Contemporary Islamic Finance: Innovations, Applications and Best Practices

CHAPTER 10

Shari'a-Compliant Mutual Funds

MONEM SALAM

President, Saturna Sdn. Bhd.

Former Director of Islamic Investing of Saturna Capital and Deputy Portfolio Manager of the Amana Mutual Funds Trust

A mutual fund is an investment by a group of shareholders that is run by a professional fund manager. A mutual fund can be a corporation or trust that issues shares. The money is pooled for investment purposes, and the gains or losses are shared proportionally among holders. In addition, the mutual fund appoints a manager to run the fund. Investing in a mutual fund raises many concerns to Muslims about the Islamic legality of the investment itself. Yet, what many overlook is that a mutual fund is similar to Islamic investments: musharaka and mudaraba.

MUSHARAKA VERSUS MUDARABA

In a musharaka (equity partnership) transaction, two or more partners contribute capital to a project, though not necessarily in equal amounts. In this shared equity arrangement, a partner with a larger investment has proportionally more control over the decisions that are made and would absorb a larger percentage of any potential losses, again on a proportional basis. To make the terms of the agreement clear from the start, a musharaka contract must specify each partner's profit as a predetermined portion of whatever the total profit turns out to be. However, unlike the way loss is apportioned, profit isn't necessarily proportional to the investment amount.

Musharaka contracts may be either permanent or diminishing, ...