Are mutual funds halal or haram?

Why conventional mutual funds raise concerns

A mutual fund is simply a pool of investors’ money. The concern is not pooling itself, which resembles a partnership, but the assets. Conventional money market and income funds earn most of their return from interest on government securities, bank deposits and bonds. Conventional equity funds may hold shares of banks, insurers or companies with large interest-based debt and income.

Most contemporary Islamic scholars therefore consider conventional funds unsuitable for Muslims who want to avoid riba, while accepting funds that are structured and supervised to comply with Shariah.

How Islamic mutual funds stay Shariah-compliant

In Pakistan, an Islamic fund must appoint a Shariah advisor and follow the SECP’s Shariah governance rules. The advisor approves what the fund may buy and reviews it regularly. Its main safeguards are:

• Permissible assets only: Shariah-screened shares on the Pakistan Stock Exchange, sukuk, Islamic bank deposits and placements, and other approved instruments instead of interest-bearing securities.
• Business screening: companies whose core business is impermissible, such as conventional banking, insurance, alcohol, gambling or tobacco, are excluded.
• Financial screening: companies must keep interest-based debt, interest income and similar ratios below limits set by the Shariah board. The KMI-30 index of the Pakistan Stock Exchange follows such a screen.
• Purification: if a company earns a small amount of non-compliant income, the fund gives the matching share of its income to charity.
• Shariah audit: the fund’s compliance is reviewed and reported to unit holders.

Is the profit from an Islamic fund like interest?

No. Interest is a fixed return on a loan regardless of the outcome. An Islamic fund’s return comes from owning assets: dividends and price changes of shares, rental or profit payments on sukuk, and profit shared by Islamic banks under partnership contracts. That is why fund returns are never guaranteed and can fall as well as rise.

Money market and income funds are often described by their “profit rate”, but that is just their recent return expressed as a yearly rate.

How to check whether a fund is Shariah-compliant

Look for the fund’s classification in MUFAP data, which labels every Islamic fund “Shariah Compliant”, and the name of its Shariah advisor in the offering document and monthly fund manager report. Every fund on Islamic Funds is classified as Shariah-compliant by MUFAP.

Scholars do not all agree on every screen, so if you follow a particular scholar or school, compare the fund’s Shariah policy with their guidance.

Which type of Islamic fund suits you?

Islamic money market funds hold short-term Islamic instruments and suit savings and emergency funds. Islamic income funds hold sukuk and longer instruments for steady medium-term returns. Islamic equity funds invest in screened shares for long-term growth with higher ups and downs. Islamic voluntary pension schemes (VPS) are for retirement saving.