Islamic Shariah classification of Mutual Funds in India

The fact that you have searched for this article is that you have doubt on the shariah compliance of MF's in India.
I have already discussed Shariah Compliant MF's in India.

Tip: Whenever you want to check a fund, just head to moneycontrol.com and search for the fund name in Mutual Funds. On opening the fund details, click Portfolio and it will show all details of where it is invested.

First an Islamic classification of MF is necessary for them to be categorized as permissible or not.

Based on duration, they can be classified as

• Open-ended
• Close-ended

Close-ended are always Haram since they have significant interest component.

Classification based on investment type is what we need to analyze here. I have added as many keywords as I could in the classification since there are several marketing words in the funds name.:

1. Equity (Stocks) based
1. Normal Equity - Diversified, Big/Mid/Low Cap
2. Equity Linked Saving Scheme (ELSS)/ Tax Saving
3. RGESS/ Tax Saving
4. Index
5. Sectoral/ Thematic
6. Arbitrage
2. Debt (Interest) based
1. Long/ Medium/ Short/ Ultra short
2. Bonds
3. Gilt /Treasury/ G-Sec
4. Money Market/ Liquid
3. Mixed or Balanced or Hybrid
1. Pension/ Retirement Plans
2. Income
3. Debt/ Equity oriented
4. Commodities/ ETF
5. Fund of Funds
1. International
2. Indian

First we target the easy ones:
#2 (Debt/ Money Market) and #3 (Hybrid/ Balanced) are clearly 100% Interest based earnings and hence nothing to discuss on them. Even if they say "equity oriented" they will still have significant interest component.

#4 (Commodities/ ETF) is based on metals or gold or other commodities. As per Islamic law, you have to first take physical possession of goods before selling. In these cases you never get the goods nor are you aware if even the Mutual Fund has taken physical delivery of goods.

#5 (Fund of Funds) is based on other Mutual Funds in that they buy portion of other Mutual Funds. Because of this it becomes very difficult to analyze where the money is invested and hence should be avoided.
I will inshallah research more on them and cover in a future post.

Gold ETF and Gold Mutual Funds are already covered in this article:
Halal Ways of Investment in Gold

Equity Funds:

1. Normal Equity - Diversified, Big/Mid/Low Cap
2. Equity Linked Saving Scheme (ELSS)/ Tax Saving
3. RGESS/ Tax Saving
4. Index
5. Sectoral/ Thematic
6. Arbitrage

#1, #2, #3, #4 all will have significant investments in stocks of haram sectors (banking/ finance/ alcohol/ tobacco, media) around 25% - 40%.

#6 is arbitrage which is haram (arbitrage is kind of a daily betting)

#5 maybe considered somewhat permissible but there are some red flags obviously. First the sector has to be proper (Banking/Finance is obviously not useful). However, if you take Technology, then the problem comes that they earn most of the revenue working on IT for finance/banking projects. For Infrastructure, the problem will come that the stocks are all heavily into debt and are paying large amounts as interest.

Shariah Compliant Mutual Funds in India: Are they really Islamic?

Update (30-Dec-2016): Adding Fund Performance section.

Most people (including Muslims), are not really aware of Mutual Funds (MF). Many literate people might have heard it but few would have invested after some investigation in the fund.

I am not discussing MF details; there are plenty of articles out there to explain it. Also a general islamic classification of MF's is discussed here: Islamic Shariah classification of Mutual Funds in India
In this article we only discuss the halal status of Mutual Funds who declare themselves as Shariah based.

Summary

For those who need quick answers, here is a list of shariah compliant MF's in India:

1. Tauras Ethical Fund: Much better than other MF but Not 100%. 
2. Tata Ethical Fund: Likely to be valid.
3. SBI Shariah Equity Fund: Never launched.
4. Goldman Sachs CNX Nifty Shariah BeES Equity Fund; It self declares not 100% shariah based

There are only 2 Shariah based Mutual funds in India (note Goldman Sachs is ETF, not MF). Now we discuss in detail about them.

What makes them Shariah based

Most primary thing that makes them Shariah based is they follow a Shariah stock index S&P Shariah or CNX Shariah). What this index is and what stocks it contains will be a separate discussion. Some of its characteristic:

1. Investing in islamically legal business companies.
2. Debt is not high.
3. Interest income is very low.

Other characteristic:

1. Long term investment.
2. No short-selling or day trading which is same as betting.
3. No liquid investment in interest bearing components.
4. No lending of MF assets.
5. No investment in other mutual funds.
6. No investment in any derivatives.

Fund Details

These are equity funds but no tax saving. There is no entry load; no exit load if withdrawn after a year; trail commission 1.5 to 2.5%.

Performance is good enough for long term.

Tauras Ethical Fund: 

It invest based on stocks as present in S&P BSE 500 Shariah index. If you consider the S&P Shariah index to be 100% halal, then this fund will be fine. However, the index definitely contains stocks of companies that have upto 30% debt or 5% interest income and the fund does nothing about it. All this is clearly mentioned in the Scheme Information Document. And this is the problem with the fund.

Tata Ethical Fund:

This fund invests in stocks based on the CNX Shariah 500 Index. As a result, it suffers from the same problem as that of Tauras Ethical Fund. However, it does one thing important: Purification.

Once the Mutual Fund has earned profit, it calculates any non-legal income from Interest and donates to charity and you only get the actual profit.

Because of this am tempted to say that this could be the only halal MF. Only thing am not sure how they deal with stocks of companies that have taken loans.

Fund Performance:

It is important to also see if your investment is giving your profit or loss. Else you would be better off not investing at all.
Performance of all 3 Funds is below average compared to other Equity Funds.
They are not making loss but the profit is very small about 10-13% over 3 years. This obviously is far less than inflation. But this is the state of most halal investments; the returns are very less.
Perhaps this is the test of Allah, most haram investments will give excellent returns.

Concluding Notes

• If you are determined to invest in MF then Tata Ethical Fund can be considered.
• SBI Shariah fund that was to be launched with tax saving but did not see the light of the day.
• Goldman Sachs CNX Nifty Shariah Index Exchange Traded Fund itself truthfully declares that although they follow a Shariah based stock index they are not completely shariah compliant. This can be found in its Scheme Information Document.