Islamic Principles of Equity Investing

 Islamic principles of equity investing

Just like other matters, people do ifrat (immoderation) and Tafreet (negligence) and avoid I’tedal and iqtesad (moderation, middle way) in equity investing also. On one hand, there exists a tribe that is indifferent to the Shariah’ guidelines and indulges in all kinds of transactions without delving into its permissibility. On the other hand, some see too many Shariah issues and consider it better to avoid them. Such is the importance of moderation Quran says about the immoderation of the previous communities in the following words:

وَلَوۡ اَنَّهُمۡ اَقَامُوا التَّوۡرٰٮةَ وَالۡاِنۡجِيۡلَ وَمَاۤ اُنۡزِلَ اِلَيۡهِمۡ مِّنۡ رَّبِّهِمۡ لَاَ كَلُوۡا مِنۡ فَوۡقِهِمۡ وَمِنۡ تَحۡتِ اَرۡجُلِهِمۡ‌ؕ مِنۡهُمۡ اُمَّةٌ مُّقۡتَصِدَةٌ‌  ؕ وَكَثِيۡرٌ مِّنۡهُمۡ سَآءَ مَا يَعۡمَلُوۡنَ

“If they had observed the Torah and the Gospel and that which was revealed unto them from their Lord, they would surely have been nourished from above them and from beneath their feet. Among them, there are people who are moderate, but many of them are of evil conduct” (5:66 Quran)

Another verse that establishes the importance of moderation:

ثُمَّ اَوۡرَثۡنَا الۡكِتٰبَ الَّذِيۡنَ اصۡطَفَيۡنَا مِنۡ عِبَادِنَاۚ فَمِنۡهُمۡ ظَالِمٌ لِّنَفۡسِهٖ‌ۚ وَمِنۡهُمۡ مُّقۡتَصِدٌ  ‌ۚ وَمِنۡهُمۡ سَابِقٌۢ بِالۡخَيۡرٰتِ بِاِذۡنِ اللّٰهِؕ ذٰلِكَ هُوَ الۡفَضۡلُ الۡكَبِيۡرُؕ 

“Thereafter We made the ones whom We elected of Our bondmen inherit the Book. Then, of them are (some) who are unjust to themselves, and of them are (some) who are moderate, and of them are (some) who are forerunners in charitable (deeds), by the permission of Allah. It is that (which) is the great Grace.” (35:32)

As per Ibne Kathir Zalim in the above verse in one who is careless about doing some obligatory actions, and who commit some forbidden actions, Muqtasid fulfills his obligations and avoids things that are forbidden, but may neglect some good deeds, And Sabiqun fil Khairat are those who do obligatory actions and things which are encouraged, and who avoid doing unlawful and disliked actions, and avoid some permissible actions.

After invoking iqtesad now let me break it down for both of such mindsets at the opposite side of the continuum of permissibility regarding equity investing straightforwardly.

The basic principle underlying the fiqhul Muamlat (Islamic jurisprudence related to commercial transactions) is:

 "الأصل في الأشياء الإباحة حتى يدل الدليل على التحريم"  (السیوطی، عبد الرحمن بن ابی بکر، الاشباہ والنظایر، دار الکتب العلمیہ بیروت،١٤٠٣ ھ, 60/1)

"The default status of things is indifference until the proof indicates prohibition". This view is as per the Shafai School of jurisprudence. It is also the majority Hanafi view according to Ibn `Abidin quoting Sharh Usul al-Pazdawi in his Hashiya (1386H ed. 4:161)

This legal maxim is derived from various quranic verses and prophetic narrations. I will quote two here:

وَمَا لَكُمْ أَلاَّ تَأْكُلُواْ مِمَّا ذُكِرَ اسْمُ اللّهِ عَلَيْهِ وَقَدْ فَصَّلَ لَكُم مَّا حَرَّمَ عَلَيْكُمْ إِلاَّ مَا اضْطُرِرْتُمْ إِلَيْهِ وَإِنَّ كَثِيرًا لَّيُضِلُّونَ بِأَهْوَائِهِم بِغَيْرِ عِلْمٍ إِنَّ رَبَّكَ هُوَ أَعْلَمُ بِالْمُعْتَدِينَ

“What is wrong with you that you do not eat of that on which Allah’s Name has been mentioned while He has explained to you in detail what is forbidden to you, except under compulsion of necessity? And most surely many leave (others) in Misguidance by their vain desires out of ignorance. Certainly, your Lord knows best those who exceed the limits.” (6:119 Quran)

In other words, Haram (prohibited) things have been explained clearly by Allah SWT, and those things which are not declared haram are Halal (permitted) by default. So the default status of things is Halal. 

In surah Jasia Allah SWT says:

وَسَخَّرَ لَـكُمۡ مَّا فِى السَّمٰوٰتِ وَمَا فِى الۡاَرۡضِ جَمِيۡعًا مِّنۡهُ‌ ؕ اِنَّ فِىۡ ذٰلِكَ لَاٰيٰتٍ لِّقَوۡمٍ يَّتَفَكَّرُوۡنَ

“And He has subjugated for you whatever there is in the heavens and whatever there is in the earth, all from His own. Surely in this, there are signs for a people who reflect” (45:13 Quran). 

Commenting on this verse Ibne Taymiyah says if everything on this earth has been subjugated for us then it is also permitted to rejoice them (otherwise there is no benefit of subjugation) (مجموع الفتاوی ابن تیمیہ536/21)

Once it is established that the default status in muamlaat is ibahah (permission) (there are exceptions to this rule), then in investing matters we need to bring evidence from Nasse Qatai (definitive sources) for declaring something haram (forbidden). 

Three basic prohibitions are relevant in the case of equity investing:

1. Riba (loosely can be translated as interest, however, the Quranic concept of Riba is wider)

2. Gharar (excessive uncertainty/risk)

3. Maysir/Qimar (gambling/speculation)

Riba: Despite a lot of effort to make it halal using innovative interpretations of clear prohibitive Quranic verses, the dominant majority (Jamhur) still considers the present interest-based transactions as Haram. 

Gharar: Gharar in Islamic jurisprudence terminology is used to describe the uncertainty in a transaction. For example, unknown price, unknown seller, undefined quantity, etc. The basic principle is to save the parties in a transaction from tadlis (cheating in business) and ghabn (to deceive). In Today’s parlance, we can say frauds and scams are prohibited (Or do I need to say such an obvious thing?). Undefined terms lead to disputes and Shariah aims to close the doors of disputes. 

Maysisr/Qimar: The prohibition of gambling is also an undisputed injunction of Quran. All such zero-sum games (ones profit is another’s loss) are haram. Leveraged trading (or should I also say second and minute trading), futures and options are prohibited on this ground. Interestingly, Maysir is derived from yusr (which means ease) in which people wish for something valuable with ease without paying equivalent compensation. (Are you thinking of get-rich-quick schemes?). 

It is also interesting that Quran has clubbed together the matter of wine and Maysir in a single verse. Allah SWT says:

“They ask thee concerning wine and gambling. Say: ‘In them is great sin and some benefits for people; but the sin is greater than the benefits’.” (4: 219)

The above are the three basic prohibitions although there are other furui (ancillary) details. 

Islamic Screening of Stocks

Based on the above introduction, scholars have formulated screening criteria to evaluate the shariah compliance of stocks. 

1. Business Screen: The first screen is that the primary activities of the company must be Halal, Therefore, all those sectors whose business is Haram are screened out. Gambling stocks, banks, and insurance stocks, wine stocks are examples of stocks that are normally excluded from this screen.

2. Financial screens: a) The debt-equity ratio must not exceed 30%. The debt includes both short-term and long-term interest-based borrowings. 

b) Interest-taking deposits must be less than 30% of the market capitalization.

c) Income generated from prohibitive activities must not exceed 5% of the total income of the company.

The above criteria of shariah-compliance is by Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the largest Shariah-Standard setting body with Sh. Muhammad Taqi Usmani as president and other well-known 20 members from all over the world. It can safely be said that it represents Ijma’ of Juamhoor Ulema. Some woke people get triggered with the word jamhoor, therefore, it has been mentioned why jamhoor Ulema has been used here. 

Those who are familiar with the financial statements can easily screen a company without any expert help however, if one is completely new to investments one may take advice from Shariah Investment Advisors (Few in India perform the screening and also advise clients on Shariah-compliant stock investing). 

It is also worth mentioning that the above criteria has been set with the objective of “removal of hardship and creating ease” for investors. However, if someone has reservations over the ijtehad of the above scholars he may become more restrictive. For example, one may consider 30% debt-equity ratio too high. In that case, there are plenty of stocks in India that are completely debt-free. They may go for them. 

Further, the above criteria is reductionist and compliance-based. True Shariah-based criteria should also reflect the Islamic ideals of justice, green environment, human rights etc. For instance, a combination of Islamic and ESG investing is more desirable and shariah-based. Or for example, a firm that pays very well to its employees is nearer to Islamic ideal of كَىۡ لَا يَكُوۡنَ دُوۡلَةًۢ بَيۡنَ الۡاَغۡنِيَآءِ مِنۡكُمۡ‌  “so that it (wealth) may not merely circulate between the rich among you”. This incorporation of Islamic ideals in investing is still an active area of ijtehad. In investing we must not ignore the Quranic morality and ethics. So you should avoid ITC stock on this basis or will you not?