There are many options available to an individual intending to plan for his retirement. Be it PPF, ULIP, NSC's etc. Most retirement options fall into two categories,-those which promise a fixed assured return and those, like pension plans, which offer non-assured returns. There are very few retirement planning options available in mutual funds. At present, two funds, UTI Retirement Benefit Plan and Kothari Pioneer Pension plan fill the retirement mutual fund void. Both these schemes come equipped with Section 88 benefits and are therefore, on this count, at par with other retirement planning options like PPF, PF etc. Both the UTI Retirement Benefit Plan (RBP) and Kothari Pioneer Pension Plan (KPPP) allow the investor to plan for retirement, making it possible for him to receive regular income after retirement. Before an investor goes in for a retirement plan he needs to evaluate its various basic parameters:
Returns - In this case the comparison of returns vis a vis the fixed return instruments like PPF etc. is easy. The returns generated in the case of PPF is again, like Infrastructure Bonds, a fixed rate of 9.5 per cent unlike the returns of pension plans which can vary over a period of time. Also when it comes to comparing the returns between the two mutual fund options the investor must keep in mind, the track record of the scheme as well as his timing of entry. Both these factors will impact his return. However, in the case of infrastructure bonds, returns are fixed, irrespective of the time of entry. For instance Empirically, KPPP has turned in a better performance than Infrastructure Bonds so far. The fund has returned an annualised 15.20 per cent since inception as compared to a return of 9.5 per cent in the case of Infrastructure Bonds.
Lock in period - In case of fixed return instruments like PPF etc, the lock-in period is very long, with intermediate withdrawals after a certain number of years. In case of infrastructure bonds as well as pension funds the there is a 3 year lock-in period but in case of KPPP the withdrawal at the end of 3 years comes at a nominal penal charge.
Liquidity - In PPF, the liquidity is pretty low. A loan can be taken at the end of 3 years but even that is only to the extent of 25 per cent of the balance at the end of the preceding financial year. A withdrawal is permissible every year from the 7th financial year of the date of opening of the account. So, the loan and the withdrawal can be taken after a specified period of time and that too with certain riders. In the case of KPPP, the entire amount is withdrawable after the expiry of three years subject to a penal charge, otherwise the investor can exit only after reaching 58 years of age.
Rebate Eligibility -The tax benefits under both the PPF and the pension plans is the same in terms of the section 88 benefit which makes the investor eligible for tax benefits of 20 per cent of the amount invested in the scheme. The infrastructure bonds however offer an additional advantage in terms of enhanced amount of Rs 80,000 (link) of tax benefit under section 88.
Taxability of Interest/Dividend - Returns from PPF are tax free, Interest received on infrastructure bonds qualifies for tax exemption under Section 80L. This is not the case with dividend received from pension mutual funds like KPPP. Dividend received from KPPP is subject to dividend distribution tax of 10 per cent.
Minimum Investment - A minimum amount of Rs 100 has to be invested every year to keep the account alive in PPF unlike the facility of investing in installments of Rs 500 in case of KPPP. Also the minimum amount that can be invested in the pension plans is Rs 10,000. In the case of bonds the investor has to bring in a minimum amount of Rs 5000
Maximum Investment - The maximum amount that can be invested under PPF in a particular financial year is Rs 60,000 whereas there is no such restriction on the maximum amount that can be invested in the pension plans. No tax benefit is however given for investments made above Rs 60,000 in the case of KPPP.
Investment Installments - In the case of KPPP the minimum cumulative sum of Rs 10,000 can be invested in installments of Rs 500. In the case of bonds the investor has to bring in the entire minimum amount of Rs 5000 in lump sum.
Investment Mix - A comparison on this attribute is important when choosing between any pension plan offered by a mutual fund. Normally balanced schemes are offered. However, over a period of time the portfolio may vary. For instance ULIP has essentially become a growth scheme whereas KPPP is still focussed on debt though the equity component in the scheme has gone up over a period of time.
Additional Benefits - ULIP gives an insurance cover and an accident cover along with section 88 benefit, whereas, the other instruments do not offer this.
Wednesday, February 13, 2008
Monday, December 17, 2007
The Trading Technique That Will Always Keep You on the Right Side of the Market
In my special five-part trading course -- "Swing Trading Done Right: The Secrets to Putting the Odds in Your Favor" -- I shared numerous technical analysis insights and techniques with you. I demonstrated how to accurately label the peaks and valleys of a trend, how to draw a trendline, and how to spot the thrust, consolidation and countertrend movement typical of any "cell" of a given trend.
You learned about support and resistance, and about "the alternation principle," which states that old support, when broken, becomes new resistance. I also demonstrated a number of specific, highly profitable trading strategies based on the use of support and resistance. In my lesson on candlesticks, I shared several original ideas on candles and pointed out five key reversal candlesticks that not only nailed all major turning points for the S&P in a six-month historical time period, but that are also likely to do so again in the future.
In today's Bonus Report, which I've reserved for paid subscribers only, I want to share with you one of the most valuable technical analysis tools I have learned in more than 30 years of studying the subject. I call it, "The Trading Technique That Will Always Keep You on the Right Side of the Market."
The concept is "four-stage analysis." As I mentioned Lesson #5 of my trading course, the basic method is not original to me. An important researcher named Stan Weinstein discussed the four stages in a book entitled Secrets for Profiting in Bull and Bear Markets. The book is not new -- it was written in 1988 -- and is not all that widely known. However, that does not necessarily make it unimportant. When I discussed four-stage analysis at the local chapter of our technical analysis society, almost no one had heard of the idea, and even fewer folks were actually putting it into practice. Believe me -- this omission has undoubtedly cost those traders loads of money.
Over the years, I have read many, many books on technical analysis. I hold a large number of these in my personal collection and have borrowed countless more from the library. Yet out of all of these many valuable works, there are only FOUR books that I would unhesitatingly recommend to serious students of technical analysis. For me, these are the "classics." I define a classic as a book that I cannot fully absorb in one reading. It is a work I will return to again and again, each time gaining something new that I missed the time before.
Weinstein's book is a member of this very select short list. Unless you have an unusual local bookstore, you will probably need to order it. I think it will more than repay your investment.
You can order this book today for under $14 by visiting the following link:
"Stan Weinstein's Secrets For Profiting In Bull and Bear Markets"
I came across four-stage analysis in the mid-1990s. I covered it dutifully in my TD Waterhouse courses when I discussed moving average systems, but did not fully appreciate its value. It wasn't until the bear market started in 2000 that I realized how important this concept is.
Four-stage analysis is now my starting point whenever I analyze a chart. It is a concept largely geared toward investors. Yet as I've worked with four-stage analysis over time, I've developed many of my own insights and have worked hard to customize the idea to the swing trading timeframe I operate in.
In today's special Bonus Report, I will begin by clearly explaining Weinstein's basic concept of the four stages. Next, I will show you how I use four-stage analysis as a basis for swing trading. Finally, I will explain how I have customized this concept and will show you how you can use it to make more profitable swing trading decisions.
(1.) FOUR-STAGE ANALYSIS EXPLAINED
Four-stage analysis is always done with a weekly chart, and it is based on the relation of a stock or index's price to its own simple 30-week moving average. (Weinstein never explains why he chooses the 30- and not the 40-week, but I have performed my own studies on this topic and will tell you about these later.)
Basically, the concept says that every stock or index sequentially moves through four stages: Basing (I), Advancing (II), Topping (III) and Declining (IV). Furthermore, this cycle is repeated over and over again throughout time. The four stages provide a roadmap that indicates not only where a particular stock is at, but also where it's headed in the future.
Before we get into too many details on this important topic, a quick review of some of the key points of moving averages may be of value. A moving average may be thought of as a "curved trendline." During a bullish period, the moving average provides support, and during a bearish period resistance. In a bullish period, the moving average is consistently below the stock price. Just as importantly, during a bullish period the moving average consistently slopes upward. Meanwhile, bearish periods are the exact opposite. In these cases, the moving average is consistently above the price and slopes downward.
(2.) CISCO AND FOUR-STAGE ANALYSIS
I've presented you with a historical chart of Cisco Systems (CSCO) below to help explain the four stages -- particularly stages IV and I. It contains weekly data for a three-year period from about March 2000 to March 2003.
The chart begins with CSCO at the very end of stage II -- "Advancing." You can see this at the very left-hand edge, as the stock is still rising and is above an upward sloping 30-week moving average. CSCO's hyperbull market began in late 1998 when the shares tested support at $10. By the time the stock finally topped out at an April 2000 peak of $80, those who had held for the two-year stratospheric ride were showing healthy gains of 800%.
The selloff that occurs after a major price peak is often met with disbelief. CSCO's was no exception. The stock, which at the time was perceived as one of the great "blue chips" of the Internet era, had been at $80 in April, yet by June was selling for "fire-sale" prices in the $50 range. Naturally, investors at that time reasoned that the shares were a downright bargain, and they jumped headfirst into the pool. As it turns out, they were right in doing so. After all, in the spring of 2000, CSCO's moving average was still rising.
From a low of $50, CSCO quickly rallied to $70. Here it met resistance, and then created a failed ascending triangle. It then formed stage III -- a period in which the price played "tag" with a moving average that had now flattened out dramatically.
With CSCO, as with many tech stocks of the time, stage III was extremely short, lasting only about three months (from July to October of 2000). The stock took the form of a rectangular consolidation between $60 and $70. Investors who were not aware of four-stage analysis likely saw this as normal sideways action and did not pick up any real danger signals. (FYI -- We will return to stage III in more detail later in this report when we discuss Lennar.)
In late 2000, however, note that there is a change in the stock's visual pattern. The moving average had been sloping upward until now, but for the first time in a very long while it was finally beginning to slope downward. Notice how all of the consolidation takes place below the 30-week moving average, which is now DOWNWARD SLOPING.
Once CSCO broke below the consolidation at around $40 the stock experienced a "waterfall" decline. An alert swing trader who recognized that a stage IV decline had started could have made a nearly 300% profit in just eight weeks by being short at this time, as the stock plummeted from $40 to $15. Recognizing the stage IV decline also saved the swing trader from taking heavy losses, as many other traders were still establishing long positions in this "bargain" stock at that time.
Stage I Begins
After an enormous stage IV decline, any feelings of affection for the stock felt during the stage II advance have probably changed into anger and hatred. Rallies are sold into and provide persistent selling pressure that checks meaningful advances.
In stage I, however, supply and demand come into a rough balance. The stock stops going dramatically lower and instead begins to move sideways. The steeply declining 30-week moving average now begins to move horizontally, reflecting consolidation in the stock. The stock is beginning to form what is known in technical analysis as a "base."
From an investor's point of view, Weinstein notes, stage I is generally to be avoided. I assert, however, that a swing trader can profit from this period by going long at support and going short at resistance. As the chart presented above ends, CSCO remained in a stage I consolidation or base-building process.
Stage II
To more closely examine stage II, we will look at a historical chart for Garmin (GRMN) -- a manufacturer of GPS satellite receivers. The shares opened on the NYSE at $16 in late 2000 and essentially went sideways for the next two years. Note the very strong resistance established at just under $25, which contained the stock on four separate occasions during this period.
During this two-year time period the 30-week moving average basically moved within a sideways trading range. However, with the breakout in late November 2002, the moving average began to slope upward. A brief correction in January 2003 took the stock from $32 back to $28, but held above an upward-sloping moving average -- a signature of a stage II stock. As the historical chart above ended, GRMN was in a strong stage II period.
If you remember back to the uncertain market environment of early 2003, you'll note that GRMN was a strong stage II stock in a bearish stage IV market. I compare this coupling to a dog walked on a long, retractable leash. The leash, which in this analogy is the bear market, allows the dog to go for short runs, but the dog soon runs out of leash and is pulled abruptly back. When the market has a countertrend rally, however, these stocks often advance smartly and are well worth swing trading from the long side.
Stage III
After a long stage II advance, most investors love the stock. However, valuation may become a concern, and advances in the share price are often limited. A warning of an imminent stage III may occur when prices for the first time in a long while decline below a rising or flat 30-week moving average.
Below you'll find a historical chart of major homebuilder Lennar (LEN). Investors who held the stock at the time the chart ended needed to be very aware of the support level at $50. If this support level were to break, then the stock would likely experience a swift, painful drop. On the positive side, of course a break below $50, reinforced by a declining 30-week moving average that remained above the share price, would provide alert swing traders with an excellent shorting opportunity. For LEN, the stock would probably reach minor support at $45 very quickly.
When I write my weekly newsletter, I always start each issue off by discussing "The Primary Trend." I typically include several moving averages in this analysis, but the one I pay the most attention to is the 30-week. For example, as the historical chart below shows, the S&P was in a clear stage IV decline at the time this chart was drawn.
Savvy swing traders should always analyze the stock they are trading in conjunction with the overall market. In a stage II market, there is a strong tailwind at the back of most stocks. Breakouts carry further, and swing trading from the long side is typically successful as long as one makes sure not to catch the market (or any particular stock, for that matter) at a very overbought point. As the saying goes, everyone is a genius in a bull market.
In a stage IV market, on the other hand, the primary trend is a downward one. Breakouts of stage II stocks usually get their wings clipped by the overall market. Except for very brief periods, it is very difficult to trade the market from the long side during a stage IV decline. Instead, the swing trader's job is to find shorting opportunities. For example, stocks just breaking down from stage III consolidation patterns often prove to be excellent short candidates. Similarly, those that are in advanced stage IV declines, but which have broken an important support level, are also usually worth shorting. I've summarized these and many other trading tactics below.
Based on the above discussion, it is clear swing traders should choose trading strategies in harmony with the market's prevailing stage. With this in mind, here are some general principles to follow:
1.) In a stage IV market most of your trades should be from the short side. You should identify and track stocks that are liable to break down from stage III or are already in an advanced stage IV selloffs. Short these stocks as they break down from support levels. You can see a good example of this strategy by examining the historical chart of Harrah's (HET) below. Aggressive traders who want a quicker entry point may also short these stocks when they rally, when they hit important levels of resistance and then begin to decline, or when they fail to break through resistance.
During periods of countertrend rallies, previously identified stage II stocks should be traded from the long side. The chart of GRMN we discussed above would be an example of this strategy.
2.) In a stage II market, most of one's trades should be from the long side. Stocks that are in stage II advances should be bought when they are oversold or when they break out of a resistance area. The chart of Glamis Gold (GLG) below provides a good example of a stage II stock in a stage II group -- precious metals. At the time the chart was drawn, the shares were in a multi-year uptrend. Note how the stock made an excellent swing trade whenever it broke through a resistance level.
3.) Stage I and Stage III markets are trickier to trade than stage II or stage IV. During a stage I market, you should identify those stocks that are showing high relative strength and that have already entered a stage II advance. Meanwhile, during stage III markets, seek to find stocks that have already broken down from their own stage III consolidations.
(5.) A SWING TRADING SYSTEM BASED ON THE FOUR STAGES
One question I am often asked when I teach four-stage analysis is, "Why was the 30-week moving average chosen?" Indeed, the moving average that analysts typically use to define the long-term trend is 40 weeks or 200 days.
Weinstein does not deal with that question, so I decided to find out for myself. What I discovered was that the 30-period moving average best defines a stock's trend. Moreover, the 30-period moving average works best over ALL trading time frames whether you are using weekly, daily, hourly or even five-minute periods!
Again, look at the chart of Lennar (LEN) above. Note how a trendline drawn off the low near $30 in September 2001 breaks at just about the same time that the 30-period moving average flattens out and begins to go sideways. Also observe how even in a "trendless" period of consolidation, the 30-period moving average describes the "trend" by going sideways.
This shows the power of the 30-period moving average. If you wish to experiment, try inserting other moving averages -- such as the 10, 20 40 or 50-week -- into the chart. You will find they are not nearly as good at defining the trend and picking up on trendline breaks.
After that insight, I began to experiment with daily and intraday charts. To my delight, I found that the 30-period moving average consistently best defined the trend. That key discovery, when used along with the existing framework I had developed over a lifetime of technical analysis study, led me to create my own proprietary swing trading system.
I share this system with you as part of the commitment I made in my very first trading lesson -- to teach you everything that I know about technical analysis. Up until this time I have told only a few close friends about this discovery. And though I sent my five-part trading course free of charge to all trial subscribers, I've reserved this bonus report EXCLUSIVELY for long-term StreetAuthority Swing Trader subscribers. Before I share my system, however, I'd like to request that you not share this report with your friends or "trading buddies." It is meant for paid long-term subscribers only, and I hope it remains our secret.
The trading system involves four indicators: price relative to the S&P 500, MACD, the Bollinger band and full stochastics. Volume bars are included, as well as a number of moving averages. You could add additional indicators to this core group if you'd like, but they really are not necessary. The moving averages are the daily 150, 30, 20, 6 and 4.
Let me explain why I chose these specific "pieces" of the system. The 150-day moving average (equivalent to the 30-week) allows me to pinpoint the long-term trend for any given stock. If it is sloping downward and price is below the moving average, then the stock is in a stage IV decline and I believe the stock should be traded from the short side only. Countertrend rallies should be ignored. (If we are in a stage IV market, during the countertrend rallies you should instead buy long on stage I or stage II stocks).
The 30-day moving average defines a short- to intermediate-term trend. It is 20%, or 1/5, of the 150-day moving average. If we were to go short, we would want to find stocks whose 30-week moving average is above the 30-day moving average, with both moving averages sloping down and both still above the share price.
I've included the 20-period moving average in this system because it is the centerpoint of the Bollinger band, which I use as an overbought/oversold indicator. The 20- and 30-period moving averages also give me a crossover signal. (A crossover signal is generated when a shorter moving average cross over a long-term one, and visa versa.)
The final moving averages are the 6- and the 4-day, which for me define short-term swing trading trends. In conjunction, these two moving averages create vital crossover signals. The 6-day moving average is 20%, or 1/5, of the 30-day moving average. Meanwhile, the four-day moving average is a subtle way of tracking the hourly trend. Since there are 6.5 hours in a trading day (9:30 A.M. to 4:00 P.M., Eastern Standard Time), a 4-day moving average is approximately the same as a 30-hour moving average. Again, the two moving averages give crossover signals.
Stochastics is an oversold indicator. It will confirm and reinforce an oversold signal on the Bollinger band. MACD will give a later signal, confirming the stochastics buy or sell.
In one of my very first issues of the Swing Trader, I recommended a short trade on Teradyne (TER). The trade subsequently racked up a 13% gain in roughly one week. Below I've presented a three-month chart of TER from that time period. FYI -- I chose a 3-month period to ensure a very clear chart.
Note how the daily chart reproduces in miniature the four stages, which would be observable on the weekly. I find that observation fascinating. If you look closely, you will see that in a three-month period, TER completes several "miniature" four-stage cycles. I've labeled each of these in the chart above. Since TER is in a stage IV decline according to the 30-week moving average, every time the stock forms a "miniature stage" III top and breaks down from it, this creates an opportunity to sell short.
I'd like you to focus your attention on the miniature stage III top that occurred in early January. Note the following setup. First there was a gravestone doji candle. It occurred outside the Bollinger band and with stochastics overbought. TER then went sideways for four days. At the end of that period, note the large dark cloud cover candle followed by a hangman. (Again, I've labeled each of these on the chart.)
Immediately after the hangman, the 6-day moving average (magenta) negatively crossed through the 4-day (green). They penetrated the downward sloping 150, 30 and 20 on the next trading day as the shares sold off on high volume. Stochastics and MACD signals gave sell signals almost simultaneously. Support was also broken at $13.
After the 4- and 6-day moving averages crossed, they stayed in bearish alignment until mid-February when TER created a miniature stage I base. Just previous to the mid-February positive 4- and 6-day crossover, there were two dojis in three days, suggesting supply and demand had come into balance. Positive stochastics and MACD signals were also evident. Clearly, it was time to cover the short.
TER would NOT, however, in my system be traded long at this time, as it was below the downward sloping 30-week moving average and was therefore a stage IV stock at the time this chart was drawn. Instead, the alert swing trader would then be waiting for another miniature stage III top and breakdown, confirmed by the indicator signals, signaling that it was again time to short TER.
In today's Bonus Report for paid subscribers only -- "The Trading Technique That Will Always Keep You on the Right Side of the Market" -- I have shared with you some precious technical analysis secrets that I have discovered through years and years of patient study. Rest assured that I will continue to use these very same concepts each week to select stocks for my Swing Trader newsletter that have the capacity to make you money from both the short and long side. In addition, I will continue to share with you other key technical analysis ideas in my regular "Inside the Black Box" articles.
Thank you for once again for subscribing to my weekly newsletter -- the Swing Trader -- and best of success in the markets!
Dr. Melvin Pasternak
Editor
The StreetAuthority Swing Trader
StreetAuthority LLC
P.O. Box 83217
Gaithersburg, MD 20883-3217
USA
Saturday, September 22, 2007
Return on Equity (ROE)
What It Is:
Return on equity (ROE) is a measure of profitability that calculates how many dollars of profit a company generates with each dollar of shareholders' equity. The formula for ROE is:
ROE = Net Income/Shareholders' Equity
ROE is sometimes called return on net worth.
How It Works/Example:
Let's assume Company XYZ generated $10,000,000 in net income last year. If Company XYZ's shareholders' equity equaled $20,000,000 last year, then using the ROE formula, we can calculate Company XYZ's ROE as:
ROE = $10,000,000/$20,000,000 = 50%
This means that Company XYZ generated $0.50 of profit for every $1 of shareholders' equity last year, giving the stock an ROE of 50%.
Why It Matters:
ROE is more than a measure of profit; it's a measure of efficiency. A rising ROE suggests that a company is increasing its ability to generate profit without needing as much capital. It also indicates how well a company's management is deploying the shareholders' capital.
It is important to note that if the value of the shareholders' equity goes down, ROE goes up. Thus, write-downs and share buybacks can artificially boost ROE. Likewise, a high level of debt can artificially boost ROE; after all, the more debt a company has, the less shareholders' equity it has (as a percentage of total assets), and the higher its ROE is.
Some industries tend to have higher returns on equity than others. As a result, comparisons of returns on equity are generally most meaningful among companies within the same industry, and the definition of a "high" or "low" ratio should be made within this context.
Tuesday, September 18, 2007
What is Capitulation?
Capitulation:
Financial capitulation occurs when investors attempt to exit an investment or market so quickly that they are willing to surrender any and all gains to do so. Panicked behavior often causes a capitulation, and investors may attempt to liquidate most or all of their holdings in these circumstances.
How It Works/Example:
A capitulation frequently occurs after a security or a market has endured a long, downward slide in value; it is the final act of hitting bottom. There are four general signs a capitulation is occurring or has occurred.
Significant Changes in Trading Activity
Capitulations commonly involve unusually high trading volumes and price declines, typically over one or two trading days (although they can last longer).
High Levels of Cash Held by Mutual Funds
The presence of large numbers of investors attempting to exit the market by selling their mutual fund shares frequently compels mutual funds to hold high levels of cash in order to meet those demands.
Unusually High Derivatives Activity
Large increases in put purchases or option volatility indexes indicate that investors are either strongly betting against a market increase or are rapidly attempting to hedge against expected price declines.
Continued and Profound Negative Investor Sentiment
Capitulations are most frequently attributed to investors emotionally "giving up," rather than to external forces like changes in the fundamental outlook of a company. This negative investor sentiment may be the cause (or effect) of reaction and opinion communicated by the media, analysts, traders, or other investors.
Why It Matters:
Because capitulations generally reflect the final bottoming-out of a security or market, prices typically increase after a capitulation. Thus, capitulations can signal the beginning of a turnaround in a stock or market.
Financial capitulation occurs when investors attempt to exit an investment or market so quickly that they are willing to surrender any and all gains to do so. Panicked behavior often causes a capitulation, and investors may attempt to liquidate most or all of their holdings in these circumstances.
How It Works/Example:
A capitulation frequently occurs after a security or a market has endured a long, downward slide in value; it is the final act of hitting bottom. There are four general signs a capitulation is occurring or has occurred.
Significant Changes in Trading Activity
Capitulations commonly involve unusually high trading volumes and price declines, typically over one or two trading days (although they can last longer).
High Levels of Cash Held by Mutual Funds
The presence of large numbers of investors attempting to exit the market by selling their mutual fund shares frequently compels mutual funds to hold high levels of cash in order to meet those demands.
Unusually High Derivatives Activity
Large increases in put purchases or option volatility indexes indicate that investors are either strongly betting against a market increase or are rapidly attempting to hedge against expected price declines.
Continued and Profound Negative Investor Sentiment
Capitulations are most frequently attributed to investors emotionally "giving up," rather than to external forces like changes in the fundamental outlook of a company. This negative investor sentiment may be the cause (or effect) of reaction and opinion communicated by the media, analysts, traders, or other investors.
Why It Matters:
Because capitulations generally reflect the final bottoming-out of a security or market, prices typically increase after a capitulation. Thus, capitulations can signal the beginning of a turnaround in a stock or market.
Friday, May 4, 2007
Business related islamic questions
Q: Is it permissible to enter a competition, whereby the winner is chosen
from a box of mixed 'names' wrapped in paper? One condition is that the
enterant must purchase any of their products.
A:
Assalaamu `alaykum waRahmatullahi Wabarakatoh
In the name of Allah, Most Gracious, Most Merciful
If the product is sold at a fair market price, then any award given to a
particular purchaser is a voluntary gift for which one can draw a lot.
However, if the price is increased on the basis of an intended award by
drawing a lot, then this will be gambling and will not be permissible.
(Justice Mufti Taqi Usmani; Pakistan)
And Allah knows best
Question : Often customers forget their valuables on my premises. Many
months pass by without anyone claiming those valuables. What should be done
with them?
Answer:
Assalaamu `alaykum waRahmatullahi Wabarakatoh
In the name of Allah, Most Gracious, Most Merciful
Such items fall in the category of Luqta (lost items). If you are certain
that the owner will not return to claim his valuables, it can be given to
the poor and needy as charity on behalf of the owner. However, after giving
it in charity, if the owner returns to claim the item, you will be liable to
pay the owner. (Shaami vol.4 pg.279; Maktab Tijariyya)
And Allah knows best
Q: A person sold his business. Among the conditions of sale was that the
purchaser pay out all the creditors of the business. The creditors were not
consulted. Now that the new owner is insolvent and has not yet paid the
previous owner - who is responsible for those debts?
A:
Assalaamu `alaykum waRahmatullahi Wabarakatoh
In the name of Allah, Most Gracious, Most Merciful
According to Shari'ah, in order for the transfer (Hawala) of a debt to be
valid, besides the original owner of the business and purchaser, the
creditor(s) must also consent to the transfer of the debt. Since the
creditor(s) did not consent to the transfer of the debt, the previous owner
of the business is responsible for those debts. (Raddul Mukhtaar vol.4
pg.321; Kuwait)
And Allah knows best
Wassalam
Mufti Ebrahim Desai
Darul Iftaa, Madrassah In'aamiyyah
from a box of mixed 'names' wrapped in paper? One condition is that the
enterant must purchase any of their products.
A:
Assalaamu `alaykum waRahmatullahi Wabarakatoh
In the name of Allah, Most Gracious, Most Merciful
If the product is sold at a fair market price, then any award given to a
particular purchaser is a voluntary gift for which one can draw a lot.
However, if the price is increased on the basis of an intended award by
drawing a lot, then this will be gambling and will not be permissible.
(Justice Mufti Taqi Usmani; Pakistan)
And Allah knows best
Question : Often customers forget their valuables on my premises. Many
months pass by without anyone claiming those valuables. What should be done
with them?
Answer:
Assalaamu `alaykum waRahmatullahi Wabarakatoh
In the name of Allah, Most Gracious, Most Merciful
Such items fall in the category of Luqta (lost items). If you are certain
that the owner will not return to claim his valuables, it can be given to
the poor and needy as charity on behalf of the owner. However, after giving
it in charity, if the owner returns to claim the item, you will be liable to
pay the owner. (Shaami vol.4 pg.279; Maktab Tijariyya)
And Allah knows best
Q: A person sold his business. Among the conditions of sale was that the
purchaser pay out all the creditors of the business. The creditors were not
consulted. Now that the new owner is insolvent and has not yet paid the
previous owner - who is responsible for those debts?
A:
Assalaamu `alaykum waRahmatullahi Wabarakatoh
In the name of Allah, Most Gracious, Most Merciful
According to Shari'ah, in order for the transfer (Hawala) of a debt to be
valid, besides the original owner of the business and purchaser, the
creditor(s) must also consent to the transfer of the debt. Since the
creditor(s) did not consent to the transfer of the debt, the previous owner
of the business is responsible for those debts. (Raddul Mukhtaar vol.4
pg.321; Kuwait)
And Allah knows best
Wassalam
Mufti Ebrahim Desai
Darul Iftaa, Madrassah In'aamiyyah
Saturday, April 28, 2007
S&P launches Shariah-Compliant Indices for GCC
NEW YORK: Standard & Poor's, the world's leading index provider has announced the launch of a fully investable GCC Shariah Index in the Gulf and around the world.
The S&P GCC Shariah Series, which have been designed to capture the largest and most liquid stocks across the GCC, will pave the way for the creation of mutual funds, ETF's and structured products that will enhance liquidity and improve risk management across the Gulf's highly concentrated equity markets.
The new S&P indices for Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and United Arab Emirates Shariah include only those stocks, which comply with Shariah-law.
The company said a growing pool of petrodollars, high financial sophistication among Muslim investors, and a greater desire to invest in compliance with religious norms was fuelling the explosive growth of Islamic financial products.
Source = Geo.tv
The S&P GCC Shariah Series, which have been designed to capture the largest and most liquid stocks across the GCC, will pave the way for the creation of mutual funds, ETF's and structured products that will enhance liquidity and improve risk management across the Gulf's highly concentrated equity markets.
The new S&P indices for Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and United Arab Emirates Shariah include only those stocks, which comply with Shariah-law.
The company said a growing pool of petrodollars, high financial sophistication among Muslim investors, and a greater desire to invest in compliance with religious norms was fuelling the explosive growth of Islamic financial products.
Source = Geo.tv
Thursday, April 5, 2007
Business Ethics in Islam
Al Hud (Hud)
Chapter 11: Verses 84-85
"To the Madyan people (We sent) Shuaib, one of their own brethren: he said: "O my people! Worship Allah: you have no other god but Him. And give not short measure or weight: I see you in prosperity, but I fear for you the Penalty of a Day that will encompass (you) all round. "And O my people! give just measure and weight, nor withhold from the people the things that are their due: commit not evil in the land with intent to do mischief."
Prophet Shuaib was sent among a people who were very much involved in business. These people were very proud of their business knowledge and success, but they were dishonest. He told them to observe ethics in business. They became very angry with him and told him, "Don't mix religion with business." The Qur'an tells us that Allah's punishment came upon those people and only Prophet Shuaib and his followers were saved.
It is indeed serious that everyone must adhere to ethical standards in business. Business and ethics are not separate, rather they are interconnected. Prophet Muhammad (peace and blessings be upon him) was an ideal human being in every respect. He was a very honest and successful businessman.
Prophet Muhammad gave many teachings on business and economic issues, he covered almost every aspect of business and economics. Here are only a few major principles of fair business dealings according to Islam.
- No fraud or deceit, the Prophet is reported to have said, "When a sale is held, say, �There's no cheating�" (Al-Bukhari).
- Sellers must avoid making too many oaths when selling merchandise. The Prophet is reported to have said, "Be careful of excessive oaths in a sale. Though it finds markets, it reduces abundance" (Muslim).
- Mutual consent is necessary. The Prophet is reported to have said, "The sale is complete when the two involved depart with mutual consent" (Al-Bukhari).
- Be strict in regard to weights and measures. The Prophet is reported to have said, "When people cheat in weight and measures, their provision is cut off from them" (Al-Muwatta '). He told the owners of measures and weights, "You have been entrusted with affairs over which some nations before you were destroyed" (Al-Tirmidhi ).
- The Prophet forbade monopolies. "Whoever monopolizes is a sinner" (Abu Dawud ).
- Free enterprise, the price of the commodities should not be fixed unless there is a situation of crisis or extreme necessity.
- Hoarding merchandise in order to increase the prices is forbidden .
- Transaction of haram items, such as intoxicants, are forbidden.
Shares that were disallowed in March 2007 analysis
Shares that were disallowed in March 2007 analysis. Explanation is given below. It should be noted that you may consider the rules too strict / not strict enough for yourself:
Company Reason
SNGP E
SSGC E
LUCK E
TELE A & E
POL B
TRG B
PIOC E
JPGL E
PPTA E
AACIL E
HCAR E
ANL E
ANL
NCL E
ATRL C
APL B
DAWH B
DANC E
DANC
NRL B
PIAA E
BOSI E
NML E
DGKC E
CSAP E
WAZIR E
PNSC B
ATLH E
GTYR E
DSFL E
KOHW E
PCCL E
MTL B
GADT E
CRESCENT TEXTILE B & E
IBFL D & E
Reason Explanation
A Haram Income Ratio should be <5%
B Illiquid to Total Asset Ratio should be > 20%
C Liquid asset per share should be = to or less then the share price
D Investment in Non-Shariah Compliant Business Cap<33%
E Debt to Market Capitalization should be <45%
Most of the disallowed shares are due to reason E. But why Debt to Market Cap is used as opposed to Debt to Total Assets and why 45% and not 33% as in case of Reason D? And it is a bit more relaxed than the criteria posted on Al-meezan web site that was posted earlier (included at bottom of the e-mail). So it is again upto the individual to figure out what he/she feels comfortable with. In the end it is not Taqi Usmani or any other mujtahid who will be responsible. It will be u!!!
Source: A very Good Friend, Meezan Bank Websit
Shariah / Sharya Compliant Trading
In an equity or mutual fund (unit trust) the amounts are invested in the shares of joint stock companies. The profits are mainly derived through the capital gains by purchasing the shares and selling them when their prices are increased. Profits are also earned through dividends distributed by the relevant companies. From this angle, dealing in equity shares can be acceptablein Shariah subject to the following conditions:
1. The main business of the company does not violate Shariah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shariah, eg. companies manufacturing, selling or offering liquor, pork, haram meat, or involved in gambling, night club activities, pornography, prostitution, or involved in the business of hire purchase or interest etc.
2. If the main business of these companies is halal, like automobiles, textile, etc. but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company.
3. If some income from interest-bearing accounts or non-Halal activities is included in the income of the company, the proportion of such income should not exceed 5% of the total income. If it exceeds 5%, it is not permissible to invest in that company. However, if it does not exceed 5%, it must be given in charity, and must not be retained by him. For example, if 5% of the whole income of a company has come out of interest-bearing deposits, 5% of the dividend
must be given in charity. Moreover, the company's total short term and long term investment in non-permissible business should not exceed 30% of the company's total market capitalization.
{It may be questioned "What is the basic rationale of this limitation of 5%?" Infact, there is no specific basis derived from the Holy Quran or Sunnah for the 5% rule of non halal (impermissible) income. However, this is only the collective outcome (consensus) or ijtihad
of contemporary Shariah Scholars. To explain this consensus of their ruling, we shall have to go back to the origin or basis of company on Shariah perspective. As mentioned in the books and research papers of Islamic jurists, companies come under the ruling of Shirkatul Ainan. But if the rule of partnership is truly applied in a company, there is no possibility for any kind of impermissible activity or income. Because every shareholder of a company is a sharik (partner) of the company, and every sharik, according to the Islamic jurisprudence, is an agent of the other partners in matters of joint business. Therefore, the mere purchase of a share of a company embodies an authorization from the shareholder to the company to carry on its business in whatever manner the management deems fit. If it is known to the shareholder that the company is involved in an un-Islamic transaction, and he continues to hold the shares of that company, it means that he has authorized the management to proceed with that un-Islamic transaction. In this case, he will not only be responsible for giving his consent to an un-Islamic transaction, but that transaction will also be rightfully attributed to himself, because the management of the company is working under his tacit authorization.
However, a large number of Shariah Scholars say that Joint Stock Company is basically different from a simple partnership. In partnership, all the policy decisions are taken through the consensus of all partners, and each one of them has a veto power with regard to the policy of the business. Therefore, all the actions of a partnership are rightfully attributed to each partner. Conversely, the majority takes the policy decisions in a joint stock company. Being composed of a large number of shareholders, a company cannot give a veto power to each shareholder. The opinions of individual shareholders can be overruled by a majority decision. Therefore, each and every action taken by the company cannot be attributed to every shareholder in his individual capacity. If a shareholder raises an objection against a particular transaction in an Annual General Meeting, but his objection is overruled by the majority, it will not be fair to conclude that he has given his consent to that transaction in his individual capacity, especially when he intends to refrain from the income resulting from that transaction. Therefore, if a company is engaged in a halal (permissible) business, but also keeps its surplus money in an interest-bearing account, wherefrom a small incidental income of interest is received, it does not render all the business of the company unlawful. Now, if a person acquires the shares of such a company with clear intention that he will oppose this incidental transaction also, and will not use that proportion of the dividend for his own benefit, then it cannot be said that he has approved the transaction of interest and hence that transaction should not be attributed to him. In short, the matter of traditional partnership is different from the partnership of company in this aspect. Therefore if a very small amount of income is earned through these means despite of his disapproval, then his trade in shares would be permissible with the condition that, he shall have to purify that proportion of income by giving it to charity. Now a question could be raised as to what extent or what limit that income would be forgone. Definitely, this matter could not be left on decisions or opinions of lay men, therefore, it was resolved through the consensus of proficient Shariah Scholars that the limit of impermissible income should not exceed 5% of the total income}
4. The leverage or debt to equity ratio of the company should not exceed 30%. To explain the rationale behind this condition, it should be kept in mind that, such companies sometimes borrow money from financial institutions that are mostly based on interest. Here again the afore mentioned principle applies i.e. if a shareholder is not personally agreeable to such borrowings, but has been overruled by the majority, these borrowing transactions cannot be attributed to him. Moreover, even though according to the principles of Islamic jurisprudence, borrowing on interest is a grave and sinful act, for which the borrower is responsible in the Hereafter; but, this sinful act does not render the whole business of the borrower as Haram (impermissible). It is explained in the conventional books of Islamic jurisprudence that the contract of loan is among those, that are called "Uqood Ghair Muawadha" (Non compensatory contracts), therefore, no void condition such as condition of interest can be stipulated. However, if such a condition has been stipulated, the condition itself is void, but it will not invalidate the contract. Since, the contract remains valid despite of void condition, the borrowed amount would be permissible to use and it would be recognized as owned by the borrower. Hence, anything purchased in exchange for that money would not be unlawful. However, the responsibility of committing the sinful act of borrowing on interest rests on the person who willfully indulges in such a transaction but this does not render his entire business as unlawful. But it should also be remembered that the extent of investment in shares of companies, that involve borrowing should be limited. Can this limit be the same as the 5% limit that is applied to interest income? No, because in this case this activity does not affect the income of the company, it is less severe than interest based income, therefore, Shariah scholars and Islamic jurists extended the limit (from 5% which is limit of interest/impermissible income) to 30%. The basis of 30% is that the 30% is less than one third (1/3rd) of the total asset of the company and one third has been considered abundant by the following Hadith of the Holy prophet (SAW) "One third is big or abundant" (Tirmizy). Hence whatever is less than one third, would be insignificant. Therefore to avoid the majority or abundance specified in the hadith, such limit is fixed at less than one third of the total asset of the company.
5. The shares of a company are negotiable only if the company owns some illiquid assets. If all the assets of a company are in liquid form, i.e. in the form of money they cannot be purchased or sold except at par value, because in this case the share represents money only and the money cannot be traded in except at par. What should be the exact proportion of illiquid assets of a company for warranting the negotiability of its shares? The contemporary scholars have different views about this question. Some scholars are of the view that the ratio of illiquid assets must be 51% in the least. They argue that if such assets are less than 50%, then most of the assets are in liquid form, and therefore, all its assets should be treated as liquid on the basis of the juristic principle: The majority deserves to be treated as the whole thing. Some other scholars are of the view that even if the illiquid asset of a company is 33%, its shares can be treated as negotiable. The basis of this view is a well-known Hadith that means "One third is big or abundant" (Tirmizy).
They say that according to the Hadith one-third illiquid assets will be considered as sufficient or abundant for this purpose. The third view (of the scholars of the sub continent of Pakistan and India) is based on the Hanafi jurisprudence. The principle of the Hanafi School is that whenever an asset is a combination of liquid and illiquid assets, it can be negotiable irrespective of the proportion of its liquid part. However, this principle is subject to two conditions:
A. The illiquid part of the combination must not be in insignificant quantity. It means that it should be in a considerable proportion.
B. The price of the combination should be more than the value of the liquid amount contained therein. For example, if a share of 100 dollars represents 75 dollars, plus some fixed assets, the price of the share must be more than 75 dollars. In this case, if the price of the share is fixed at 105, it will mean that 75 dollars are in exchange of 75 dollars owned by the share and the balance of 30 dollars is in exchange of the fixed assets. Conversely, if the price of that share is fixed at 70 dollars, it will not be allowed, because the 75 dollars owned by the share are in this case against an amount which is less than 75. This kind of exchange falls within the definition of 'riba' and is not allowed. Similarly, if the price of the share, in the above example, is fixed at 75 dollars, it will not be permissible, because if we presume that 75 dollars of the price are against 75 dollars owned by the share, no part of the price can be attributed to the fixed assets owned by the share. Therefore, some part of the price (75 dollars) must be presumed to be in exchange of the fixed assets of the share. In this case, the remaining amount will not be adequate for being the price of 75 dollars. For this reason the transaction will not be valid. However, in practical terms, this is merely a theoretical possibility, because it is difficult to imagine a situation where the price of a share goes lower than its liquid assets.
Among the three different views mentioned above, the most conservative view is the first one. Therefore, nowadays that has been adopted by the majority of Shariah boards of Islamic mutual funds or in screening of the Islamic stocks methodology.
Conclusion:
The purchase and sale of shares is permissible in Shariah. An Islamic Equity Fund can be established on this basis. The subscribers to the Fund will be treated in shari'ah as partners inter se. All the subscription amounts will form a joint pool and will be invested in purchasing the shares of different companies. The profits can accrue either through dividends distributed by the relevant companies or through the appreciation in the prices of the shares. In the first case i.e. where the profits are earned through dividends, a certain proportion of the dividend, which corresponds to the proportion of interest earned by the company, must be given in charity. The contemporary Islamic Funds have termed this process as 'purification'.
Some scholars are of the view that even in the case of capital gains, the process of 'purification' is necessary, because the market price of the share may reflect an element of interest included in the assets of the company. The method of purification adopted by Dow Jones Islamic market Index are in favor of this view.
As we have discussed above for the negotiability of the share, it is essential for the share or securities that they represent more than 55% illiquid assets. If a mutual fund has 10% cash and 90% shares, we shall have to see how much of these shares represent fixed assets. Fixed assets include land, equipment, machinery and leased assets. If these shares represent more than 55% of fixed or illiquid assets, such shares or Musharkah certificates of mutual fund can be negotiated at other than par value as well. Sale of option short sale, future sale and forward sale where some principles of Shariah are lacking are not permissible...
1. The main business of the company does not violate Shariah. Therefore, it is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shariah, eg. companies manufacturing, selling or offering liquor, pork, haram meat, or involved in gambling, night club activities, pornography, prostitution, or involved in the business of hire purchase or interest etc.
2. If the main business of these companies is halal, like automobiles, textile, etc. but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company.
3. If some income from interest-bearing accounts or non-Halal activities is included in the income of the company, the proportion of such income should not exceed 5% of the total income. If it exceeds 5%, it is not permissible to invest in that company. However, if it does not exceed 5%, it must be given in charity, and must not be retained by him. For example, if 5% of the whole income of a company has come out of interest-bearing deposits, 5% of the dividend
must be given in charity. Moreover, the company's total short term and long term investment in non-permissible business should not exceed 30% of the company's total market capitalization.
{It may be questioned "What is the basic rationale of this limitation of 5%?" Infact, there is no specific basis derived from the Holy Quran or Sunnah for the 5% rule of non halal (impermissible) income. However, this is only the collective outcome (consensus) or ijtihad
of contemporary Shariah Scholars. To explain this consensus of their ruling, we shall have to go back to the origin or basis of company on Shariah perspective. As mentioned in the books and research papers of Islamic jurists, companies come under the ruling of Shirkatul Ainan. But if the rule of partnership is truly applied in a company, there is no possibility for any kind of impermissible activity or income. Because every shareholder of a company is a sharik (partner) of the company, and every sharik, according to the Islamic jurisprudence, is an agent of the other partners in matters of joint business. Therefore, the mere purchase of a share of a company embodies an authorization from the shareholder to the company to carry on its business in whatever manner the management deems fit. If it is known to the shareholder that the company is involved in an un-Islamic transaction, and he continues to hold the shares of that company, it means that he has authorized the management to proceed with that un-Islamic transaction. In this case, he will not only be responsible for giving his consent to an un-Islamic transaction, but that transaction will also be rightfully attributed to himself, because the management of the company is working under his tacit authorization.
However, a large number of Shariah Scholars say that Joint Stock Company is basically different from a simple partnership. In partnership, all the policy decisions are taken through the consensus of all partners, and each one of them has a veto power with regard to the policy of the business. Therefore, all the actions of a partnership are rightfully attributed to each partner. Conversely, the majority takes the policy decisions in a joint stock company. Being composed of a large number of shareholders, a company cannot give a veto power to each shareholder. The opinions of individual shareholders can be overruled by a majority decision. Therefore, each and every action taken by the company cannot be attributed to every shareholder in his individual capacity. If a shareholder raises an objection against a particular transaction in an Annual General Meeting, but his objection is overruled by the majority, it will not be fair to conclude that he has given his consent to that transaction in his individual capacity, especially when he intends to refrain from the income resulting from that transaction. Therefore, if a company is engaged in a halal (permissible) business, but also keeps its surplus money in an interest-bearing account, wherefrom a small incidental income of interest is received, it does not render all the business of the company unlawful. Now, if a person acquires the shares of such a company with clear intention that he will oppose this incidental transaction also, and will not use that proportion of the dividend for his own benefit, then it cannot be said that he has approved the transaction of interest and hence that transaction should not be attributed to him. In short, the matter of traditional partnership is different from the partnership of company in this aspect. Therefore if a very small amount of income is earned through these means despite of his disapproval, then his trade in shares would be permissible with the condition that, he shall have to purify that proportion of income by giving it to charity. Now a question could be raised as to what extent or what limit that income would be forgone. Definitely, this matter could not be left on decisions or opinions of lay men, therefore, it was resolved through the consensus of proficient Shariah Scholars that the limit of impermissible income should not exceed 5% of the total income}
4. The leverage or debt to equity ratio of the company should not exceed 30%. To explain the rationale behind this condition, it should be kept in mind that, such companies sometimes borrow money from financial institutions that are mostly based on interest. Here again the afore mentioned principle applies i.e. if a shareholder is not personally agreeable to such borrowings, but has been overruled by the majority, these borrowing transactions cannot be attributed to him. Moreover, even though according to the principles of Islamic jurisprudence, borrowing on interest is a grave and sinful act, for which the borrower is responsible in the Hereafter; but, this sinful act does not render the whole business of the borrower as Haram (impermissible). It is explained in the conventional books of Islamic jurisprudence that the contract of loan is among those, that are called "Uqood Ghair Muawadha" (Non compensatory contracts), therefore, no void condition such as condition of interest can be stipulated. However, if such a condition has been stipulated, the condition itself is void, but it will not invalidate the contract. Since, the contract remains valid despite of void condition, the borrowed amount would be permissible to use and it would be recognized as owned by the borrower. Hence, anything purchased in exchange for that money would not be unlawful. However, the responsibility of committing the sinful act of borrowing on interest rests on the person who willfully indulges in such a transaction but this does not render his entire business as unlawful. But it should also be remembered that the extent of investment in shares of companies, that involve borrowing should be limited. Can this limit be the same as the 5% limit that is applied to interest income? No, because in this case this activity does not affect the income of the company, it is less severe than interest based income, therefore, Shariah scholars and Islamic jurists extended the limit (from 5% which is limit of interest/impermissible income) to 30%. The basis of 30% is that the 30% is less than one third (1/3rd) of the total asset of the company and one third has been considered abundant by the following Hadith of the Holy prophet (SAW) "One third is big or abundant" (Tirmizy). Hence whatever is less than one third, would be insignificant. Therefore to avoid the majority or abundance specified in the hadith, such limit is fixed at less than one third of the total asset of the company.
5. The shares of a company are negotiable only if the company owns some illiquid assets. If all the assets of a company are in liquid form, i.e. in the form of money they cannot be purchased or sold except at par value, because in this case the share represents money only and the money cannot be traded in except at par. What should be the exact proportion of illiquid assets of a company for warranting the negotiability of its shares? The contemporary scholars have different views about this question. Some scholars are of the view that the ratio of illiquid assets must be 51% in the least. They argue that if such assets are less than 50%, then most of the assets are in liquid form, and therefore, all its assets should be treated as liquid on the basis of the juristic principle: The majority deserves to be treated as the whole thing. Some other scholars are of the view that even if the illiquid asset of a company is 33%, its shares can be treated as negotiable. The basis of this view is a well-known Hadith that means "One third is big or abundant" (Tirmizy).
They say that according to the Hadith one-third illiquid assets will be considered as sufficient or abundant for this purpose. The third view (of the scholars of the sub continent of Pakistan and India) is based on the Hanafi jurisprudence. The principle of the Hanafi School is that whenever an asset is a combination of liquid and illiquid assets, it can be negotiable irrespective of the proportion of its liquid part. However, this principle is subject to two conditions:
A. The illiquid part of the combination must not be in insignificant quantity. It means that it should be in a considerable proportion.
B. The price of the combination should be more than the value of the liquid amount contained therein. For example, if a share of 100 dollars represents 75 dollars, plus some fixed assets, the price of the share must be more than 75 dollars. In this case, if the price of the share is fixed at 105, it will mean that 75 dollars are in exchange of 75 dollars owned by the share and the balance of 30 dollars is in exchange of the fixed assets. Conversely, if the price of that share is fixed at 70 dollars, it will not be allowed, because the 75 dollars owned by the share are in this case against an amount which is less than 75. This kind of exchange falls within the definition of 'riba' and is not allowed. Similarly, if the price of the share, in the above example, is fixed at 75 dollars, it will not be permissible, because if we presume that 75 dollars of the price are against 75 dollars owned by the share, no part of the price can be attributed to the fixed assets owned by the share. Therefore, some part of the price (75 dollars) must be presumed to be in exchange of the fixed assets of the share. In this case, the remaining amount will not be adequate for being the price of 75 dollars. For this reason the transaction will not be valid. However, in practical terms, this is merely a theoretical possibility, because it is difficult to imagine a situation where the price of a share goes lower than its liquid assets.
Among the three different views mentioned above, the most conservative view is the first one. Therefore, nowadays that has been adopted by the majority of Shariah boards of Islamic mutual funds or in screening of the Islamic stocks methodology.
Conclusion:
The purchase and sale of shares is permissible in Shariah. An Islamic Equity Fund can be established on this basis. The subscribers to the Fund will be treated in shari'ah as partners inter se. All the subscription amounts will form a joint pool and will be invested in purchasing the shares of different companies. The profits can accrue either through dividends distributed by the relevant companies or through the appreciation in the prices of the shares. In the first case i.e. where the profits are earned through dividends, a certain proportion of the dividend, which corresponds to the proportion of interest earned by the company, must be given in charity. The contemporary Islamic Funds have termed this process as 'purification'.
Some scholars are of the view that even in the case of capital gains, the process of 'purification' is necessary, because the market price of the share may reflect an element of interest included in the assets of the company. The method of purification adopted by Dow Jones Islamic market Index are in favor of this view.
As we have discussed above for the negotiability of the share, it is essential for the share or securities that they represent more than 55% illiquid assets. If a mutual fund has 10% cash and 90% shares, we shall have to see how much of these shares represent fixed assets. Fixed assets include land, equipment, machinery and leased assets. If these shares represent more than 55% of fixed or illiquid assets, such shares or Musharkah certificates of mutual fund can be negotiated at other than par value as well. Sale of option short sale, future sale and forward sale where some principles of Shariah are lacking are not permissible...
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