial
capital in a variety of contracts and assets that are acceptable to Islamic protocol. The purpose of
this chapter is to explore these investment alternatives in greater detail. We will begin with a
brief discussion about the process of securitization in Islamic finance.
Securitization in Islamic Finance
Even before the recent meltdown in the mortgage market, securitization had become a
standard process in contemporary Western finance. It allows financial institutions to originate
tradable, liquid financial instruments from a wide variety of other financial assets, not only
mortgages, but also receivables and loans. This process, which can only take place with assets
which have an associated cash flow, leads to the creation of an asset backed security. It has
become a powerful tool in modern finance. Presumably, the recent mortgage collapse will only
be a temporary setback in the continued use of securitization in the financial world.
However, from the advent of collateralized debt obligations in the 1980s, securitization
has been greeted with an unfriendly reception by many Muslim jurists, who are keenly averse to
new financial instruments secured by debt. This is due to the fact that the sale of debt is strictly
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prohibited in Islam. Likewise, contemporary jurists – some in Malaysia are notable exceptions –
have also prohibited trading in debts and liabilities. General trading of one liability for another
has been forbidden due to gharar, which would arise from uncertainty about the delivery of
either compensation. However, classical jurists ruled that it is permissible to cancel one debt
against another of equal amount and maturity (maqassa). Forwarding a debt to a third party –
hawala – is also permitted. Most modern jurists hold that selling a liability to the debtor was
halal, with the qualification that the debt must be sold at or below face value to the debtor
himself (El-Gamal, 2006, pp. 102-106).
Real Estate
Buying, maintaining, leasing, and selling real estate is fundamentally a permissible
business in the eyes of the Sharia. Real estate is one of the most widely used methods of
investment in the West (even though it has been associated with some spectacular bubbles and
panics, such as the current financial crisis which, as noted, was precipitated by flawed mortgages
and mortgage-backed securities). Real estate and property development is a key industry in the
Middle East, the Arab world, and the Muslim world. However, investing in real estate generally
requires having a substantial amount of capital readily available with which to purchase and
develop properties. Few individual investors have the financial resources to invest in real estate
on a wide scale. Even for those who do possess the financial wherewithal to do so, it may not be
feasible or efficient for a number of reasons. Consequently, investing in a real estate investment
trust, or REIT, is usually a more suitable option.
A REIT is an entity that invests in different kinds of real estate or real estate related
assets. The properties can be of a residential nature, or be commercial real estate properties, such
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as offices, hotels, and malls. Many REITs specialize in one type of property. REITs can also
invest in mortgages secured by real estate. There are three principal types of REITs:
1. Equity REITs are the most common type of REIT. They invest in, or own real estate
and distribute profits to their investors from the rents they collect.
2. Mortgage REITs provide funds to real estate owners and developers. In addition,
they invest in financial instruments that are secured by mortgages on real estate.
3. Hybrid REITs are a combination of equity and mortgage REITs, as their name
suggests.
In order to be classified as a REIT, an entity must conform to several specific guidelines enacted
by the IRS. A company must pay 90% of its income to investors annually. The firm must also
invest at least 75% of its total assets in real estate. Lastly, the company has to earn 75% or more
of its gross income from investments in real property and/or mortgages tied to real property
(Securities and Exchange Commission, 2004).
Equity REITs represent the most permissible option for Muslims (unless of course a firm
invests in Islamic mortgages), which hold the majority of their assets in the form of real estate.
The majority of their income also comes from rent. And because REITs are legally required to
pass much of their income on to investors in the form of dividends, REITs are an excellent
investment option for Muslims looking for reliable, stable sources of income. Furthermore,
REITs have exhibited low correlations with other asset classes – which means that they are
suitable for diversification, thus making them useful additions to any equity portfolio.
However, in terms of Sharia compliance, REITs do have an Achilles heel; they are
usually highly leveraged. The optimal level of debt for the average REIT is somewhere in the
40% to 60% range, well above the commonly accepted cutoff of approximately 33%. Since
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REITs offer such desirable benefits to investors, two approaches have been suggested that would
allow Muslim investors to reap the benefits of these securities. First, the principle of maslaha is
often invoked; since REITs offer such clear advantages to investors, a higher debt benchmark
should be used to screen them. A debt to asset ratio of 50% is considered a reasonable
benchmark. The second approach, offered by Mahmoud El-Gamal, is to consider only nonmortgage or unsecured debt when computing debt to asset or debt to market capitalization ratios
during screening. All secured or mortgage debt can easily be “Islamized” through a number of
Islamic contractual forms. In a recent study, El-Gamal examined thirteen REITs, and found that
when unsecured debt-to-assets ratios were employed, ten of those REITs actually passed the
33% screen (El-Gamal, 2006, pp. 129-132).
Private Equity and Venture Capital – Mudaraba and Musharaka
Profit and loss sharing (PLS) is the ideal business form in Islamic finance in that it
promotes equity and the sharing of risk and reward between parties. The partnership is the
primary expression of this principle, and is highly regarded in Islamic financial fiqh. The use of
partnerships in Arabia predates the Islamic period, and is highly revered in the Arab and Muslim
worlds. Many of Muhammad’s Companions entered into partnerships during and after his
lifetime. Forms of partnership are recognized and legalized in both the Quran and the Hadith.
Christians who lived in Muslim controlled areas of Europe were likely thus inspired by the Arabs
and Muslims to adopt the practice and spread it to other parts of the Continent. Partnerships have
a long and rich tradition in classical Islamic jurisprudence (Ayub, 2007, pp. 307-311).
This chapter will focus on the two main forms of partnerships in use in contemporary
Islamic finance: mudaraba and musharaka. These two forms are considered by many jurists and
scholars to be the workhorse of true Islamic finance, and the two forms that contribute the most
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to Islamic finance’s goals of productivity, equity, and PLS. In many jurists’ opinion, mudaraba
and musharaka constitute the axis on which modern Islamic finance is supposed to turn.
Mudaraba
A mudaraba (also known as a qirad and muqarada by the Shafii and Maliki schools
respectively) is a silent partnership between an investor or investors, or sleeping partners (known
as the rabb al-mal) who provide capital to an agent (the mudarib) who acts on their behalf. The
mudarib invests the capital on behalf of the investors. The investors and the agent share the
profits of a venture, if there are any, according to a pre-determined ratio. For example, the
contract may specify that the investors receive 60% of the profits while the mudarib receives
40%. Capital losses are borne strictly by the investor, while the agent loses his or her time and
any profit he or she would have realized had the venture been successful. The mudarib may only
use the funds for purposes that are explicitly defined in the contract. At the conclusion of the
mudaraba transaction, the mudarib must return the principal and the predetermined share of
profit to the investors.
In terms of the business of the mudaraba, the mudaraba can be either restricted or
unrestricted. In a restricted mudaraba, the mudarib may only engage in the business or
businesses specified by the rabb al-mal. In the unrestricted mudaraba the rabb al-mal leaves it to
the discretion of the mudarib to engage in whatever businesses he or she wishes. In both types of
mudaraba, the business must of course conform to the religious litmus test in order to be deemed
acceptable.
The capital of a mudaraba must be currency and not any other form of real property; this
injunction exists in order to prevent gharar in that the price of the real property may fluctuate
before it is converted to cash. It is also impermissible to use a debt owed by the mudarib or
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anyone else to the rabb al-mal as capital. This stipulation is clearly meant to prevent the rabb almal from guaranteeing the return of his principal and an illegitimate return on the loan, namely
the forbidden riba.
The rabb al-mal may impose restrictions on the mudarib, but the mudarib is afforded a
great deal of flexibility and freedom in deciding how to conduct business and earn profits. Every
madhhab with the exception of the Hanbalis does not permit the mudarib to use his own capital
in the venture. It is the duty of the mudarib to liquidate the mudaraba; however each madhhab
differs as to which party has the final say over the proper time of dissolution. The Hanbali and
Hanafi schools allow a mudaraba contract to specify a pre-determined duration, after which
mudarib may no longer conduct business on behalf of the investor(s) (Wakin, 1993, pp. 284-285;
Ayub, 2007, pp. 320-327; Warde, 1999).
Musharaka
The traditional musharaka is a full contractual partnership formed to pursue a specific
line of business or project. The project can be a new venture or an existing one that requires
additional capital. Each partner in the musharaka receives an equity stake in the venture – this is
the primary difference between the mudaraba and the musharaka. In contrast to the mudaraba, a
musharaka allows each partner to contribute capital and to jointly share in the profits and losses
of the venture. Another key difference between the two contracts is that in the musharaka each
partner not only contributes capital, but also contributes some amount of labor. Musharaka can
also include non-Muslims provided that the guidelines of the Sharia are observed. As in the
mudaraba, the capital infused in a musharaka must be a liquid asset i.e. money.
The musharaka is the modern Islamic contract that conforms most closely to the ideals of
Islamic finance in that it is true profit-and-loss sharing. Each partner receives profits or bears
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losses in proportion to the share of capital he or she provided. Some jurists argue that a partner
can receive more than the ratio of his or her investment as compensation for supplying more
labor to the musharaka. This view is held on the basis that labor is also an important factor in the
success of the venture and the generation of profit. Regardless of disagreements about the share
of profit, there is universal consensus on the point that losses must be shared in accordance with
the amount of capital invested by each partner (Latham, 1993, pp. 671-672; Ayub, 2007, pp.
312-318; Warde, 1999).
The Link to Modern Private Equity and Venture Capital
Even the most casual observer can appreciate the similarities that exist between
conventional Western private equity and venture capital structures and the two main forms of
Islamic PLS, mudaraba and musharaka. Both focus on creating a partnership between lender and
borrower, with financiers actively involved in the management of the venture and ensuring that it
is as profitable as possible. Islamic PLS and venture capital feature long term commitments on
the part of financiers to entrepreneurs and their ventures, rather than the short term focus of
conventional, interest-based lenders.
This type of investment is not limited to very wealthy Muslims or Islamic institutional
investors. There are two avenues through which middle class Muslims can also participate in
mudarabas and musharakas. First, there is the “double mudaraba”, a contract endorsed by Frank
Vogel, the director of Harvard Law School’s Islamic Legal Studies Program. The structure of the
double mudaraba is simple. Investors place their capital with an Islamic financial institution in a
primary mudaraba, thereby making the institution a mudarib. The institution then invests those
funds, as well as its own capital, with entrepreneurs in a number of secondary mudarabas. The
institution then can redistribute its profits from these secondary ventures to its own primary
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investors. Second, Islamic PLS offers the potential to develop a secondary market of mudaraba
and musharaka certificates in which both Muslims and non-Muslims alike could invest. Indeed,
mudaraba certificates have been in use since the early 1980s (Warde, 1999; Ayub, 2007, p. 389).
Islamic Bonds – Sukuk
Muslims are prohibited from investing in conventional bonds, but they do have an
Islamic alternative. This alternative is known as a sakk (plural: sukuk), the Arabic term for bond
or certificate. Before the advent of sukuk, it was widely held than an Islamic debt market could
not be developed due to the Sharia prohibition on the sale of debt. But the materialization of
different types of sukuk has demonstrated that some feature and benefits of a debt market can be
made available to Islamic firms and investors.
Many participants are involved in a typical sukuk issuance, but there are always four key
players:
1. The originator or issuer
2. The special purpose vehicle (SPV), which is incorporated specifically for the
securitization process, managing the issue, and purchasing the underlying assets from the
issuer
3. Investment banks
4. Subscribers to the issuance, which are usually central banks, Islamic banks, and
individuals (Ayub, 2007, p. 393)
Sukuk can be issued on the basis of Islamic contracts such as ijara. They can be either
variable return sukuk or fixed return sukuk. There are various categories of sukuk that are based
on Islamic financial contracts, such as mudaraba, musharaka, and ijara (Ayub, 2007, p. 396).
128
Since lease backed sukuk are some of the most popular in contemporary Islamic finance, we will
use that structure as an example for a typical sukuk transaction.
Tabreed
2. Leases assets of the
trust (sold back at
maturity)
3. Lease payments and
exercise price on
dissolution event
4. Periodic payments
and/or dissolution
payments
1. Sells trust shares
Tabreed
Sukuk
Holders
SPV
1. Sale price =
$100 M
1. Sukuk
proceeds =
$100M
Figure 19. Tabreed Sukuk Transaction Structure 27
In March 2004, Tabreed Financing Corporation, an SPV of the National Central Cooling
Company (United Arab Emirates) issued $100 million in corporate sukuk. At first glance, the
diagram above seems complex. However, the transaction was completed in a rather simple,
straightforward manner. Tabreed held trust assets – in the form of central cooling plants – in trust
for the sukuk holders. These plants were purchased by Tabreed with the proceeds of the sale of
the sukuk. Tabreed leased the plants back to NCCC, which subsequently made rental payments to
Tabreed. In turn, Tabreed redistributed these rental payments to the holders of the sukuk. When
the sukuk matured, NCCC would purchase the plant from Tabreed. In addition, if any
27
Diagram from El-Gamal 2006 p. 7
129
“dissolution event” such as the destruction of the plants or anything else that would stop the flow
of rental payments, had occurred, then payments would have continued in the form of a
repurchase price (El-Gamal, 2006, pp. 5-7).
Sukuk hold an enormous amount of potential for the Islamic financial industry. They can
be used for liquidity and fund management as well as for monetary policy. Indeed, Sudan uses
them to control liquidity in its economy. In addition to Middle Eastern and Muslim majority
countries and firms, corporations in Europe and Japan are beginning to tap the sukuk market in
order to raise short term and long term funds. Sukuk also promise to be instrumental in raising
the huge amounts of funds needed for infrastructure development in the Muslim world (Ayub,
2007, pp. 389-415; El-Gamal, 2006, pp. 102-116).
Call and Put Options
While call and put options, which are equity derivatives, may be exotic for some
investors in the West, they are nevertheless popular investment instruments and constitute an
important part of many investment strategies. Simply put, an option is the right to buy (call
option) or sell (put option) shares of common stock at a specific price during a specified time
period. In a call option contract, a party (not the company in question) issues the call option to
buy a company’s common stock within a certain time frame for a certain strike price, which may
then be bought by another investor. Conversely, an investor who holds a put option has the right
to sell shares of a company’s stock at a designated strike price within a certain time period. Put
options are an excellent tool for investors who believe that a stock price will decline in the future,
or for someone who owns shares of a certain company and want to protect themselves from a
price decline (Reilly and Brown, 2006, p. 86). If the price of the stock moves in the holder’s
130
favor, the holder can exercise his or her right to buy or sell the stock at the strike price. The
holder can simply abandon the options contract if the price moves unfavorably.
As useful as they may be, options are considered impermissible under the Sharia by many
Islamic scholars to be. This is because delivery of a good (in this case a stock) must be given and
taken in accordance with a contract regardless of price movements. Because an option grants the
right, not the obligation, to purchase or sell a stock on or before a date of expiration, many
Islamic scholars feel that options are thus not compliant with the Sharia.
However, as in nearly all issues relating to the interpretation of the Sharia, there are some
scholars who feel that call and put options may be made permissible through the use of arbun. In
an arbun contract, a buyer agrees to purchase some asset and makes an advance payment, which
is less than the full purchase price. If the buyer decides to accept the asset, then she will pay the
purchase price less the amount of the advance. If she decides not to take the asset, then the seller
keeps the advance. Interestingly, classical law does not require a time limit to be fixed to this
contract. The arbun is Islamic finance’s closest answer to the call option. The Organization of
the Islamic Conference (OIC) Academy endorsed arbun with the stipulation that a time limit be
specified in the contract. 28
Many (if not most) scholars feel that arbun is a void contract. The lack of a time limit
requirement makes the contract unacceptably indefinite. If the buyer decides not to take the
assets, the seller still gets to keep the advance or down payment, which many scholars consider
to be an unjust enrichment (akl al-mal bi al-batil). Also, some scholars also cite a hadith in
28
A put option, however, is another story. The most analogous Islamic financial contract to a put option is the third
party guarantee (TPG), which are usually provided by Islamic banks. The TPG is used to guarantee the installment
payments of customers who have bought goods through murabahas. Thus the TPG can be seen as the Islamic
alternative to the default penalty used in conventional finance. The bank is paid an administrative fee, which cannot
be expressed as a percentage of the contract’s value, by the customer who buys the good or goods. The TPG is a sort
of put option for the purchaser; if they decide to stop paying the balance of the installment payments for the good for
whatever reason, they can theoretically surrender the asset to the bank. This acts as a put option where the strike
price is equal to the unpaid installment payments. (Vogel and Hayes, 2006, pp. 228-229).
131
which Muhammad forbade the contract. The Hanbalis are the only madhhab that endorses arbun,
citing other hadiths and stories from early Islam they feel lends credence to the contract. Some
Hanbalis insist that a time limit be placed in the arbun contract, while most do not (Ayub, 2007,
pp.209-210; Vogel and Hayes, 2006, pp. 156-164).
Preferred Stock
Preferred shares are another popular investment option in conventional finance.
Sometimes used to meet the long term equity needs of an established company, preferred shares
of stocks often carry distinct benefits that common shares do not. Although they usually do not
have voting rights, preferred shares typically are senior to common shares in the payment of
dividends and other payouts and in the event of bankruptcy liquidation. Preferred shareholders
are paid after bond holders and before common shareholders in a bankruptcy. Almost all
preferred shares have some sort of fixed dividend amount, negotiated with the corporation. There
is no consensus on whether or not preferred stocks are Sharia compliant. It is accepted that while
one group of shareholders cannot receive a higher/more senior fixed dividend than other
investors, they can have a higher payout ratio. Ideally, the owners of the class of stock with the
higher payout ratio would pay a premium for this privilege, or would forego other advantages,
such as voting rights (Vogel and Hayes, 2006, pp. 196-197).
Interest on Bank Deposits
In the West, deposits in a bank are liabilities as they are considered to be loans from
depositors to the institution. Islamic financial theory views deposits in much the same way, and
thus the Islamic rules regarding loans apply to them. Contemporary Muslim scholars
consequently view the interest paid on conventional bank deposits to be forbidden. This view
was endorsed in 1965 at a conference of Islamic scholars in Cairo (Hardie and Rabooy, 1991, p.
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59). Likewise, depositors may not receive free services while they hold accounts at a bank
because the services are considered a form of return. Muslims are forbidden to receive interest,
no matter if it is in the form of money or services. The bank would also be in the wrong if they
could easily repay the depositors’ funds, which are considered loans (Hardie and Rabooy, 1991,
p. 64).
Zero Coupon Bonds and Islamic Certificates of Deposit
Zero Coupon Bonds
Zero coupon bonds by definition yield no interest. So at first glance, it seems like these
instruments would be perfect investment choices for Muslims. However, such bonds are issued
at a discount to buyers relative to other bonds and debt instruments available in the marketplace.
It can be argued that this means that the discount can be influenced by or even determined by the
interest rates on other securities. Samuel Hayes, a professor of the Harvard Business School who
has written prolifically on issues in Islamic finance, sees no point at which interest is not built
into the price of a zero coupon bond (S. Hayes, personal communication, November 4, 2008).
Islamic Certificates of Deposit
Traditional CDs are riba based, and are thus unacceptable for Muslim investors. However,
certificates based on murabaha deposits are a Sharia compliant option, and can even be tradable
in a secondary market. These certificates will undoubtedly be much riskier than traditional CDs.
First, the returns on such investments’ underlying deposits are only known ex post facto rather
than ex ante, which may cause their market value to fluctuate and vary from the redemption price.
This risk can be mitigated somewhat by the shorter the time to maturity. Unlike conventional
CDs whose returns are determined largely by macroeconomic variables, the returns on Islamic
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CDs would be influenced primarily by microeconomic conditions, because it is the profits of the
Islamic bank or company that determine the return (Wilson, 1991, pp. 205-214).
Conclusion
Despite the number of restrictions that Muslim investors face, there are a number of
investment alternatives available for their use. Islamic financial institutions and increasingly,
Western financial institutions, are in the process of developing and engineering new Sharia
compliant products and services designed to meet the needs of their clientele.
But the industry is currently prohibition driven. Most practitioners of Islamic finance
focus solely on replicating conventional, interest based financial products using medieval Islamic
contracts such as murabahas. This preoccupation invariably leads to the formulation of hiyal, or
legal ruses, to circumvent these prohibitions. The prohibition-focused nature of the Islamic
financial industry has caused some Islamic financial institutions to lose sight of the broader aims
of Islam and the Sharia. Unfortunately, it also provides a fertile breeding ground for
manifestations of the phenomenon known as Sharia arbitrage.
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CHAPTER VII.
SHARIA ARBITRAGE
Introduction
Islam is the world’s fastest growing religion, and it is no surprise that this growth is
accompanied by a concurrent rise in demand for financial and business products that fit within
the confines imposed by ubiquitous Islamic religious restrictions. This represents a major source
of opportunity for financial institutions seeking new customers and business.
Many of the products developed for the nascent Islamic finance industry are based upon
nominate contracts developed during the early centuries of Islamic jurisprudence, as discussed in
chapter IV. While this backwards-looking approach has provided a strong foundation for the
industry, it can also lead to a phenomenon known as Sharia arbitrage. As we shall see, Sharia
arbitrage is a severe handicap for the industry, in terms of both innovation and reputation.
What is Sharia Arbitrage?
In finance, there are two kinds of arbitrage. The first type is the textbook definition of
arbitrage. When the fundamental “law of one price” 29 breaks down in practice, opportunities to
engage in arbitrage arise. A specific tangible good has different prices in different markets. An
arbitrageur can purchase the good in market A, where it has a lower price, and resell it in market
B, where it has a higher price. Minus transactions costs, the difference between market B’s price
and market A’s price represents the arbitrageur’s profit. The second type of financial arbitrage is
regulatory arbitrage. When a financial product or service is banned in country A, but allowed in
country B, financial professionals can synthesize a new product that mimics the attributes of the
disallowed product for use in country A.
29
This theory states that in an efficient market all identical goods must have only one price. This also applies to
services but since services are not easily transferred across borders, most economists focus on tangible goods.
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Sharia arbitrage, a term coined by Mahmoud El-Gamal, is a form of regulatory arbitrage.
Simply put, Sharia arbitrage occurs when Islamic financial institutions create and sell Islamic
versions of conventional financial products, usually at a premium. The term ‘Sharia arbitrage’
may be new, but the phenomenon itself has existed for centuries. In Medina, during the time of
the jurist Malik, various hiyal were being used to skirt the prohibition on riba (Hassan and Lewis,
2007).
Sharia arbitrage can occur because Islamic finance is currently a prohibition-driven
industry which serves a captive market of Muslims who must adhere to those prohibitions and
would rather not use conventional financial products. But the Islamic finance industry uses those
conventional financial products as the inspiration for its own products, and seeks to create
alternatives that closely mirror the properties of conventional products while still being deemed
permissible (El-Gamal, 2006, p. 175; El-Gamal, 2005, pp. 117-119). Furthermore the diversity of
juristic opinion espoused by different madhhabs and Sharia boards can also engender
opportunities for Sharia arbitrage (Aktar, 2007).
How Sharia Arbitrage Works
As currently practiced, Sharia arbitrage occurs primarily through two main methods. The
first method is dual characterization of financial contracts, and the second method is through
using degrees of separation in financial contracts.
Dual characterization refers to the use of two sets of terms, one for jurists and one for
regulators, in Islamic financial contracts. An example of this method is murabaha financing of
home buying (i.e. a bank buys a home, and then sells it to a Muslim customer for the price plus a
credit markup). Regulators see this as secured lending (which is un-Islamic) and customers view
the contract as safe, because it does not violate the rigid restrictions of Islamic law and in fact
136
has the approval of the Sharia board. The mortgage documents often feature terms like loan,
interest, and borrower, but Sharia boards of US Islamic home finance providers assure Muslims
that these terms are only included to meet US regulatory requirements. Customers can even
deduct the “markup” component of the mortgage on their annual taxes (El-Gamal, 2005, pp. 120122).
The second major method of Sharia arbitrage is the use of degrees of separation. With
this technique, different segments of a financial contract are viewed individually rather than as a
whole. By using multiple degrees of separation, an otherwise impermissible transaction can be
made Sharia compliant. Consider the following telling examples provided by El-Gamal (2005):
1. B sells a stapler to A, for the cash price of $100. A turns around and sells the
stapler to B for a credit price of $105 payable in one year. This practice is called
“bay` al-`ina” (same item sale-resale). Some jurists (e.g. the Hanbalis) forbade it
based on Prophetic traditions, while others (e.g. the Malikis) forbade it based on
the principle of sadd al-dhara’i` (prevention of stratagems to achieve illegal ends
through legal means). However, some others (e.g. the Hanafi jurist Abu Yusuf
and Al-Shafi`i) allowed the contract, ruling on each of the two separate valid sales
separately. Provided that the second sale is not stipulated in the first, they
reasoned, one cannot forbid the practice based on speculation about the
contracting parties’ unobservable intentions.
2. C sells a stapler to A, for the cash price of $100. A sells the stapler to B for the
credit price of $105 payable in one year. B sells stapler to C for the cash price of
$100. This practice is called Tawarruq (literally, monetization – of the stapler in
this example). Abu Hanifa contemplated this contract as a variation on the previous one,
with a third party serving as intermediary (muhallil). While he forbade the simple `inah
(without a third party), he was more accommodative of Tawarruq. Most jurists
considered Tawarruq invalid, defective or reprehensible. However, there were two
reports on ibn Hanbal’s opinion on this contract, thus allowing a faction of the Hanbali
school to approve the contract, which is quickly replacing Murabaha as the favorite mode
of financing in the GCC.
3. C sells stapler to A, for the cash price of $100. A sells stapler to B for credit price of $105
payable in one year. B sells stapler to D for cash price of $100. D sells stapler to C for
cash price of $100. Now, we have added two intermediary entities (C and D) between
lender (A in all examples) and borrower (B). Contracts with larger numbers of
intermediaries do not have explicit names in classical jurisprudence, and were not
discussed in their writings (pp. 123-124).
137
Adding multiple degrees of separation to a contract allows Sharia arbitrageurs to circumvent
Islamic prohibitions and replicate conventional financial products. Since adding many degrees of
separation can be expensive in terms of transactions costs, bankers tend to keep them to a
minimum (El- Gamal, 2005, pp. 123-124).
The Dangers and Consequences of Sharia Arbitrage
Sharia arbitrage poses a number of dangers to the long term development of Islamic
finance, and its effects could have far-reaching consequences for the nascent industry.
First of all, Sharia arbitrage leads to higher transactions costs and economic inefficiency.
As evidenced by the degrees of separation approached described above, Sharia arbitrage usually
adds extra costs to contracts due to superfluous and unnecessary transactions. Another example
of this is the incorporation of special purpose vehicles (SPVs) to conduct parts of certain
transactions. And of course there are the fees associated with hiring lawyers and jurists to
structure and package products and certify their permissibility (El-Gamal, 2005, p. 127).
The methods of Sharia arbitrage also bear a striking and disturbing resemblance to
methods of financing criminal activities. The use of SPVs, which can be used in tax evasion, and
the numerous degrees of separation, which divide funds from their final destinations, can both be
used in money laundering and other criminal activities. In addition, because Sharia arbitrage uses
many of the same strategies, this may expose the industry to abuse by criminals who wish to use
Islamic financial contracts to conceal their financing activity and fund their illegal operations.
This possibility is especially troublesome in a post 9/11 world where Muslim movements are
often viewed with suspicion (El-Gamal, 2006, pp. 176-177; El-Gamal, 2005, pp. 128-130).
The deleterious effects of Sharia arbitrage’s nature also pose a significant threat to the
overall health of the Islamic finance industry. Sharia arbitrage is quite lucrative in its early stages;
138
even after accounting for added transactions costs from inefficient contracts and products, profit
margins are still attractive. Like any competitive industry, the existence of profit leads other
firms to enter the market. The proliferation of competition forces existing players to seek out
new avenues of business and find ways to cut costs. This drive to cost-cutting may lead some
firms - especially those who do not have the size, scope, and economies of scale enjoyed by
mammoth players like HSBC - to sacrifice quality in their operations, such as by incorporating
SPVs in less reputable areas. This can lead to Enron-like scandals and loss of confidence in the
Islamic financial industry (El-Gamal, 2006, pp. 181-183).
Sharia arbitrage in Islamic finance is preoccupied with manipulating medieval
jurisprudence contracts to replicate conventional financial products. Through complex financial
engineering, new products can be created that follow the form of Islamic law but not its spirit
and allow users to engage in speculation (Yashpal, 2008). This mere imitation of conventional
products lends credence to the argument that many firms’ products adhere to the Sharia in form
but not substance. The focus on imitation rather than on innovation to meet the needs of Muslims
is a serious defect of IFIs which practice Sharia arbitrage in the opinion of many scholars and
experts. Thus Sharia arbitrage can damage the credibility of the industry in the eyes of Muslims
(El-Gamal, 2006, pp. 183-184). When “Islamic” products differ from conventional products only
in minute details, both potential and existing customers may feel alienated from the industry.
Some may even turn to conventional financial products and services.
Moving Forward
As it exists now, Islamic finance is a prohibition driven industry. In everything from
scholarly literature to newspaper and magazine articles, the main interest is clear; IFIs, Sharia
boards, ordinary Muslims, and outside observers continually fixate on the haram. As we have
139
seen, this single minded focus provides a fertile breeding ground for the growth and proliferation
of Sharia arbitrage. We have also seen the destructive attributes of Sharia arbitrage that pose a
real danger to the industry’s long term growth, stability, and reputation.
Sharia arbitrage’s most harmful effect however is that it can and most likely will lead to
stagnation in this small yet growing industry. Islamic finance is developing at a rapid pace, but it
is still a niche market. If those in the industry hope to maintain this rate of growth so that Islamic
finance becomes a viable, attractive alternative to conventional finance, it must drop this current
mode of imitation. Bankers and jurists should focus on creating and innovating unique products
of their own rather than simply replicating conventional financial products. On a deeper level,
the industry must move away from trying to satisfy form to delivering true substance, namely by
seeking and embodying the aims of Islam. Only in this way can the industry retain its current
customers and attract new ones.
It has been acknowledged that the Islamic financial industry currently tends to serve high
net worth Muslims who are looking for “Islamic” products that mimic conventional ones and are
satisfied with these products’ Sharia-board certifications.
However, it is not this relatively small group that will provide the basis for sustained, long term
growth of the industry. Rather, it is middle class Muslims, and poor Muslims who aim to reach
that socioeconomic status, who will constitute the largest and most important consumer segment
for the industry. The Islamic finance industry cannot afford to ignore this already large and
growing middle class. Furthermore, this class of Muslims tends to be well-educated and not as
complacent in their acceptance of Sharia board pronouncements (El-Gamal, 2006, p. 176;
Wharton School of Business, 2004). Muslims are not unintelligent; they are well aware that
many products offered by the Islamic finance industry are Islamic in name only. They are not
140
fooled by Arabic names and dual characterization; indeed these attributes of Sharia arbitrage are
more likely to disenchant them than earn their business and trust. Attracting this class of
customers will require that the industry shift away from Sharia arbitrage to products that offer
economic efficiency and represent a sincere effort to adhere to the ideals of the Sharia and Islam
as closely as possible.
It is not enough to focus on prohibitions and negative screens like those discussed in
chapter IV. In order to move forward, Islamic finance must also seek, support, and promote that
which is positive. In numerous places in the Quran, Muslims are commanded to enjoin what is
good and forbid what is wrong. 30 Ergo, Muslims must not only refrain from sin and push others
to do so as well, but they must also actively do the things that are good, i.e. the things that are
wajib and mandub. The overarching aim of the Sharia after all is to promote and protect the
welfare of man while bringing him closer to God. Specifically, the maqasid al-Sharia, previously
mentioned in chapter II, are the goals that the Sharia was designed to protect. Anything that
furthers and promotes these goals should be pursued and supported by Muslims in general and
the Islamic finance industry in particular. Islamic culture has a number of institutions and
features that are well suited to promoting the positive goals of the Sharia, such as waqf 31 and
zakat 32. The industry should try to develop and promote products that serve not just economic
goals, but further social and spiritual goals as well. It is only in this fashion that Islamic finance
can truly be called Islamic and differentiate itself from the conventional financial industry.
Conclusion
Islamic finance is an industry that holds enormous potential for both Muslims and non30
See Quran 3:110, 3:104, and 9:71
Waqf is a religious endowment, similar to a common law trust, which is exclusively dedicated to religious and/or
charitable purposes.
32
Zakat, one of the well known five pillars of Islam, is alms given to the poor. It is incumbent upon every Muslim to
set aside a specific portion of their income for zakat payments.
31
141
Muslims alike across the world. Its guiding light – the Sharia – was meant to protect and promote
the best interest of humankind. The Sharia itself is imbued with a strong sense of fairness, justice,
equality, and social responsibility.
The current prohibition-focused nature of the Islamic financial industry is a handicap and
a hindrance that may prevent it from reaching that full potential. Furthermore, the phenomenon
of Sharia arbitrage poses a clear threat to the industry’s development, innovation, and reputation.
In order to move forward, practitioners of Islamic finance must loosen themselves from
the overzealous adherence to juristic form and the tendency to merely replicate conventional
financial products. If the industry ever wishes to emerge as a viable alternative to conventional
finance, it must abandon these propensities and recommit to the rich legacy of innovation and
originality that has characterized Islamic law for centuries. In doing so it will not just attract
Muslim customers, but also non-Muslims who are looking for a financially and morally
satisfying way to pursue their financial and business dealings.
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CHAPTER VIII.
CONCLUSIONS
Due to the heightened interest that has surrounded Islam and the Middle East in recent
years, it is no small wonder that Islamic finance has received such an intense amount of attention.
This attention has led scholars and financial professionals alike to devote themselves to further
study of this exciting and fascinating field. Muslims too have turned to Islamic finance in
increasing numbers for the opportunity to exercise their faith in their financial dealings. This
swell of interest was a catalyst for this study. Specifically, the aim of this work has been to
investigate the performance of Islamic equity funds versus their conventional counterparts. On a
broader level, an analysis of Islamic law and the juristic underpinnings of modern Islamic
finance has been made in order to gain a deeper appreciation for its historical, theological, and
philosophical roots.
Islamic finance sits under the canopy of Islamic law. Indeed, Islamic finance cannot be
fully understood without first understanding Islamic law. And Islamic law in turn is a part of the
wider body of the Sharia, the true and righteous method of conduct for Muslims. Islamic law has
a rich history of innovation and healthy (oftentimes sharp) debate. It is fluid and changing,
nothing at all like the hardened monolith that it is often incorrectly assumed to be. While the
current era of Islamic law is characterized by a high degree of taqlid, it still can, should, and does
adapt to ever changing times. It rises to the challenges presented by the modern age, ones that
were never even conceived of during the time of Muhammad, with the same spirit possessed by
the jurists of old. The growth and development of Islamic finance, which uses the contracts and
143
forms devised in Islam’s classical and medieval ages to construct financial products to meet the
needs of Muslims, is a testament to that spirit of adaptability.
The results obtained in chapter V indicate that Muslims may not necessarily have to pay
an opportunity cost for adhering to their faith in their financial affairs. While of course longer
time horizons are needed to make more certain judgments, the Islamic funds have charted
excellent performance over the time horizons considered and have performed well versus their
conventional counterparts. Indeed, the superior returns of the Amana funds have attracted the
attention and funds of non-Muslim investors as well.
That has important implications for global investors, both Muslim and non-Muslim. The
analysis of chapter V suggests that combining moral/ethical considerations with the traditional
risk vs. return standard may not lead to financial loss. Islamic investing and all socially
responsible investing are conservative by nature. It involves and encourages examining company
fundamentals and rewards corporate responsibility. This can help socially conscious investors
avoid being dragged down by companies penalized for unethical behavior and/or engaged in
businesses that do not comply with their specific standards. For example, the Islamic funds were
partly insulated from the turmoil in the markets during the last quarter of 2008 because of their
lack of financial stocks. Socially responsible investing is value investing, and can offer long term
gain and capital appreciation, rather than short term profits. Islamic investing in particular is
averse to speculation, which can lead to financial and economic instability, as this recent global
credit crisis and economic slowdown has shown us.
This study’s conclusions open up a multitude of opportunities for further research. First,
the future performance of the Islamic funds should be closely tracked and monitored. Longer
144
time horizons will provide us with more information about their performance and quality of
management.
Second, as discussed above, the TIE’s positive screens could benefit from more debate
and input from Sharia specialists and individual Muslim investors. Furthermore, separate TIE’s
could be developed for each industry. For instance, the “proper treatment of animals” screen may
be better suited to companies in the clothing, health, and beauty industries than, say,
telecommunications companies. Each industry has different and idiosyncratic concerns that may
be better accounted for with its own TIE.
Above all, it is the author’s hope that this work inspires the creation and development of
new, innovative Sharia-compliant products with an equal focus on Sharia prohibitions and
positive benefits. While Islamic financial products should not solely mimic conventional
instruments, it is important to remember that Islamic finance and conventional, interest-based
finance are not always antagonistic, mutually exclusive spheres. Indeed, they can inform and
inspire each other. There are numerous conventional financial constructions that can be easily
adapted to Islamic standards. Search funds are an excellent example of the potential synergies
that exist between Islamic and conventional finance.
Created and developed over 25 years ago, a search fund is little known business model
that can offer outstanding long term return. In a typical search fund, entrepreneur(s) with little to
no practical, managerial experience (mostly graduates of elite business schools) are financially
backed by a small group of investors. The investors provide money for the entrepreneur(s) to
search for an attractive acquisition target – a promising business with revenue of $10 million to
$30 million dollars. Once the entrepreneur(s) find a desirable business, the investors finance the
company’s purchase. The entrepreneur(s) become managers of the company, where they can
145
gain from the expertise and knowledge of the investors, who join the newly acquired company’s
board of directors. Studies have shown that the search fund investors can receive an average
annual return of 30 percent or higher (Bowers, 2009, p. B5). The search fund model can easily be
replicated through the mudaraba contract discussed in chapter VI.
The implications of this study reach far beyond the Muslim world. Islamic financial
products and contracts can be attractive to non-Muslim markets as well. Islamic finance is
buttressed by ethical principles that have broad-based appeal to Muslims and non-Muslims alike.
These same principles can help us create a more ethical financial system and illustrate the
similarities and common values that are present across the globe. As globalization and
technology tighten the linkages between us, long held assumptions about so-called barriers
between Muslims and non-Muslims begin to break down. Islam is a powerful force the world
over, and will undoubtedly remain so. Globally, Islamic finance is well suited to help accomplish
this paradigm shift. It has already taken root in the US financial system, as evidenced by the
Islamic equity funds profiled in this study, and is on track to gain market share in the foreseeable
future. Islamic finance can be used as a tool to introduce non-Muslims to Islam as a positive,
beneficial, and ethically-driven entity that seeks only the best interests of humanity and the
planet.
146
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CHAPTER X.
LIST OF APPENDICES
Appendix A.
Portfolio Holdings of the Iman Fund
Appendix B.
Portfolio Holdings of the Amana Income Fund
Appendix C.
Portfolio Holdings of the Amana Growth Fund
Appendix D.
Portfolio Holdings of the Azzad Ethical Income Fund
Appendix E.
Portfolio Holdings of the Vanguard US Growth Index Fund
Appendix F.
Portfolio Holdings of the Vanguard Equity Income Fund
Appendix G.
The Good Money Indexes
a. Good Money and Dow Jones Industrial Averages
b. Good Money and Dow Jones Utility Averages
Appendix H.
Dow Jones US Islamic Market Index Components
Appendix I.
Glossary
Appendix J.
TIE Example Rationale
152
APPENDIX A.
Portfolio Holdings of the Iman Fund – November 30, 2008
Company
Quantity
Market Value
United Technologies Corp.
3,500
169, 855
FedEx Corp
5,500
388,575
United Parcel Service, Inc.- Class B
6,200
357,120
Magna International Inc.-Class A (b)
1,500
42,165
Harley-Davidson, Inc.
1,200
20,412
Thor Industries, Inc
6000
93,840
PepsiCo, Inc.
3,600
204,120
Alexion Pharmaceuticals, Inc. (a)
9,000
302,940
Amgen, Inc. (a)
8,000
444,320
Genentech, Inc. (a)
5,500
421,300
Gilead Sciences, Inc. (a)
5,700
255,303
Seattle Genetics, Inc. (a)
10,000
86,600
Vertex Pharmaceuticals Inc. (a)
6,000
147,540
Agrium Inc. (b)
4,100
128,822
Ashland Inc
5,000
47,750
Monsanto Co.
1,000
79,200
Mosaic Co.
1,200
36,420
Syngenta AG - ADR (b)
2,300
82,846
Terra Industries Inc.
4,400
64,724
Zoltek Companies, Inc. (a)
8,000
64,400
Career Education Corp. (a)
5,000
92,400
The Brink’s Co.
5,500
119,735
CoStar Group Inc. (a)
2,000
65,240
Layne Christensen Co. (a)
3,000
67,740
Cisco Systems, Inc. (a)
13,500
223,290
Corning Inc.
13,300
119,833
EchoStar Corp. - Class A (a)
7,000
119,490
Harris Corp.
7,500
261,600
Infinera Corp. (a)
9,000
87,840
Juniper Networks, Inc. (a)
5,500
95,590
QUALCOMM, Inc.
8,200
275,274
Research In Motion Ltd. (a)(b)
1,100
46,717
Apple Inc. (a)
1,500
139,005
153
Aecom Technology Corp. (a)
7,000
185,430
Chicago Bridge & Iron Co N.V. (b)
15,700
159,669
Foster Wheeler Ltd. (a)(b)
6,100
135,786
Granite Construction Inc.
7,500
321,675
Jacobs Engineering Group Inc. (a)
3,000
134,310
McDermott International, Inc. (a)(b)
5,300
51,675
Quanta Services, Inc. (a)
9,000
146,340
500
29,990
Ivanhoe Mines Ltd. (a)
15,500
36,580
Genuine Parts Co.
1,100
43,065
Brink’s Home Security Holdings, Inc. (a)
5,500
110,000
Chunghwa Telecom Co. Ltd. - ADR (b)
9,075
141,933
Pioneer Drilling Co. (a)
19,500
143,130
Acuity Brands, Inc.
8,000
215,680
AZZ Inc. (a)
5,000
120,300
Baldor Electric Co.
9,000
148,320
700
21,805
SunPower Corp. (a)
6,033
156,979
Agilent Technologies, Inc. (a)
3,300
62,139
Amphenol Corp. - Class A
3,000
69,660
FLIR Systems, Inc. (a)
3,000
93,060
NIDEC CORPORATION - ADR (b)
8,300
102,754
ScanSource, Inc. (a)
3,000
51,030
Trimble Navigation Ltd. (a)
2,000
40,720
Core Laboratories N.V. (b)
2,000
133,220
Diamond Offshore Drilling, Inc.
1,700
125,460
FMC Technologies, Inc. (a)
1,300
35,711
Natural Gas Services Group (a)
8,000
82,400
Noble Corp. (b)
1,000
26,790
Patterson-UTI Energy, Inc.
21,500
268,535
Rowan Companies, Inc.
13,000
225,550
Schlumberger Ltd. (b)
6,600
334,884
Superior Well Services, Inc. (a)
10,000
102,500
Lance, Inc.
4,000
78,120
Nestle SA - ADR (b)
4,415
159,712
Peet’s Coffee & Tea Inc. (a)
4,000
90,280
Vulcan Materials Co.
Rockwell Automation, Inc.
154
FNX Mining Co. Inc. (a)(b)
3,000
7,407
Teck Cominco Ltd.-Class B (b)
5,000
24,600
Becton, Dickinson & Co.
2,100
133,413
C.R. Bard, Inc.
6,000
492,180
DENTSPLY International, Inc.
1,000
26,080
Illumina, Inc. (a)
10,000
220,100
Medtronic, Inc.
3,700
112,924
Zimmer Holdings, Inc. (a)
Fresenius Medical Care AG & Co. KGaA ADR (b)
7,500
279,900
3,000
131,850
PSS World Medical, Inc. (a)
7,000
121,730
Panasonic Corp. - ADR (b)
2,800
33,432
3M Co.
2,000
133,860
VistaPrint Ltd. (a)(b)
3,000
49,050
Google Inc. (a)
Accenture Ltd. - Class A (b)
Automatic Data Processing, Inc.
Infosys Technologies Ltd. - ADR (b)
Ampco-Pittsburgh Corp.
Bucyrus International, Inc. - Class A
CIRCOR International, Inc.
Illinois Tool Works, Inc.
750
8,000
9,500
2,500
5,000
4,000
7,500
7,000
219,720
247,840
390,070
62,875
83,250
78,120
163,725
238,840
Joy Global Inc.
3,500
81,515
Kaydon Corp.
7,000
215,950
L.B. Foster Co.- Class A (a)
5,000
159,350
The Manitowoc Co., Inc.
7,500
59,100
Parker Hannifin Corp.
6,000
246,480
Robbins & Myers, Inc.
8,500
191,250
Sun Hydraulics Corp.
4,500
68,490
Michael Baker Corp. (a)
7,200
236,880
Skyline Corp.
4,600
106,122
Novo-Nordisk A/S - ADR (b)
7,300
373,030
Agnico-Eagle Mines Ltd. (b)
2,100
79,086
Brush Engineered Materials Inc. (a)
7,500
86,850
Haynes International, Inc. (a)
3,500
63,805
Kaiser Aluminum Corp.
5,000
105,550
Newmont Mining Corp.
5,500
185,075
155
Nucor Corp.
1,500
53,520
Randgold Resources Ltd. - ADR (b)
6,000
229,380
Schnitzer Steel Industries, Inc.
3,000
81,000
Sims Group Ltd. - ADR (b)
12,500
115,250
Universal Stainless & Alloy Products, Inc. (a)
3,500
42,700
CANON Inc. - ADR (b)
10,000
297,600
BG Group PLC - ADR (b)
2,500
176,461
Contango Oil & Gas Co. (a)
3,500
183,890
EOG Resources, Inc.
6,100
518,622
Imperial Oil Ltd. (b)
3,500
117,810
Occidental Petroleum Corp.
3,000
162,420
Royal Dutch Shell PLC - Class A - ADR (b)
7,400
395,530
StatoilHydro ASA - ADR (b)
20,300
345,506
Stone Energy Corp. (a)
1,980
32,908
Tesco Corp. (a)(b)
11,500
79,350
Total SA - ADR - ADR (b)
1,000
52,750
Ultra Petroleum Corp. (a)(b)
2,500
101,575
Deltic Timber Corp.
2,500
119,800
Avon Products, Inc.
1,600
33,760
Abbott Laboratories
5,000
261,950
Alcon, Inc. (b)
1,200
95,748
Amylin Pharmaceuticals, Inc. (a)
15,000
111,150
Auxilium Pharmaceuticals Inc. (a)
3,500
76,230
Eli Lilly & Co.
4,500
153,675
Forest Laboratories, Inc. (a)
2,000
48,360
Genzyme Corp. (a)
1,000
64,020
Johnson & Johnson
6,000
351,480
Providence and Worcester Railroad Co.
2,000
21,980
Applied Materials, Inc.
8,300
79,514
Atheros Communications (a)
5,500
80,300
Broadcom Corp. - Class A (a)
3,800
58,178
Cree, Inc. (a)
15,500
246,140
Cymer, Inc. (a)
9,500
223,155
Cypress Semiconductor Corp. (a)
22,000
82,060
Intel Corp.
7,500
103,500
Rambus, Inc. (a)
14,000
144,340
156
Adobe Systems, Inc. (a)
9,000
208,440
Microsoft Corp.
18,900
382,158
Nintendo Co., Ltd - ADR (a)(b)
2,000
77,747
Salesforce.com, Inc. (a)
13,500
386,370
Synopsys, Inc. (a)
7,000
112,210
Teradata Corp. (a)
10,000
134,300
VMware Inc.- Class A (a)
8,400
162,540
Bed Bath & Beyond, Inc. (a)
10,000
202,900
Best Buy Co., Inc.
12,000
248,520
Foot Locker, Inc.
3,200
21,536
O’Reilly Automotive, Inc. (a)
4,000
104,280
Staples, Inc.
15,100
262,136
Nike, Inc. - Class B
5,700
303,525
Pure Cycle Corporation (a)
12,500
33,875
China Mobile Ltd. - ADR (b)
2,500
114,575
NTT DoCoMo, Inc. - ADR (b)
2,500
41,925
Total Investments:
$23,315,486
157
APPENDIX B.
Portfolio Holdings of the Amana Income Fund – December 31, 2008
Company
Quantity
Market Value
AT&T
300,000
$8,550,000
Abbott Laboratories
170,000
$9,072,900
Air Products & Chemicals
110,000
$5,529,700
Alcoa
400,000
$4,504,000
Arch Coal
200,000
$3,258,000
Archer-Daniels-Midland
80,000
$2,306,400
AstraZeneca PLC ADS
190,000
$7,795,700
Autoliv
60,000
$1,287,600
Avery Dennison
60,000
$1,963,800
BASF SE ADS
90,000
$3,445,371
BP PLC ADS
100,000
$4,674,000
BHP Billiton ADS
85,000
$3,646,500
Black & Decker
43,000
$1,797,830
Burlington Northern Santa Fe
100,000
$7,571,000
Canadian National Railway
110,000
$4,043,600
Canadian Pacific Railway
90,000
$3,025,800
Carlisle
220,000
$4,554,000
Chunghwa Telecom ADR
241,922
$3,773,983
Colgate-Palmolive
90,000
$6,168,600
ConocoPhillips
140,000
$7,252,000
EI Du Pont de Nemours
140,000
$3,542,000
Duke Energy
70,000
$1,050,700
E.ON AG ADS
85,000
$3,310,674
Emerson Electric
180,000
$6,589,800
EnCana
200,000
$9,296,000
Exxon Mobil
110,000
$8,781,300
FPL
150,000
$7,549,500
Freeport-McMoRan Copper & Gold
100,000
$2,444,000
General Mills
150,000
$9,112,500
Genuine Parts
200,000
$7,572,000
GlaxoSmithKline PLC ADS
100,000
$3,727,000
Honeywell International
225,000
$7,386,750
Idacorp
90,000
$2,650,500
158
Illinois Tool Works
100,000
$3,505,000
Intel
200,000
$2,932,000
Johnson & Johnson
150,000
$8,974,500
Kellogg
140,000
$6,139,000
Kimberly-Clark
130,000
$6,856,200
Eli Lilly
210,000
$8,456,700
Manitowoc
250,000
$2,165,000
McGraw-Hill
150,000
$3,478,500
Methanex
200,000
$2,248,000
Microsoft
300,000
$5,832,000
Microchip Technology
200,000
$3,906,000
National Fuel Gas
130,000
$4,072,900
Nike
150,000
$7,650,000
Novartis AG ADR
150,000
$7,464,000
Nucor
140,000
$6,468,000
Parker Hannifin
80,000
$3,403,200
Pearson PLC ADS
300,000
$2,862,000
PepsiCo
100,000
$5,477,000
Pfizer
500,000
$8,855,000
Piedmont Natural Gas
60,000
$1,900,200
Plum Creek Timber
50,000
$1,737,000
Praxair
120,000
$7,123,200
Procter & Gamble
120,000
$7,418,400
RPM International
180,000
$2,392,200
Regal-Beloit
100,000
$3,799,000
Rio Tinto PLC ADS
14,000
$1,244,740
Rockwell Automation
150,000
$4,836,000
SK Telecom ADR
50,000
$909,000
Sempra Energy
40,000
$1,705,200
JM Smucker
120,000
$5,203,200
Spectra Energy
35,000
$550,900
Taiwan Semiconductor ADS
450,019
$3,555,150
Teleflex
60,000
$3,006,000
Telefónica SA ADS
100,000
$6,739,000
Telstra ADR
100,000
$1,335,140
Telus
100,000
$2,842,000
159
Tenaris SA ADR
50,000
$1,049,000
3M
115,000
$6,617,100
Tomkins PLC ADS
100,000
$731,000
Total SA ADS
75,000
$4,147,500
Unilever PLC ADS
250,000
$5,755,000
United Parcel Service
120,000
$6,619,200
United States Steel
60,000
$2,232,000
United Technologies
130,000
$6,968,000
1,000,000
$1,000,000
Valspar
40,000
$723,600
Vodafone Group PLC ADS
150,000
$3,066,000
Weyerhaeuser
Wyeth
20,000
160,000
$612,200
$6,001,600
University Bank Certificate of Dep
Total Investments:
$369,797,038
160
APPENDIX C.
Portfolio Holdings of the Amana Growth Fund – December 31, 2008
Company
Quantity
Market Value
Adobe Systems
460,000
$9,793,400
Agilent Technologies
500,000
$7,815,000
Akamai Technologies
300,000
$4,527,000
Amazon.com
200,000
$10,256,000
América Móvil SAB de CV ADS
230,000
$7,127,700
American Eagle Outfitters
450,000
$4,212,000
American Tower
60,000
$1,759,200
Amgen
200,000
$11,550,000
Anglo American PLC ADR
350,000
$4,067,000
Apple
200,000
$17,070,000
Bed Bath & Beyond
150,000
$3,813,000
Best Buy
350,000
$9,838,500
BP PLC ADS
105,000
$4,907,700
Canadian Pacific Railway
175,000
$5,883,500
Canon ADS
220,000
$6,908,000
China Mobile ADS
150,000
$7,627,500
Cisco Systems
500,000
$8,150,000
Clorox
175,000
$9,723,000
Coach
240,000
$4,984,800
Convergys
400,000
$2,564,000
Crane
210,000
$3,620,400
Cree
160,000
$2,539,200
CVS/Caremark
200,000
$5,748,000
Dentsply International
325,000
$9,178,000
Dr Pepper Snapple
150,000
$2,437,500
Eli Lilly
140,000
$5,637,800
EMCOR
275,000
$6,168,250
EnCana
150,000
$6,972,000
Express Scripts, Cl A
50,000
$2,749,000
Fastenal
155,000
$5,401,750
Gartner
100,000
$1,783,000
Genentech
140,000
$11,607,400
Genuine Parts
125,000
$4,732,500
161
Genzyme
130,000
$8,628,100
Groupe Danone ADS
380,000
$4,561,672
Hansen Natural
325,000
$10,897,250
Harris
230,000
$8,751,500
Hewlett-Packard
270,000
$9,798,300
Humana
250,000
$9,320,000
IMS Health
300,000
$4,548,000
Infosys ADS
150,000
$3,685,500
Intel
650,000
$9,529,000
International Business Machines
110,000
$9,257,600
Intuit
400,000
$9,516,000
John Wiley & Sons
100,000
$3,558,000
Johnson & Johnson
180,000
$10,769,400
LAN Airlines SA ADS
350,000
$2,817,500
Lincoln Electric Holdings
96,500
$4,914,745
Lowe's
225,000
$4,842,000
Manitowoc
300,000
$2,598,000
McGraw-Hill
220,000
$5,101,800
Noble
200,000
$4,412,000
Norfolk Southern
270,000
$12,703,500
Novartis AG ADR
150,000
$7,464,000
Novo Nordisk A/S ADS
180,000
$9,250,200
Oracle
550,000
$9,751,500
PepsiCo
200,000
$10,954,000
Petro-Canada
80,000
$1,751,200
PetSmart
305,171
$5,630,405
Pharmaceutical Product Development
250,000
$7,252,500
Potash Corp of Saskatchewan
170,000
$12,447,400
Qualcomm
300,000
$10,749,000
Quantum
400,000
$144,000
Regal-Beloit
145,000
$5,508,550
Rio Tinto PLC ADS
33,000
$2,934,030
Ritchie Bros Auctioneers
97,800
$2,094,876
Rogers Communications
200,000
$6,016,000
SanDisk
135,000
$1,296,000
Seagate Technology
250,000
$1,107,500
162
Sony ADS
120,000
$2,624,400
Staples
250,000
$4,480,000
SumTotal Systems
50,000
$142,000
Taiwan Semiconductor ADS
738,107
$5,831,045
Teck Cominco
100,000
$492,000
Teva Pharmaceutical Industries ADR
100,352
$4,271,985
Trimble Navigation
400,000
$8,644,000
Turkcell Iletisim Hizmetleri ADR
200,000
$2,916,000
United Parcel Service
200,000
$11,032,000
1,000,000
$1,000,000
VCA Antech
302,000
$6,003,760
Verigy
180,000
$1,731,600
Wyeth
200,000
$7,502,000
Xilinx
Zimmer
200,000
225,000
$3,564,000
$9,094,500
University Bank Certificate of Dep
Total Investments:
$515,042,418
163
APPENDIX D. Portfolio Holdings of the Azzad Ethical Income Fund – September 30, 2008
Company
Quantity
Market Value
Syngenta AG (Switzerland) ADR
2,200
93,104
Gymboree Corp.
2,500
88,750
Fomento Economico Mexicano S.A.B DE
C.V.
4,000
152,560
FMC Corp
2,900
149,031
Questar Corp.
2,500
102,300
Sasol Ltd.
2,300
97,727
Southwestern Energy Co.
4,400
134,376
Diana Shipping, Inc.
4,100
80,729
CPFL Energy, Inc.
1,750
97,755
Emerson Electric Co.
2,800
114,212
Lindsay Corp
1,100
80,025
Unilever PLC
3,300
89,793
Hasbro, Inc.
3,900
135,408
General Mills, Inc.
2,200
151,184
SPX Corp.
1,250
96,250
Joy Global, Inc.
1,700
76,738
Eaton Corp.
1,500
84,270
Autoliv, Inc.
2,200
74,250
Borg Warner
2,600
85,202
Baldor Electric Co.
4,000
115,240
Equitable Resources, Inc.
2,000
73,360
Luxottica Group
4,600
105,754
Greif, Inc.
1,600
104,992
Celgene Corp. *
1,700
107,576
Johnson & Johnson
2,000
138,560
Wyeth
2,900
107,126
Chunghwa Telecom Co. Ltd. (Taiwan)
4,300
101,781
Vodafone Group Public Ltd.
4,150
91,715
Canon, Inc.
2,500
94,375
Wabtec Corp
3,000
153,690
CSX Corp
2,300
125,511
Republic Services, Inc.
4,200
125,916
164
Fastenal Co.
2,400
118,536
CVS Caremark Corp.
2,700
90,882
Buckle, Inc
2,300
127,742
Ruddick Corp.
3,600
116,820
Signet Group PLC
4,750
111,055
Intel Corp.
5,750
107,698
Monolithic Power Systems, Inc. *
5,000
86,850
Aixtron AG
7,100
42,600
Asml Holding NV
4,600
81,006
Universal Health Services, Inc. Class-B
2,100
117,663
Nuance Communications, Inc
8,300
101,177
Church & Dwight Co., Inc.
2,100
130,389
AK Steel Holding Corp.
2,800
72,576
J.B. Hunt Transport Services, Inc.
3,400
113,458
Kirby Corp.
2,700
102,438
W.W. Grainger
1,550
134,803
Total Investments:
$5,084,953
165
APPENDIX E. Portfolio Holdings of the Vanguard US Growth Index – November 30, 2008
Shares
Consumer Discretionary (7.3%)
McDonald's Corp.
*
Kohl's Corp.
The Walt Disney Co.
Omnicom Group Inc.
*
Apollo Group, Inc. Class A
Lowe's Cos., Inc.
NIKE, Inc. Class B
Mkt Val
1,546,590
1,545,791
1,240,800
723,330
234,280
742,960
216,710
90,862
50,485
27,943
20,463
18,002
15,350
11,540
234,645
Consumer Staples (14.1%)
Wal-Mart Stores, Inc.
The Procter & Gamble Co.
PepsiCo, Inc.
The Coca-Cola Co.
Colgate-Palmolive Co.
Philip Morris International Inc.
Costco Wholesale Corp.
Campbell Soup Co.
Kellogg Co.
CVS/Caremark Corp.
The Kroger Co.
Molson Coors Brewing Co. Class B
General Mills, Inc.
1,943,550
863,820
737,800
888,550
620,100
933,700
608,200
605,650
439,100
619,340
643,140
282,800
175,600
108,606
55,587
41,833
41,646
40,350
39,365
31,304
19,411
19,070
17,917
17,789
12,576
11,093
456,547
Energy (7.5%)
Schlumberger Ltd.
EOG Resources, Inc.
Apache Corp.
XTO Energy, Inc.
Cameron International Corp.
National Oilwell Varco Inc.
2,243,270
931,890
431,350
162,000
242,640
162,600
113,824
79,229
33,343
6,195
5,120
4,600
242,311
Exchange-Traded Fund (0.0%)
1
Vanguard Growth ETF
3,100
122
Financials (7.2%)
CME Group, Inc.
Charles Schwab Corp.
The Goldman Sachs Group, Inc.
JPMorgan Chase & Co.
Franklin Resources Corp.
379,485
2,849,585
511,100
1,248,300
360,900
80,432
52,233
40,372
39,521
21,924
234,482
Health Care (23.4%)
Gilead Sciences, Inc.
Abbott Laboratories
Celgene Corp.
Genentech, Inc.
Teva Pharmaceutical Industries Ltd. Sponsored ADR
Medco Health Solutions, Inc.
Baxter International, Inc.
Alcon, Inc.
3,355,360
2,191,000
1,911,660
1,269,200
1,934,260
1,116,400
728,100
469,540
150,287
114,787
99,597
97,221
83,463
46,889
38,516
37,465
166
Becton, Dickinson & Co.
St. Jude Medical, Inc.
*
Thermo Fisher Scientific, Inc.
Allergan, Inc.
513,510
783,280
556,720
414,235
Industrials (5.4%)
Danaher Corp.
Emerson Electric Co.
Lockheed Martin Corp.
Fastenal Co.
Roper Industries Inc.
J.B. Hunt Transport Services, Inc.
Expeditors International of Washington, Inc.
Honeywell International Inc.
Union Pacific Corp.
557,015
821,770
377,000
662,540
551,190
571,610
360,320
154,800
71,600
30,992
29,493
29,070
25,514
25,228
15,325
12,046
4,313
3,583
175,564
Information Technology (25.2%)
Google Inc.
Apple Inc.
Hewlett-Packard Co.
Cisco Systems, Inc.
QUALCOMM Inc.
Microsoft Corp.
Activision Blizzard, Inc.
Adobe Systems, Inc.
FLIR Systems, Inc.
Intel Corp.
salesforce.com, inc.
Electronic Arts Inc.
533,195
1,681,506
3,902,800
7,140,773
3,096,495
2,441,895
1,797,700
825,039
568,270
1,011,010
377,370
525,760
156,205
155,825
137,691
118,109
103,949
49,375
21,033
19,108
17,628
13,952
10,800
10,021
813,696
Materials (4.2%)
Monsanto Co.
Praxair, Inc.
Air Products & Chemicals, Inc.
Ecolab, Inc.
1,279,575
342,040
147,430
162,720
101,342
20,198
7,041
6,247
134,828
Telecommunication Services (0.1%)
America Movil SA de CV Series L ADR
Total Common Stocks (Cost $3,938,862)
137,300
32,623
21,955
19,864
15,608
758,275
4,119
3,054,589
167
APPENDIX F. Portfolio Holdings of the Vanguard Equity Income Fund – December 31, 2008
Shares
Mkt Val
Consumer Discretionary (6.1%)
Home Depot, Inc.
Genuine Parts Co.
McDonald's Corp.
Sherwin-Williams Co.
Fortune Brands, Inc.
H & R Block, Inc.
Macy's Inc.
VF Corp.
Hasbro, Inc.
Nordstrom, Inc.
Black & Decker Corp.
The McGraw-Hill Cos., Inc.
Limited Brands, Inc.
CBS Corp.
Lennar Corp. Class A
Johnson Controls, Inc.
Autoliv, Inc.
Cracker Barrel Old Country Store Inc.
ArvinMeritor, Inc.
Oxford Industries, Inc.
Modine Manufacturing Co.
Jones Apparel Group, Inc.
National Presto Industries, Inc.
The Stanley Works
Whirlpool Corp.
2,553,100
1,221,800
433,805
395,200
228,800
326,900
574,900
108,000
194,800
384,500
107,300
146,500
309,800
289,300
233,000
103,300
64,600
54,700
368,700
116,800
201,600
94,100
6,000
10,300
7,200
58,773
46,257
26,978
23,613
9,445
7,427
5,950
5,915
5,682
5,118
4,486
3,397
3,111
2,370
2,020
1,876
1,386
1,126
1,051
1,024
982
552
462
351
298
219,650
Consumer Staples (11.5%)
Philip Morris International Inc.
Nestle SA ADR
Kimberly-Clark Corp.
Altria Group, Inc.
The Coca-Cola Co.
PepsiCo, Inc.
Unilever NV ADR
Kraft Foods Inc.
Diageo PLC ADR
ConAgra Foods, Inc.
Sysco Corp.
Lorillard, Inc.
SuperValu Inc.
H.J. Heinz Co.
1,770,855
1,514,200
913,675
2,668,755
735,082
530,700
809,300
585,189
270,450
792,600
550,188
203,700
714,700
219,200
77,050
59,962
48,187
40,192
33,277
29,067
19,868
15,712
15,345
13,078
12,621
11,479
10,435
8,242
161,500
191,300
73,860
74,200
25,425
22,700
5,611
4,597
4,566
2,991
1,102
995
414,377
The Hershey Co.
Avon Products, Inc.
The Procter & Gamble Co.
Reynolds American Inc.
J.M. Smucker Co.
Kellogg Co.
Energy (8.5%)
168
Chevron Corp.
ConocoPhillips Co.
Total SA ADR
BP PLC ADR
Marathon Oil Corp.
Valero Energy Corp.
Sunoco, Inc.
Knightsbridge Tankers Ltd.
Spectra Energy Corp.
1,903,000
977,900
801,100
879,500
603,400
335,000
57,300
128,210
67,700
140,765
50,655
44,301
41,108
16,509
7,249
2,490
1,878
1,066
306,021
963,400
39,654
Financials (19.4%)
JPMorgan Chase & Co.
Wells Fargo & Co.
Bank of America Corp.
U.S. Bancorp
The Chubb Corp.
PNC Financial Services Group
Bank of New York Mellon Corp.
Ace Ltd.
The Allstate Corp.
The Travelers Cos., Inc.
Citigroup Inc.
BB&T Corp.
Kimco Realty Corp. REIT
SunTrust Banks, Inc.
T. Rowe Price Group Inc.
Hudson City Bancorp, Inc.
NYSE Euronext
Lincoln National Corp.
MetLife, Inc.
Cincinnati Financial Corp.
Wachovia Corp.
IPC Holdings Ltd.
First BanCorp Puerto Rico
Huntington Bancshares Inc.
Bank of Hawaii Corp.
Morgan Stanley
3,708,100
3,905,520
4,845,563
2,165,879
955,062
845,182
1,308,970
670,900
811,700
310,800
1,534,700
347,700
438,809
263,200
214,000
435,400
231,100
322,800
166,700
187,300
963,100
173,100
451,700
647,400
107,100
290,700
116,916
115,135
68,226
54,169
48,708
41,414
37,083
35,504
26,591
14,048
10,298
9,548
8,021
7,775
7,584
6,949
6,327
6,082
5,811
5,445
5,336
5,176
5,032
4,959
4,838
4,663
Marshall & Ilsley Corp.
FirstMerit Corp.
Merrill Lynch & Co., Inc.
American Express Co.
Fifth Third Bancorp
NBT Bancorp, Inc.
Ameriprise Financial, Inc.
Safety Insurance Group, Inc.
Pacific Capital Bancorp
National City Corp.
Aspen Insurance Holdings Ltd.
Popular, Inc.
Federated Investors, Inc.
Protective Life Corp.
332,900
218,600
339,077
186,900
404,712
118,058
133,500
70,600
141,548
1,316,800
66,300
293,361
46,257
48,600
4,541
4,501
3,947
3,467
3,343
3,301
3,119
2,687
2,389
2,383
1,608
1,514
784
697
Exchange-Traded Fund (1.1%)
1
Vanguard Value ETF
169
Regions Financial Corp.
Marsh & McLennan Cos., Inc.
75,900
12,300
604
298
700,821
Health Care (11.1%)
Pfizer Inc.
Johnson & Johnson
Bristol-Myers Squibb Co.
Merck & Co., Inc.
Wyeth
Eli Lilly & Co.
GlaxoSmithKline PLC ADR
6,750,731
1,040,605
2,596,432
1,730,214
1,082,498
901,049
761,800
119,555
62,259
60,367
52,599
40,605
36,285
28,392
400,062
Industrials (13.6%)
General Electric Co.
Waste Management, Inc.
Caterpillar, Inc.
Republic Services, Inc. Class A
Eaton Corp.
3M Co.
Illinois Tool Works, Inc.
Schneider Electric SA
PACCAR, Inc.
Norfolk Southern Corp.
Honeywell International Inc.
Emerson Electric Co.
Northrop Grumman Corp.
United Parcel Service, Inc.
The Boeing Co.
Dover Corp.
The Timken Co.
GATX Corp.
Briggs & Stratton Corp.
Raytheon Co.
Federal Signal Corp.
7,283,172
1,620,300
838,100
1,430,100
652,300
510,000
795,700
309,673
780,800
450,300
402,462
287,000
213,713
162,900
155,900
194,100
269,400
156,176
273,700
89,100
375,115
117,987
53,697
37,438
35,452
32,426
29,345
27,889
23,056
22,331
21,187
13,213
10,507
9,626
8,985
6,652
6,390
5,288
4,837
4,814
4,548
3,080
201,600
250,611
151,300
94,000
40,200
73,525
109,700
2,738
2,614
2,239
2,030
1,540
1,037
980
491,926
4,272,700
2,757,000
279,800
170,300
206,400
189,300
607,600
71,200
62,638
53,596
11,007
4,784
3,926
3,373
2,692
480
142,496
^
R.R. Donnelley & Sons Co.
Pacer International, Inc.
Genco Shipping and Trading Ltd.
Tyco International, Ltd.
Deere & Co.
TAL International Group, Inc.
The Standard Register Co.
Information Technology (4.0%)
Intel Corp.
Microsoft Corp.
Automatic Data Processing, Inc.
Diebold, Inc.
Analog Devices, Inc.
Xilinx, Inc.
Motorola, Inc.
Jabil Circuit, Inc.
170
Materials (3.7%)
E.I. du Pont de Nemours & Co.
Packaging Corp. of America
PPG Industries, Inc.
Air Products & Chemicals, Inc.
International Paper Co.
Dow Chemical Co.
United States Steel Corp.
Eastman Chemical Co.
Olin Corp.
Compass Minerals International, Inc.
Southern Copper Corp. (U.S. Shares)
Glatfelter
Stepan Co.
Worthington Industries, Inc.
Nucor Corp.
Bemis Co., Inc.
Lubrizol Corp.
Innophos Holdings Inc.
878,027
1,384,500
409,700
313,800
906,900
528,900
143,100
166,600
274,400
78,200
276,300
472,000
74,000
273,200
52,900
82,800
14,100
3,337
22,214
18,635
17,384
15,775
10,702
7,981
5,323
5,283
4,961
4,587
4,437
4,390
3,477
3,011
2,444
1,961
513
66
133,144
Telecommunication Services (6.7%)
AT&T Inc.
Verizon Communications Inc.
Embarq Corp.
Windstream Corp.
5,058,105
2,731,428
138,355
30,100
144,156
92,596
4,975
277
242,004
Utilities (9.9%)
FPL Group, Inc.
Dominion Resources, Inc.
Consolidated Edison Inc.
1,361,066
1,320,930
813,400
68,502
47,342
31,666
805,000
339,800
799,800
304,900
406,800
382,400
702,534
318,820
243,000
179,500
174,500
443,800
128,300
171,900
402,800
162,100
197,900
154,300
36,800
28,600
31,162
28,248
26,617
16,956
14,482
14,149
10,545
9,300
7,805
7,652
6,224
5,601
5,113
5,016
4,975
4,720
4,690
2,990
1,788
698
356,241
3,446,396
PG&E Corp.
Entergy Corp.
American Electric Power Co., Inc.
Exelon Corp.
SCANA Corp.
Southern Co.
Duke Energy Corp.
Public Service Enterprise Group, Inc.
Edison International
Sempra Energy
DTE Energy Co.
CenterPoint Energy Inc.
Progress Energy, Inc.
Alliant Energy Corp.
TECO Energy, Inc.
ONEOK, Inc.
Atmos Energy Corp.
Avista Corp.
FirstEnergy Corp.
UGI Corp. Holding Co.
Total Common Stocks (Cost $4,089,454)
171
Appendix G.
GOOD MONEY AND DOW JONES INDUSTRIAL AVERAGES
GOOD MONEY INDUSTRIAL AVERAGE* VS. DOW JONES INDUSTRIAL
AVERAGE
INDUSTRY
GMIA
AEROSPACE
APPAREL
AUTOMOTIVE
BE Aerospace
Hartmarx
CHEMICALS
COMPUTERS
& SOFTWARE
CONSUMER
PRODUCTS
FINANCIAL
SERVICES
FOOD &
RESTAURANTS
FOREST
PRODUCTS
HOUSEHOLD
PRODUCTS
MACHINERY &
INDUSTRIAL
EQUIPMENT
MEDICAL & HEALTH
METALS &
MINING
MULTIFORM
& CONGLOMERATE
OFFICE
EQUIPMENT
& SUPPLIES
PETROLEUM
PRODUCTS
PHARMACEUTICALS
PRECISION
INSTRUMENTS
PUBLISHING
DJIA
The Boeing Company
None
General Motors
H. B. Fuller and
DuPont,
Minnesota Mining & Manfacturing Minnesota Mining & Manufacturing
International Business Machines
Intel
Intel, Microsoft, Hewlett-Packard
Microsoft
and Honeywell
Avon Products,
Home Depot
Callaway Golf,
and General Electric
Home Depot and Maytag
American Express,
Fannie Mae
J. P. Morgan
and First Virginia Banks
and Citigroup
Hershey Foods
Coca-Cola
and McDonald's
and McDonald's
Stora Enso
International Paper
Procter & Gamble
Procter & Gamble
Ametek and
Cummins Engine
Caterpillar
Baxter International
None
None
Aluminum Company
of America
None
United Technologies
Herman Miller
and Pitney Bowes
None
Chevron
ExxonMobil
Johnson & Johnson
and Merck & Company
Johnson & Johnson
and Merck & Company
None
Eastman Kodak
Washington Post
None
172
REAL ESTATE
DEVELOPMENT
RECREATION
RETAIL
STORES
STEEL
The Rouse Company
None
None
Target Stores
and Nordstrom
Worthington Industries
Walt Disney
TELECOMMUNICATIONS
US West Communications
TOBACCO
None
*GMIA last updated January 10, 2001.
Source: Good Money website
Wal-Mart Stores
None
AT&T Corp. and
SBC Communications
Philip Morris Companies
173
Appendix G (Cont.). GOOD MONEY AND DOW JONES UTILITY AVERAGES
GOOD MONEY UTILITY AVERAGE* VS. DOW JONES UTILITY AVERAGE
INDUSTRY
CATEGORY
GMUA
DJUA
DIVERSIFIED
SERVICES
Citizens Communications
None
AES Corp,
Dominion Resources,
Hawaiian Electric Industries,
IDACORP,
LG&E Energy,
NONNUCLEAR ELECTRIC
MidAmerican Energy,
AND/OR GAS
Montana Power,
UTILITIES
NiSource,
OGE Energy,
Otter Tail Power,
Southwest Gas,
UtiliCorp
and Xcel Energy,
None
NONNUCLEAR & NUCLEAR
ELECTRIC AND/OR
GAS UTILITIES
None
American Electric Power,
AES Corp.,
Consolidated Edison,
Dominion Resources,
Duke Energy Corp.,
Edison International,
Enron Corp.,
Excelon,
NiSource,
PG&E Corp.,
PECO Corp.,
Public Service Enterprise Group,
Reliant Energy,
Southern Company,
TXU
and Williams Companies
WATER
SERVICES
American Water Works
None
*GMUA last updated January 10, 2001.
Source: Good Money website
174
Appendix H.
Dow Jones US Islamic Market Index Components – January 21, 2009
Company
Agilent Technologies Inc.
Alcoa Inc.
Advance Auto Parts Inc.
Arkansas Best Corp.
Abbott Laboratories
Autodesk Inc.
Arch Coal Inc.
Alcon Inc.
Alberto-Culver Co.
Adobe Systems Inc.
Analog Devices Inc.
Alliance Data Systems Corp.
Adtran Inc.
American Eagle Outfitters Inc.
AGCO Corp.
Allergan Inc.
American Greetings Corp. Cl A
Skyworks Solutions Inc.
Hess Corp.
Wyeth
Akamai Technologies Inc.
AK Steel Holding Corp.
Albemarle Corp.
Honeywell International Inc.
Alkermes Inc.
Allegheny Technologies Inc.
Altera Corp.
Alexion Pharmaceuticals Inc.
Applied Materials Inc.
Applied Micro Circuits Corp.
Ametek Inc.
Amedisys Inc.
Amgen Inc.
Healthways Inc.
Amylin Pharmaceuticals Inc.
American Tower Corp. Cl A
Abercrombie & Fitch Co.
Ann Taylor Stores Corp.
Alpha Natural Resources Inc.
Ansys Inc.
Arris Group Inc.
Apache Corp.
Air Products & Chemicals Inc.
Avocent Corp.
Amphenol Corp. Cl A
Ticker
A
AA
AAP
ABFS
ABT
ADSK
ACI
ACL
ACV
ADBE
ADI
ADS
ADTN
AEO
AG
AGN
AM
SWKS
HES
WYE
AKAM
AKS
ALB
HON
ALKS
ATI
ALTR
ALXN
AMAT
AMCC
AME
AMED
AMGN
HWAY
AMLN
AMT
ANF
ANN
ANR
ANSS
ARRS
APA
APD
AVCT
APH
Market
Capitalization
LRG
LRG
MID
SML
LRG
MID
MID
LRG
MID
LRG
MID
MID
SML
MID
MID
LRG
SML
SML
LRG
LRG
MID
MID
MID
LRG
SML
MID
MID
SML
LRG
SML
MID
SML
LRG
SML
MID
LRG
MID
SML
MID
SML
SML
LRG
LRG
SML
MID
175
Apollo Group Inc. Cl A
Ariba Inc.
Arena Resources Inc.
Aeropostale Inc.
MPS Group Inc.
Astec Industries Inc.
Atheros Communications Inc.
ATMI Inc.
Atmel Corp.
Aptargroup Inc.
Atwood Oceanics Inc.
Automatic Data Processing Inc.
Auxilium Pharmaceuticals Inc.
Avon Products Inc.
AVX Corp.
Acuity Brands Inc.
AutoZone Inc.
Baxter International Inc.
Bed Bath & Beyond Inc.
Bill Barrett Corp.
C.R. Bard Inc.
Becton Dickinson & Co.
BE Aerospace Inc.
Beckman Coulter Inc.
Verizon Communications Inc.
Christopher & Banks Corp.
Baker Hughes Inc.
BJ Services Co.
Immucor Inc.
BMC Software Inc.
BioMarin Pharmaceutical Inc.
Bemis Co. Inc.
Bristol-Myers Squibb Co.
Burlington Northern Santa Fe Corp.
Brady Corp. Cl A
Brocade Communications Systems Inc.
Broadcom Corp.
Brooks Automation Inc.
Berry Petroleum Co. Cl A
Savient Pharmaceuticals Inc.
BLYTH Inc.
Peabody Energy Corp.
Bucyrus International Inc.
BorgWarner Inc.
Brown Shoe Co. Inc.
CA Inc.
Cato Corp. Cl A
Cameron International Corp.
Cooper Industries Inc. Cl A
Cubist Pharmaceuticals Inc.
APOL
ARBA
ARD
ARO
MPS
ASTE
ATHR
ATMI
ATML
ATR
ATW
ADP
AUXL
AVP
AVX
AYI
AZO
BAX
BBBY
BBG
BCR
BDX
BEAV
BEC
VZ
CBK
BHI
BJS
BLUD
BMC
BMRN
BMS
BMY
BNI
BRC
BRCD
BRCM
BRKS
BRY
SVNT
BTH
BTU
BUCY
BWA
BWS
CA
CTR
CAM
CBE
CBST
MID
SML
SML
SML
SML
SML
SML
SML
SML
SML
SML
LRG
SML
LRG
MID
SML
MID
LRG
MID
SML
MID
LRG
SML
MID
LRG
SML
LRG
MID
SML
MID
SML
MID
LRG
LRG
SML
MID
LRG
SML
SML
SML
SML
LRG
MID
MID
SML
LRG
SML
MID
MID
SML
176
Cabot Microelectronics Corp.
Coeur d'Alene Mines Corp.
Cardinal Health Inc.
Belden Inc.
Career Education Corp.
Celgene Corp.
Century Aluminum Co.
Cephalon Inc.
Cerner Corp.
CF Industries Holdings Inc.
Cognex Corp.
Chico's Fas Inc.
Church & Dwight Co.
Chemed Corp.
Check Point Software Technologies Ltd.
C.H. Robinson Worldwide Inc.
Chevron Corp.
Checkpoint Systems Inc.
Colgate-Palmolive Co.
Core Laboratories N.V.
Clarcor Inc.
Cliffs Natural Resources Inc.
Clean Harbors Inc.
Big Lots Inc.
Centene Corp.
Consol Energy Inc.
Corinthian Colleges Inc.
Cabot Oil & Gas Corp.
Coach Inc.
Cepheid
Copart Inc.
Compuware Corp.
Crane Co.
Celera Corp.
Cree Inc.
Carters Inc.
Charles River Laboratories International Inc.
Crocs Inc.
Carpenter Technology Corp.
Cirrus Logic Inc.
Carrizo Oil & Gas Inc.
Cisco Systems Inc.
Carlisle Cos.
Cintas Corp.
CTS Corp.
Citrix Systems Inc.
Cummins Inc.
Covance Inc.
Convergys Corp.
Coventry Health Care Inc.
CCMP
CDE
CAH
BDC
CECO
CELG
CENX
CEPH
CERN
CF
CGNX
CHS
CHD
CHE
CHKP
CHRW
CVX
CKP
CL
CLB
CLC
CLF
CLH
BIG
CNC
CNX
COCO
COG
COH
CPHD
CPRT
CPWR
CR
CRA
CREE
CRI
CRL
CROX
CRS
CRUS
CRZO
CSCO
CSL
CTAS
CTS
CTXS
CMI
CVD
CVG
CVH
SML
SML
LRG
SML
SML
LRG
SML
MID
MID
MID
SML
SML
MID
SML
MID
MID
LRG
SML
LRG
SML
SML
MID
SML
SML
SML
LRG
SML
MID
LRG
SML
MID
MID
SML
SML
SML
SML
MID
SML
SML
SML
SML
LRG
SML
MID
SML
MID
MID
MID
MID
MID
177
Eagle Materials Inc.
Diebold Inc.
Dress Barn Inc.
Donaldson Co. Inc.
E.I. DuPont de Nemours & Co.
Deckers Outdoor Corp.
Dell Inc.
Danaher Corp.
Dick's Sporting Goods Inc.
Viad Corp.
Dollar Tree Inc.
Genentech Inc.
Dionex Corp.
Denbury Resources Inc.
Diamond Offshore Drilling Inc.
Dover Corp.
Dow Chemical Co.
Amdocs Ltd.
Delta Petroleum Corp.
Dresser-Rand Group Inc.
Dril-Quip Inc.
Datascope Corp.
DeVry Inc.
Devon Energy Corp.
Dycom Industries Inc.
eBay Inc.
Ecolab Inc.
Energen Corp.
Estee Lauder Cos. Inc.
Callaway Golf Co.
EMC Corp.
Emulex Corp.
Eastman Chemical Co.
Emerson Electric Co.
Endo Pharmaceuticals Holdings Inc.
Energy Conversion Devices Inc.
Energizer Holdings Inc.
Entegris Inc.
Enzo Biochem Inc.
EOG Resources Inc.
Equitable Resources Inc.
ESCO Technologies Inc.
ITT Educational Services Inc.
Evergreen Solar Inc.
Express Scripts Inc.
ENSCO International Inc.
Ethan Allen Interiors Inc.
Eaton Corp.
Edwards Lifesciences Corp.
Corporate Executive Board Co.
EXP
DBD
DBRN
DCI
DD
DECK
DELL
DHR
DKS
VVI
DLTR
DNA
DNEX
DNR
DO
DOV
DOW
DOX
DPTR
DRC
DRQ
DSCP
DV
DVN
DY
EBAY
ECL
EGN
EL
ELY
EMC
ELX
EMN
EMR
ENDP
ENER
ENR
ENTG
ENZ
EOG
EQT
ESE
ESI
ESLR
ESRX
ESV
ETH
ETN
EW
EXBD
SML
MID
SML
SML
LRG
SML
LRG
LRG
SML
SML
MID
LRG
SML
MID
LRG
MID
LRG
MID
SML
MID
SML
SML
MID
LRG
SML
LRG
MID
MID
MID
SML
LRG
SML
MID
LRG
MID
SML
MID
SML
SML
LRG
MID
SML
MID
SML
LRG
MID
SML
MID
SML
SML
178
Expeditors International of Washington Inc.
Expedia Inc.
Extreme Networks Inc.
Fastenal Co.
Foundation Coal Holdings Inc.
Freeport-McMoRan Copper & Gold Inc.
FactSet Research Systems Inc.
FedEx Corp.
F5 Networks Inc.
Health Net Inc.
Massey Energy Co.
Fluor Corp.
Flowserve Corp.
FMC Corp.
Fossil Inc.
Forest Laboratories Inc.
First Solar Inc.
FMC Technologies Inc.
Frontier Oil Corp.
H.B. Fuller Co.
Foster Wheeler Ltd.
Forward Air Corp.
Gartner Inc.
Genesco Inc.
Gardner Denver Inc.
Goodrich Petroleum Corp.
Genzyme Corp.
Guess? Inc.
Graco Inc.
Gilead Sciences Inc.
Corning Inc.
Gentex Corp.
Genesee & Wyoming Inc. Cl A
Google Inc. Cl A
Genuine Parts Co.
Global Payments Inc.
Gen-Probe Inc.
Gap Inc.
Garmin Ltd.
Chart Industries Inc.
Granite Construction Inc.
W.W. Grainger Inc.
Gymboree Corp.
Haemonetics Corp.
Halliburton Co.
Hansen Natural Corp.
Harman International Industries Inc.
Hill-Rom Holdings Inc.
Home Depot Inc.
Harley-Davidson Inc.
EXPD
EXPE
EXTR
FAST
FCL
FCX
FDS
FDX
FFIV
HNT
MEE
FLR
FLS
FMC
FOSL
FRX
FSLR
FTI
FTO
FUL
FWLT
FWRD
IT
GCO
GDI
GDP
GENZ
GES
GGG
GILD
GLW
GNTX
GWR
GOOG
GPC
GPN
GPRO
GPS
GRMN
GTLS
GVA
GWW
GYMB
HAE
HAL
HANS
HAR
HRC
HD
HOG
MID
MID
SML
MID
SML
LRG
MID
LRG
SML
MID
MID
LRG
MID
MID
SML
LRG
LRG
MID
SML
SML
MID
SML
MID
SML
SML
SML
LRG
MID
MID
LRG
LRG
MID
SML
LRG
MID
MID
SML
LRG
MID
SML
SML
MID
SML
SML
LRG
MID
MID
SML
LRG
MID
179
Hewitt Associates Inc. Cl A
Harmonic Inc.
HNI Corp.
Holly Corp.
Hologic Inc.
Helmerich & Payne Inc.
Harris Corp.
Harsco Corp.
Henry Schein Inc.
Hubbell Inc. Cl B
Hewlett-Packard Co.
Hexcel Corp.
International Business Machines Corp.
InterDigital Inc.
Biogen Idec Inc.
Integrated Device Technology Inc.
IDEXX Laboratories Inc.
IDEX Corp.
Mosaic Co.
IHS Inc. Cl A
ITT Corp.
Illumina Inc.
Informatica Corp.
Insituform Technologies Inc. Cl A
Intel Corp.
Intuit Inc.
ION Geophysical Corp.
International Rectifier Corp.
Intersil Corp. Cl A
Isis Pharmaceuticals Inc.
Intuitive Surgical Inc.
Illinois Tool Works Inc.
Life Technologies Corp.
Interwoven Inc.
J.B. Hunt Transport Services Inc.
J. Crew Group Inc.
JDA Software Group Inc.
Jacobs Engineering Group Inc.
j2 Global Communications Inc.
Johnson & Johnson
Juniper Networks Inc.
Joy Global Inc.
Kaiser Aluminum Corp.
Kaman Corp.
Kinetic Concepts Inc.
Kaydon Corp.
Kirby Corp.
King Pharmaceuticals Inc.
KLA-Tencor Corp.
Kimberly-Clark Corp.
HEW
HLIT
HNI
HOC
HOLX
HP
HRS
HSC
HSIC
HUB/B
HPQ
HXL
IBM
IDCC
BIIB
IDTI
IDXX
IEX
MOS
IHS
ITT
ILMN
INFA
INSU
INTC
INTU
IO
IRF
ISIL
ISIS
ISRG
ITW
LIFE
IWOV
JBHT
JCG
JDAS
JEC
JCOM
JNJ
JNPR
JOYG
KALU
KAMN
KCI
KDN
KEX
KG
KLAC
KMB
MID
SML
SML
SML
MID
MID
MID
MID
MID
MID
LRG
SML
LRG
SML
LRG
SML
SML
SML
LRG
MID
MID
MID
SML
SML
LRG
MID
SML
SML
MID
SML
MID
LRG
MID
SML
MID
SML
SML
MID
SML
LRG
LRG
MID
SML
SML
MID
SML
MID
MID
MID
LRG
180
Sears Holdings Corp.
Kennametal Inc.
CarMax Inc.
Coca-Cola Co.
Kohl's Corp.
Quicksilver Resources Inc.
Lincoln Electric Holdings Inc.
Littelfuse Inc.
Laboratory Corp. of America Holdings
Lennox International Inc.
LKQ Corp.
Linear Technology Corp.
Eli Lilly & Co.
Lowe's Cos.
Lam Research Corp.
TrueBlue Inc.
Lattice Semiconductor Corp.
Landstar System Inc.
Southwest Airlines Co.
Lexmark International Inc.
St. Mary Land & Exploration Co.
Mattel Inc.
Matthews International Corp. Cl A
Microchip Technology Inc.
Micrel Inc.
Micros Systems Inc.
Medicines Co.
McDermott International Inc.
Medtronic Inc.
MDU Resources Group Inc.
Medarex Inc.
CVS Caremark Corp.
Methode Electronics Inc.
Magellan Health Services Inc.
Medco Health Solutions Inc.
Herman Miller Inc.
Mueller Industries Inc.
Martin Marietta Materials Inc.
3M Co.
Mentor Corp.
Molex Inc.
Monsanto Co.
Motorola Inc.
Merck & Co. Inc.
Marathon Oil Corp.
Marvell Technology Group Ltd.
Mine Safety Appliances Co.
Microsemi Corp.
Microsoft Corp.
MSC Industrial Direct Co.
SHLD
KMT
KMX
KO
KSS
KWK
LECO
LFUS
LH
LII
LKQX
LLTC
LLY
LOW
LRCX
TBI
LSCC
LSTR
LUV
LXK
SM
MAT
MATW
MCHP
MCRL
MCRS
MDCO
MDR
MDT
MDU
MEDX
CVS
MEI
MGLN
MHS
MLHR
MLI
MLM
MMM
MNT
MOLX
MON
MOT
MRK
MRO
MRVL
MSA
MSCC
MSFT
MSM
LRG
SML
MID
LRG
LRG
MID
SML
SML
MID
SML
MID
MID
LRG
LRG
MID
SML
SML
SML
LRG
MID
SML
MID
SML
MID
SML
SML
SML
MID
LRG
MID
SML
LRG
SML
SML
LRG
SML
SML
MID
LRG
SML
MID
LRG
LRG
LRG
LRG
MID
SML
SML
LRG
SML
181
EarthLink Inc.
Mettler-Toledo International Inc.
Manitowoc Co.
Minerals Technologies Inc.
Murphy Oil Corp.
Myriad Genetics Inc.
National Instruments Corp.
Noble Energy Inc.
Navigant Consulting Inc.
NCR Corp.
99 Cents Only Stores
Nordson Corp.
Noble Corp.
Newmont Mining Corp.
McAfee Inc.
National Fuel Gas Co.
Newfield Exploration Co.
NII Holdings Inc.
Nike Inc. Cl B
National Oilwell Varco Inc.
Norfolk Southern Corp.
National Semiconductor Corp.
NeuStar Inc. Cl A
NetApp Inc.
Nucor Corp.
NuVasive Inc.
NVIDIA Corp.
Novellus Systems Inc.
NVR Inc.
Newell Rubbermaid Inc.
United Online Inc.
Old Dominion Freight Line Inc.
Odyssey HealthCare Inc.
Oceaneering International Inc.
Oil States International Inc.
Olin Corp.
Owens & Minor Inc.
OM Group Inc.
Omniture Inc.
Onyx Pharmaceuticals Inc.
Oracle Corp.
O'Reilly Automotive Inc.
OSI Pharmaceuticals Inc.
OmniVision Technologies Inc.
Occidental Petroleum Corp.
ConocoPhillips
Paychex Inc.
Potlatch Corp. REIT
Plum Creek Timber Co. Inc. REIT
priceline.com Inc.
ELNK
MTD
MTW
MTX
MUR
MYGN
NATI
NBL
NCI
NCR
NDN
NDSN
NE
NEM
MFE
NFG
NFX
NIHD
NKE
NOV
NSC
NSM
NSR
NTAP
NUE
NUVA
NVDA
NVLS
NVR
NWL
UNTD
ODFL
ODSY
OII
OIS
OLN
OMI
OMG
OMTR
ONXX
ORCL
ORLY
OSIP
OVTI
OXY
COP
PAYX
PCH
PCL
PCLN
SML
MID
MID
SML
LRG
SML
SML
LRG
SML
MID
SML
SML
LRG
LRG
MID
MID
MID
MID
LRG
LRG
LRG
MID
MID
MID
LRG
SML
MID
MID
MID
MID
SML
SML
SML
MID
SML
SML
SML
SML
SML
SML
LRG
MID
MID
SML
LRG
LRG
LRG
SML
MID
MID
182
Precision Castparts Corp.
Southern Copper Corp.
Patterson Cos. Inc.
Pride International Inc.
Mednax Inc.
Exelon Corp.
Perot Systems Corp.
PETsMART Inc.
Pfizer Inc.
Procter & Gamble Co.
Stillwater Mining Co.
Parker Hannifin Corp.
Polaris Industries Inc.
Packaging Corp. of America
PerkinElmer Inc.
Children's Place Retail Stores Inc.
Polycom Inc.
Pall Corp.
Plantronics Inc.
Plexus Corp.
PMC-Sierra Inc.
Parametric Technology Corp.
Pentair Inc.
Pre-Paid Legal Services Inc.
Pharmaceutical Product Development Inc.
PPG Industries Inc.
Perrigo Co.
Progress Software Corp.
Public Storage
PSS World Medical Inc.
Pacific Sunwear of California Inc.
Patterson-UTI Energy Inc.
Phillips-Van Heusen Corp.
Quanta Services Inc.
Praxair Inc.
Corrections Corp. of America
Brink's Co.
Qualcomm Inc.
QLogic Corp.
Quest Software Inc.
RCN Corp.
Rowan Cos. Inc.
Red Hat Inc.
Robert Half International Inc.
Polo Ralph Lauren Corp.
Rambus Inc.
ResMed Inc.
Rohm & Haas Co.
Rockwell Automation Corp.
Roper Industries Inc.
PCP
PCU
PDCO
PDE
MD
EXC
PER
PETM
PFE
PG
SWC
PH
PII
PKG
PKI
PLCE
PLCM
PLL
PLT
PLXS
PMCS
PMTC
PNR
PPD
PPDI
PPG
PRGO
PRGS
PSA
PSSI
PSUN
PTEN
PVH
PWR
PX
CXW
BCO
QCOM
QLGC
QSFT
RCNI
RDC
RHT
RHI
RL
RMBS
RMD
ROH
ROK
ROP
LRG
LRG
MID
MID
SML
LRG
SML
MID
LRG
LRG
SML
MID
SML
MID
SML
SML
MID
MID
SML
SML
SML
SML
MID
SML
MID
LRG
SML
SML
LRG
SML
SML
MID
SML
MID
LRG
SML
SML
LRG
MID
SML
SML
MID
MID
MID
MID
SML
MID
LRG
MID
MID
183
Ross Stores Inc.
Range Resources Corp.
Reliance Steel & Aluminum Co.
Republic Services Inc.
RTI International Metals Inc.
IMS Health Inc.
Rayonier Inc. REIT
AT&T Inc.
Schnitzer Steel Industries Inc.
Sepracor Inc.
Superior Energy Services Inc.
Salesforce.com Inc.
Schering-Plough Corp.
Shaw Group Inc.
Sherwin-Williams Co.
Sigma-Aldrich Corp.
Smith International Inc.
Saks Inc.
Silicon Laboratories Inc.
Schlumberger Ltd.
Semtech Corp.
Snap-On Inc.
SanDisk Corp.
Senior Housing Properties Trust
Synopsys Inc.
Sonoco Products Co.
Sonus Networks Inc.
Staples Inc.
Spirit AeroSystems Hldgs Inc. Cl A
SPX Corp.
SunPower Corp. Cl A
Stericycle Inc.
SRA International Inc. Cl A
Simpson Manufacturing Co.
Nuance Communications Inc.
Steris Corp.
St. Jude Medical Inc.
Questar Corp.
Strayer Education Inc.
Stryker Corp.
Seagate Technology Inc.
Men's Wearhouse Inc.
Sun Microsystems Inc.
Southwestern Energy Co.
Sybase Inc.
Symantec Corp.
RadioShack Corp.
Timberland Co.
Tidewater Inc.
Teledyne Technologies Inc.
ROST
RRC
RS
RSG
RTI
RX
RYN
T
SCHN
SEPR
SPN
CRM
SGP
SGR
SHW
SIAL
SII
SKS
SLAB
SLB
SMTC
SNA
SNDK
SNH
SNPS
SON
SONS
SPLS
SPR
SPW
SPWRA
SRCL
SRX
SSD
NUAN
STE
STJ
STR
STRA
SYK
STX
MW
JAVA
SWN
SY
SYMC
RSH
TBL
TDW
TDY
MID
MID
MID
MID
SML
MID
MID
LRG
SML
MID
MID
MID
LRG
MID
MID
MID
LRG
SML
SML
LRG
SML
SML
MID
SML
MID
MID
SML
LRG
SML
MID
MID
MID
SML
SML
MID
SML
LRG
MID
SML
LRG
MID
SML
MID
LRG
SML
LRG
MID
SML
MID
SML
184
Techne Corp.
Teradyne Inc.
Terex Corp.
Tredegar Corp.
Thor Industries Inc.
Theravance Inc.
TIBCO Software Inc.
Titanium Metals Corp.
Tiffany & Co.
TJX Cos.
Timken Co.
Thermo Fisher Scientific Inc.
Monster Worldwide Inc.
Technitrol Inc.
Triquint Semiconductor Inc.
Terra Industries Inc.
Trimble Navigation Ltd.
ACI Worldwide Inc.
Tractor Supply Co.
Tessera Technologies Inc.
Total System Services Inc.
Toro Co.
Teletech Holdings Inc.
Tetra Technologies Inc.
Tupperware Brands Corp.
Texas Industries Inc.
Texas Instruments Inc.
Tyco International Ltd. (New)
Continental Resources Inc.
Covidien Ltd.
Tyco Electronics Ltd.
WABCO Holdings Inc.
Concho Resources Inc.
Masimo Corp.
VMware Inc.
Teradata Corp.
Zep Inc.
Patriot Coal Corp.
SandRidge Energy Inc.
Abraxis BioScience Inc.
Hillenbrand Inc.
Quanex Building Products Corp.
Intrepid Potash Inc.
Lender Processing Services Inc.
Under Armour Inc. Cl A
GrafTech International Ltd.
Intermec Inc.
UnitedHealth Group Inc.
Union Pacific Corp.
Unit Corp.
TECH
TER
TEX
TG
THO
THRX
TIBX
TIE
TIF
TJX
TKR
TMO
MWW
TNL
TQNT
TRA
TRMB
ACIW
TSCO
TSRA
TSS
TTC
TTEC
TTI
TUP
TXI
TXN
TYC
CLR
COV
TEL
WBC
CXO
MASI
VMW
TDC
ZEP
PCX
SD
ABII
HI
NX
IPI
LPS
UA
GTI
IN
UNH
UNP
UNT
SML
SML
MID
SML
SML
SML
SML
MID
MID
LRG
MID
LRG
MID
SML
SML
MID
MID
SML
SML
SML
MID
SML
SML
SML
SML
SML
LRG
LRG
MID
LRG
LRG
MID
MID
SML
MID
MID
SML
SML
MID
SML
SML
SML
MID
MID
SML
SML
SML
LRG
LRG
MID
185
Ultra Petroleum Corp.
United Parcel Service Inc. Cl B
Urban Outfitters Inc.
U.S. Cellular Corp.
United Therapeutics Corp.
United Technologies Corp.
Valmont Industries Inc.
Varian Medical Systems Inc.
Varian Inc.
Veeco Instruments Inc.
VF Corp.
Valero Energy Corp.
VistaPrint Ltd.
VeriSign Inc.
Vertex Pharmaceuticals Inc.
Varian Semiconductor Equipment Associates Inc
Wabtec
Walgreen Co.
Waters Corp.
Websense Inc.
Warner Chilcott Ltd. Cl A
Western Digital Corp.
WD-40 Co.
Werner Enterprises Inc.
MEMC Electronic Materials Inc.
Weatherford International Ltd.
Winnebago Industries Inc.
Woodward Governor Co.
Wind River Systems Inc.
Whiting Petroleum Corp.
Wausau Paper Corp.
Wal-Mart Stores Inc.
VCA Antech Inc.
Watson Pharmaceuticals Inc.
Warnaco Group Inc.
Williams-Sonoma Inc.
Watsco Inc.
West Pharmaceutical Services Inc.
Worthington Industries Inc.
W&T Offshore Inc.
Western Union Co.
Watson Wyatt Worldwide Inc. Cl A
Wolverine World Wide Inc.
United States Steel Corp.
Dun & Bradstreet Corp.
Cimarex Energy Co.
Xilinx Inc.
Exxon Mobil Corp.
Dentsply International Inc.
XTO Energy Inc.
UPL
UPS
URBN
USM
UTHR
UTX
VMI
VAR
VARI
VECO
VFC
VLO
VPRT
VRSN
VRTX
VSEA
WAB
WAG
WAT
WBSN
WCRX
WDC
WDFC
WERN
WFR
WFT
WGO
WGOV
WIND
WLL
WPP
WMT
WOOF
WPI
WRC
WSM
WSO
WST
WOR
WTI
WU
WW
WWW
X
DNB
XEC
XLNX
XOM
XRAY
XTO
MID
LRG
MID
MID
SML
LRG
MID
MID
SML
SML
MID
LRG
SML
MID
MID
SML
SML
LRG
MID
SML
MID
MID
SML
SML
LRG
LRG
SML
SML
SML
MID
SML
LRG
SML
MID
SML
MID
SML
SML
SML
MID
LRG
SML
SML
LRG
MID
MID
MID
LRG
MID
LRG
186
Yahoo! Inc.
Foot Locker Inc.
Zebra Technologies Corp. Cl A
Zale Corp.
Zimmer Holdings Inc.
Zoran Corp.
YHOO
FL
ZBRA
ZLC
ZMH
ZRAN
LRG
MID
MID
SML
LRG
SML
187
APPENDIX I.
Glossary of Portfolio Theory and Arabic and Islamic Financial Terms
Portfolio Theory Terms
Arbitrage Pricing Theory (APT) – a multiple factor-based theory of asset valuation that holds
that the expected return on an asset can be described and determined by its relationship with
other common risk factors
Beta – a measure of the systematic risk of an asset
Call Option – a contract that grants the bearer the option to purchase a stock or bond within a
certain period time at a specified price (the exercise price)
Capital Asset Pricing Model (CAPM) – a single factor-based theory of asset valuation that
estimates an asset’s required or expected return based on its systemic risk relative to that of the
market portfolio
Capital Market Line (CML) – a line that extends from the intercept point and represents the
risk free rate tangent to the original Markowitz efficient frontier; investments on the capital
market line dominate those portfolios on the efficient frontier
Certificate of Deposit – certificates issued by banks and savings and loans associations that pay
higher interest rates than regular deposit accounts
Efficient Frontier – the set of portfolios that offer the maximum rate of return for each and
every level of risk, or the minimum risk for every rate of return
Holding Period Return (HPR) – an investment’s total return, including all sources of income,
for a specified time period
Holding Period Yield (HPY) – the holding period return expressed as a percentage (HPR – 1)
Market Portfolio – the portfolio that includes all risky assets available for investment
Preferred Stock – an instrument that has the characteristics of a stock and a bond, in that it
represents ownership in a company like a stock and pays a fixed dividend to investors like a
bond; preferred stock usually has no voting rights and the claims of preferred stockholders are
superior to those of common shareholders and subordinate to bondholders
Private Equity – investors and investment funds that make direct stakes in private companies or
buy the outstanding shares of a public company to “take it private”; private equity investors and
firms have access to tremendous financial resources that they can commit for long periods of
time
Put Option – a contract that grants the bearer the right to sell a stock or bond within a certain
period at a specified exercise price
188
Real Estate Investment Trust (REIT) – a security that is traded on an exchange like a stock
and invests in real estate directly through mortgages or in the properties themselves; can be
equity, mortgage, or hybrid REITs
Risk Free Asset – an asset whose returns have zero variance (usually considered to be Treasury
securities, especially T-bills)
Risky Asset – an asset whose returns are considered to be uncertain
Risk Free Rate – the theoretical rate of return on a risk free asset (the interest rate on the 3
month Treasury bill is generally considered to be the risk free rate)
Security Market Line (SML) – line that represents the combination of risk and return on
investments
Separation Theorem – the theory which holds that the investment decision (whether to invest in
the market portfolio on the CML) is separate from the financing decision (whether to borrow or
lend at the risk free rate)
Systematic Risk – the risk that cannot be diversified away; measures the variability of returns to
due to macroeconomic factors that affect all risky assets
Unsystematic Risk – idiosyncratic risk; represents the risk that is unique to an asset due to its
own inherent characteristics; unlike systematic risk, it can be diversified away in a portfolio
Venture Capital – a form of high risk investment that provides financing for small businesses
and startup companies, and can also include managerial and technical expertise; most venture
capital comes from a group of wealthy investors, investment banks, and/or a dedicated venture
capital firm
Zero Coupon Bond – a bond, sold at a discounted price, which pays its par value at the date of
maturity but no interest payments
189
Arabic and Islamic Financial Terms
Bida – innovation
Caliph – successor or representative; the head of the Islamic state; the title was held by the first
four successors of Muhammad, and later the Umayyad, Abbasid, and Ottoman dynasties, as well
as other competing ruling factions in Egypt, Spain, and North Africa
Companion - early Muslims who saw or spoke with Muhammad, the most prominent of which
were his close associates
Fatwa - a non-binding religious opinion issued by a religious scholar or scholars
Faqih/pl. Fuquha – a judge
Fiqh – Islamic jurisprudence
Gharar - excessive risk and uncertainty in business and finance
Hadith - a report from one or more of the Companions of what Muhammad said or did
Halal - any object or an action which is permissible for Muslims to use or engage in
Haram – the opposite of halal; any object or an action which is impermissible for Muslims to
use or engage in
Hila/pl. Hiyal – ruse or stratagem used to evade various prohibitions in Islamic law
Ibadat - refers to matters of religion and other obligations incumbent upon Muslims
Ijara – lease; refers to selling benefit, use, or service for a fixed price or wage
Ijma – the consensus of Islamic jurists
Ijtihad - deductive juristic reasoning
Ikhtilaf – disagreement among jurists
Illa – basis for analogy
Ilm – knowledge
Isnad – a hadith’s chain of narrators
Istislah - a mode of legal reasoning that uses maslaha as grounds for making a legal decision
Jahiliyya – the age before the coming of Islam
190
Jamhur - a lesser degree of consensus, obtained when a majority of jurists agrees on a specific
ruling
Madhhab – a school of Islamic jurisprudence
Mujtahid - one who practices ijtihad
Makruh – an action that is frowned upon but not expressly prohibited and punished
Mandub - an action that is recommended but not mandatory
Maqasid al Sharia – the goals and objectives of Islamic law
Maslaha - public interest or welfare
Maysir – gambling
Muamalat – refers to social, political, and economic practices and issues that are most akin to
the subject matter of other legal systems
Mubah – an action that is permissible but neither rewarded nor punished
Mudaraba – a silent partnership
Mufti – an Islamic scholar who interprets the Sharia and can issue fatwas
Murabaha – a credit, or cost plus, sale
Musharaka - a full contractual partnership formed to pursue a specific line of business or
project
Naskh – the doctrine of abrogation
Qadi – an Islamic judge
Qard – a loan
Qiyas – a form of ijtihad, juristic reasoning by analogy
Quran – the holy book of Islam
Riba - unjustified enrichment through the exploitation of others or through the appropriation of
other’s property for one’s own use without a legitimate reason; commonly equated with interest
in modern times
Sadaqa – a voluntary act of charity, as opposed to zakat, which is obligatory
191
Sakk/pl. Sukuk – an Islamic bond
Sharia - the method of conduct that Muslims must employ in their lives, revealed in the Quran
and the Sunna
Sunna – the sayings and actions of Muhammad; the example of the Prophet
Taqlid – imitation
Ulama - the community of legal/religious scholars who were well versed in Islam and the Sharia
Wajib – an obligation that is incumbent upon Muslims to perform
Waqf - a religious endowment, similar to a common law trust, which is exclusively dedicated to
religious and/or charitable purposes
Zakah - one of the well known five pillars of Islam, is alms given to the poor. It is incumbent
upon every Muslim to set aside a specific portion of their income for zakah payments
Zann – opinion
192
APPENDIX J.
TIE Example Rationale
American Eagle Outfitters – AEO
Screen
1
Score
3
2
3
3
3
6
2
7
2
9
3
•
•
•
•
•
•
•
•
•
•
Rationale
Has vendor code of conduct to promote equity and fair trade
Supports Jumpstart (national early education program), Big Brothers
Big Sisters, and Student Conservation Association (high school and
college students working to protect environment)
Has American Eagle Foundation - focuses on improving the quality of
life anywhere AE Associates and customers live, work and play.
Foundation gives out grants to nonprofit, public charities in
Pittsburgh, New York City and Ottawa, Kansas and gift card
donations
Prohibits child labor among vendors, as well as forced/involuntary
labor
Two women executives
Wholesome images of women that aren’t overly sexualized
Many minority models in ads
Moving some production to Cambodia and Vietnam where quality of
products may decline
Strictly prohibits the use of real animal fur in all of its products
Prohibits the use of animal testing on its products
Nucor Corp. – NUE
Screen
2
Score
3
3
3
•
•
•
•
4
2
•
•
Rationale
Has supported Habitat for Humanity for years
Company has a committee to keeping workers safe on the job –
obviously dedicated to worker safety through a number of companywide initiatives
Recycles one ton of steel every two seconds, making it the largest
recycler of any material in America--more than the nation's entire
aluminum can industry
Has participated in elite environmental programs, such as the
Environmental Protection Agency's National Environmental
Performance Track program
Sponsored construction of a regional butterfly aviary, launched a
waterfowl protection project, and helped preserve wetlands
But its plants do release greenhouse gases, including carbon dioxide.
While the company makes strides in reducing energy use, its
processes are still energy intensive.
William’s Sonoma – WSM
Screen
Score
•
7
3
•
Rationale
Williams Sonoma brand has natural good food, like grass fed meats
high in omega 3’s, free range poultry, caviar is harvested from
sustainably farmed Northern California white sturgeon raised in
filtered artesian well water and fed a completely natural diet
Its products have a reputation for high quality
193
McDermott International – MDR
Screen
1
Score
2
3
2
•
•
•
4
1
•
•
Rationale
Code of conduct contains antitrust language
Code of conducts supports equal opportunity in hiring and promotion,
and contains a non-discrimination policy
Operations and properties can emit environmentally hazardous
substances; also uses coal, natural gas, etc.
Power Generation Systems segment is a leading supplier of fossilfired steam generating systems
Designed and built the world's largest waste-to-energy facility in
Florida
Sigma-Aldrich Corp. – SIAL
Screen
Score
•
1
3
•
•
2
3
•
•
4
3
6
3
8
3
•
•
•
Rationale
An equal opportunity employer; also has anti-discrimination policies
with respect to suppliers, applicants, customers, and other business
associates
One of company’s explicit core beliefs is that employees should be
treated with respect and dignity
Strictly prohibits harassment, sexual and otherwise, of employees
suppliers, applicants, customers, and other business associates
Sigma-Aldrich Foundation supports numerous non-profit
organizations through monetary grants
Dedicated to making their operations environmentally sound and
reducing their negative impacts on the environment
Dedicated to reusing materials, recycling, and reducing waste and
spent material released in the air, water, or land
Stringent anti-discrimination policies and commitment to equal
opportunity
Products are used in pharmaceutical research and the life sciences,
biotechnology, industrial, and electronic applications
FactSet – FDS
Screen
Score
2
2
6
2
•
•
Rationale
FactSet supports communities by making financial contributions,
matching our employees' monetary donations, sponsoring local
programs, and promoting employee activism
FactSet is an equal opportunity and affirmative action employer
Corinthian Colleges – COCO
Screen
6
Score
2
•
Rationale
3 women executives in high management
Foot Locker – FL
Screen
Score
•
2
3
•
Rationale
Company supports well-established non-profit organizations, schools
and youth centers
Works with The Fred Jordan Mission on its annual back-to-school
giveaway event, providing shoes and supplies to thousands of
impoverished youths in downtown Los Angeles
194
•
6
3
•
•
•
Foot Locker Foundation - hosted an “On Our Feet” fundraising gala
each year, the proceeds of which are donated to organizations such as
the Twin Towers Fund and United Negro College Fund
Two women executives
Wholesome images of women
Many minority models in ads
Tiffany’s – TIF
Screen
1
Score
3
2
3
•
4
3
•
•
•
•
Rationale
Committed to stopping the flow of blood or conflict diamonds
Refuses to knowingly purchase rubies from Myanmar due to its
human rights violations
The Tiffany Foundation – supports design and decorative arts,
environmental and cultural preservation, responsible mining, and
coral reef conservation
Working to stop destruction of coral reefs
Opposed to destructive gem and metal mining in culturally significant
areas
Ralph Lauren – RL
Screen
Score
•
2
3
3
3
•
•
•
6
1
•
Rationale
Ralph Lauren foundation serves a large variety of organizations and
causes, including cancer care, underserved communities, and the
American Heroes Fund (scholarships for children of 9/11 victims)
Uses models of color on runway and in print work
Women are presented tastefully in ads and aren’t excessively
sexualized
Commitment to fair labor practices among its suppliers does not seem
to be very strong
As of its 2008 10K, the company is a defendant in 3 legal cases where
it is accused of improper treatment of workers and improper
compensation practices