What it means
Malta's financial regulator gives one official description: its guidance note says such funds invest only in instruments consistent with Islamic principles, including bans on riba (interest), haram activities, maisir (gambling) and speculative transactions. They are expected to appoint a Shariah board or adviser and to run Shariah screening.
The fund is still a fund under ordinary law, because the same note says Shariah funds are regulated like conventional funds in the same category. Shariah rules apply only to the extent they are consistent with existing regulation, and the regulation prevails in a conflict.
Screening is the part investors meet most, and the Securities Commission Malaysia describes one methodology for listed shares. It checks the share of income from non-compliant activities against a 5% benchmark and tests cash over total assets and debt over total assets, each of which must be below 33%.
That Malaysian method is one example, not a global standard, because other index providers and boards set their own tests, so a fund's documents should say which method it uses and how often the screen is reviewed. The Maltese guidance also covers mistakes found after purchase: if a holding is found non-compliant, the manager should dispose of it within three months, unless it is reclassified in that period.
Income earned during the non-compliant period is purified, for example by giving it to independent charities, while the principal cost may be kept. Disclosure matters because the label depends on judgement, so offering documents should describe the Shariah adviser's background, conflicts, the screening method and risks.
The note says the restricted universe may mean lower returns and higher volatility than an unrestricted fund, and that the regulator does not monitor ongoing Shariah compliance. An investor should ask three questions: who is the Shariah adviser, what screen applies, and what happens to purification income.
Those answers matter more than the word Islamic in a fund name.
In practice
Real-world examples.
Example
A fictional equity fund holds a company with $400 million in total income. Of that, $14 million comes from a non-compliant activity. The share is 3.5%, below a 5% benchmark, so it passes that one test but must still pass the other screens.
Example
A fictional company has $120 million of interest-bearing debt and $450 million of total assets. The debt ratio is 26.7%, below a 33% limit. The same company could still fail a business-activity or qualitative review.
Example
A fictional fund receives $20,000 in income from a holding later found non-compliant. Under the Maltese approach the income is purified, while the original cost may be retained. The investor checks the fund report to see where the money went.
Formula
Calculation
Business-activity ratio = non-compliant income / total income. Debt ratio = interest-bearing debt / total assets. Cash ratio = conventional cash and equivalents / total assets.
Worked example for a fictional company with $400 million of total income, $14 million of it from non-compliant activity, $120 million of interest-bearing debt, $100 million of conventional cash and $450 million of total assets:
- Business-activity ratio = 14 / 400 = 3.5%, below a 5% benchmark.
- Debt ratio = 120 / 450 = 26.7%, below 33%.
- Cash ratio = 100 / 450 = 22.2%, below 33%.
These figures illustrate one published screen and do not apply to every fund.Case study
Seen in the real world.
This case study is fictional and illustrative. A fund manager reviews a listed company for a Shariah-compliant equity fund. Its non-compliant income is 3.5% of total income, and its debt ratio is 26.7%. The manager's screen passes both numbers.
The Shariah adviser still asks about the company's other activities and any qualitative concerns. The adviser withholds approval until the company's latest report is reviewed. Three months later, a new report shows that a business line now makes up more than the permitted share. The manager follows the fund's policy and starts disposal.
Income earned in the period is calculated for purification, and independent charities are named in the fund's report. The case shows that the label is an ongoing process. A single test does not end the review. Investors still examine fees, concentration and the risk of a smaller investable universe.
Watch out
Common mistakes.
- Assuming every Shariah-compliant fund uses the same screening thresholds.
- Treating the label as a guarantee of returns or lower risk.
- Ignoring who the Shariah adviser is and whether conflicts are disclosed.
Questions
People also ask.
Are Shariah-compliant funds outside normal fund regulation?
No. The Maltese guidance says they are regulated like conventional funds in the same category.
What is purification?
It is the handling of income from a non-compliant holding, such as giving it to independent charities, as described in the Maltese guidance.
Do all screens use 5% and 33%?
No. Those figures come from the Securities Commission Malaysia method. Other methods can differ.
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