What is a Halal ETF, and how is it different from a Conventional ETF?
I asked this question on this platform sometime in March for enlightenment purposes, but I didn’t get an answer—probably due to oversight.
I recently decided to look into it myself, and I thought it might be useful to share what I have learned, especially for anyone else who may not be familiar with the concept.
First, what is an ETF?
ETF stands for Exchange-Traded Fund.
Simply put, an ETF is a fund that holds a collection of assets—such as shares of different companies—and allows investors to buy units of that entire basket through the stock market.
For example, instead of buying shares in 50 different companies individually, you could buy one ETF that tracks an index containing those 50 companies.
So, what is a Halal ETF?
A Halal ETF is an exchange-traded fund whose underlying investments are selected and managed according to Islamic (Shariah) investment principles.
The ETF structure itself is not necessarily “Islamic” or “non-Islamic.” What makes an ETF halal is primarily the assets it holds and the rules used to select and manage those assets.
Halal ETFs generally exclude businesses whose primary activities are considered prohibited under Islamic principles, such as:
– Conventional banking and interest-based financial services
– Alcohol production and sales
– Gambling and betting
– Pork-related businesses
– Adult entertainment
– Certain other prohibited activities
In addition to screening the nature of the business, Shariah-compliant ETFs generally apply financial-ratio screens to avoid companies whose levels of interest-bearing debt, interest income, or other non-compliant financial activities exceed specified thresholds.
Some Shariah-compliant funds may also have a process for dealing with small amounts of non-compliant income, commonly referred to as purification.
How is it different from a conventional ETF?
The biggest difference is the investment criteria.
A conventional ETF can generally invest in companies according to its stated investment objective without applying Shariah restrictions.
A halal ETF adds another layer of screening: “Is this company and its financial structure permissible under the applicable Shariah methodology?”
For example:
Conventional ETF:
May hold a broad basket containing conventional banks, alcohol companies, gambling companies, technology companies, energy companies, manufacturers, etc., depending on the index it tracks.
Halal ETF:
Would screen out companies involved in prohibited activities and apply additional Shariah financial screens to the companies that remain.
A simple way to think about it
Imagine two supermarkets.
The conventional supermarket stocks products according to normal commercial and regulatory considerations.
The halal supermarket also follows those considerations, but has an additional rule: certain products cannot be stocked because they don’t meet its religious requirements.
The same basic concept applies to ETFs.
Does “Halal ETF” mean the investment is guaranteed to make money?
Absolutely not.
“Halal” refers to Shariah compliance, not profitability or safety.
A halal ETF can still lose money because the underlying shares can fall in value. It can also experience volatility just like conventional ETFs.
Similarly, two halal ETFs can have very different levels of risk depending on what they invest in, the countries they cover, their sector concentration, fees, and the index they track.
One important point
Not every ETF marketed as “Islamic” or “Shariah-compliant” necessarily follows exactly the same methodology.
Different Shariah boards, index providers and fund managers may use somewhat different screening criteria.
Therefore, before investing, it is worth checking:
1. What index does the ETF track?
2. Who performs the Shariah screening?
3. What sectors are excluded?
4. What financial-ratio thresholds are used?
5. Does the fund have a purification policy?
6. What are the management fees and other costs?
7. What are the risks and historical performance?
8. Which Shariah board or scholars oversee/approve the methodology?
In summary
ETF describes the investment vehicle.
Halal/Shariah-compliant describes the rules governing the investments inside that vehicle.
So, a halal ETF is essentially an ETF that applies Shariah-based investment screens to the assets it holds.
The important distinction is therefore not simply:
«”ETF vs Halal ETF”»
but rather:
«”ETF following conventional investment criteria vs ETF following Shariah-compliant investment criteria.”»
I am sharing this primarily for financial education and enlightenment, not as an investment recommendation.
If anyone with expertise in Islamic finance, Shariah-compliant investing or ETFs notices anything that needs correction or further clarification, I would genuinely appreciate the contribution. It would be useful for everyone on the platform.
This is a very good explanation. One point I would add is that simply seeing “Islamic” or “Shariah” in an ETF’s name should not be enough to conclude that it is halal. The actual screening methodology matters. For example, imagine an ETF holds 100 companies. A conventional ETF may include banks, insRead more
This is a very good explanation. One point I would add is that simply seeing “Islamic” or “Shariah” in an ETF’s name should not be enough to conclude that it is halal. The actual screening methodology matters.
For example, imagine an ETF holds 100 companies. A conventional ETF may include banks, insurance companies, alcohol producers, technology companies, manufacturers and oil companies, depending on the index it tracks.
A Shariah-compliant ETF might remove the conventional banks, alcohol and gambling companies, then apply financial screens to the remaining companies. For instance, a company may have a perfectly halal business but still fail the screening if its interest-bearing debt or non-compliant income exceeds the methodology’s permitted threshold.
Another important point is that Shariah compliance and investment performance are two different questions.
Suppose I invest ₦500,000 in a halal ETF and, after one year, the underlying companies perform poorly. My investment could fall to ₦400,000. The investment can still be Shariah-compliant even though I lost ₦100,000.
Likewise, a conventional ETF could return 20% while a halal ETF returns 8%. Higher returns do not automatically make the conventional ETF preferable for someone whose investment decisions must follow Shariah principles.
I also agree strongly with the point about checking the methodology. Before investing, I would want to know who performs the Shariah screening, what financial ratios they use, who the Shariah scholars are, how purification is handled, what index is being tracked, and what fees are charged.
So, in my view, the right question isn’t just, “Is this ETF halal?”
It should be:
“Why is this ETF considered Shariah-compliant, who determined that, and what exactly are the rules being applied?”
That gives the investor a much better basis for making an informed decision.
See lessThank you very much sir, this is really insightful 👏
Thank you very much sir, this is really insightful 👏
See lessA Halal ETF is like choosing what to stock in Mama Ngozi's store. Let me explain.Imagine Mama Ngozi is setting up her provision store. She decides to only stock items that meet certain rules - no alcohol, no pork, nothing related to gambling, and nothing against her religious beliefs. This is similaRead more
A Halal ETF is like choosing what to stock in Mama Ngozi’s store. Let me explain.
Imagine Mama Ngozi is setting up her provision store. She decides to only stock items that meet certain rules – no alcohol, no pork, nothing related to gambling, and nothing against her religious beliefs. This is similar to a Halal ETF, which only includes investments that follow Islamic (Shariah) principles.
On the other hand, a conventional ETF is like a regular store without any restrictions. They can stock anything from banks to alcohol companies to technology firms without considering specific guidelines.
So, the big difference here is the investment criteria. A Halal ETF has extra rules that limit what can be included based on Islamic principles, while a conventional ETF can invest in a wider range of companies without those restrictions.
Just like in Mama Ngozi’s store, where she carefully chooses what products to sell, a Halal ETF also carefully selects which companies to include based on Shariah-compliant guidelines. This adds an extra layer of screening to ensure the investments align with Islamic beliefs.
Remember, choosing a Halal ETF does not guarantee profits. Just like Mama Ngozi’s store can face risks like market competition or changes in consumer preferences, investments in a Halal ETF can also experience volatility and losses depending on market conditions.
Before deciding to invest in a Halal ETF, it’s essential to understand the specific screening criteria, the sectors excluded, fees involved, historical performance, and the overseeing Shariah board. This way, you can make informed decisions that align with your beliefs and financial goals.
In summary, a Halal ETF follows Islamic investment guidelines, while a conventional ETF operates without these specific restrictions. Just like Mama Ngozi carefully curates her store inventory, a Halal ETF selects investments that comply with Shariah principles. Remember, understanding the rules and risks involved is crucial before diving into any investment opportunity.
If you need more explanation, let me know!
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