Working With Islamic Finance (page 3 of 3)

Fixed-Income Funds

Retirement Investments: Retirees who want their investments to comply with the tenets of Islam face a dilemma in that fixed-income investments include riba, which is forbidden. Therefore, specific types of investment in real estate, either directly or in securitised fashion (a diversified real estate fund), could provide steady retirement income while not running afoul of Shariah law.

Sukuk: In a typical ijara sukuk (leasing bond-equivalent), the issuer will sell the financial certificate to an investor group, which will own them before renting them back to the issuer in exchange for a predetermined rental return. Like the interest rate on a conventional bond, the rental return may be a fixed or floating rate pegged to a benchmark, such as Libor.

The issuer makes a binding promise to buy back the bonds at a future date at par value. Special purpose vehicles (SPV) are often set up to act as intermediaries in the transaction. A sukuk may be a new borrowing, or it may be the Shariah-compliant replacement of a conventional bond issue.

The issue may even enjoy liquidity through listing on local, regional or global exchanges, according to an article in CFA Magazine titled "Islamic Finance: How New Practitioners of Islamic Finance are Mixing Theology and Modern Investment Theory" (2005).

Basic insurance vehicles

Traditional insurance is not permitted as a means of risk management in Islamic law. This is because it constitutes the purchase of something with an uncertain outcome (form of ghirar), and because insurers use fixed income - a form of riba - as part of their portfolio management process to satisfy liabilities.

A possible Shariah-compliant alternative is cooperative (mutual) insurance. Subscribers contribute to a pool of funds, which are invested in a Shariah-compliant manner. Funds are withdrawn from the pool to satisfy claims, and unclaimed profits are distributed among policy holders. Such a structure exists infrequently, so Muslims may avail themselves of existing insurance vehicles if needed or required.

Conclusion

Islamic finance is a centuries-old practice that is gaining recognition throughout the world and whose ethical nature is even drawing the interest of non-Muslims. Given the increased wealth in Muslim nations, expect this field to undergo an even more rapid evolution as it continues to address the challenges of reconciling the disparate worlds of theology and modern portfolio theory.

See also:
Setting shariah standards
Faith in finance
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