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What is an ETF?

What is an ETF and does it have a place as a sharia-compliant Islamic investment? This was a recent topic of discussion with an old friend so I thought I would pen a few words as I realised we had not really touched on it.

At IFG, we’re big on breaking what seem like complex financial topics into simple language so that you are empowered to make your own decisions and benefit economically. ETFs seem like a foreign world, but they are actually really quite simple.

What an ETF is

It stands for an exchange-traded fund. Let’s break that down from back to front.

The ‘fund’ part of it is simply because it is a collection of money which is managed by a fund manager. The fund manager will make decisions about how to allocate the collective pot of money which all the investors have put in, with the idea being that if the collective whole is successful, your portion of that fund will see a positive return.

The exchange-traded bit of it means that the fund is listed on a stock exchange. This seems a bit confusing at first because one normally associates individual companies being listed, not funds. But funds can and do exist on the stock market, and you can buy them much in the same way as you would buy an individual company. The difference is obviously that you aren’t buying an individual company’s shares when you buy into an ETF, you are buying a portion of the collective fund. If the fund performs successfully, the traded price of the fund will inevitably rise with it, and you will therefore be able to sell you shares of the ETF back to the market at a higher price.

What goes into an ETF?

You will find all types of ETF on the market. For instance, you will find some ETFs specifically focussed on one type of thing – for example, gold. The fund manager will buy into what he or she deems to be good exposure to gold – that might be gold miners, explorers, actual physical gold, etc. Other ETFs might be focussed on ethical investments – they will be investing in companies that fit their criteria of being ethical; some ETFs have small cap exposure, international exposure, etc.

Many ETFs simply track an index. That means that the ETF holds all the companies in the FTSE100, for example, and thus it essentially becomes a tracker of the FTSE100. This is a really good way to track global indices: some ETFs will for example buy a selection of stocks from lots of different parts of the world thus giving you good global exposure. We’ll discuss the sharia-compliance aspect towards the end.

The benefits

The most obvious benefit is that you can choose an ETF based on a macro theme. For instance, let’s say you know you want exposure to commodities, you can simply hone in on ETFs that are focussed on that. You don’t have to worry about picking individual companies and you can leave that down to the expertise of the fund manager.

More than this, because the ETF has a sizeable pot of money, it has investments open to it that won’t be open to you. For instance, a fund manager might invest in unlisted companies, or other types of investments that wouldn’t be open to you as an individual but are open to the fund manager with the money that they have at their disposal and the contacts and networks in which they operate. So buying into an ETF potentially gives you some exposure into areas you would otherwise not be able to access.

A further benefit is that you can leave your investment well alone. This is great for the more passive investors who do not want to be checking stock exchange news every day to keep up to speed with their individual stocks portfolio. You are outsourcing management of your investment to a fund manager and nothing is needed from you.

Lastly, diversification is an obvious benefit to ETFs as well. ETFs will generally hold a good number of assets within the fund so that the bad performance of any single aspect of the ETF will not have too bad an impact on the overall value of the fund.

The drawbacks

There are costs associated with holding an ETF beyond the actual trading cost to buy and sell [read this article for more about trading costs]. The actual administration costs of the ETF are baked into the price so you won’t see that charge directly. What you will have deducted from your account is whatever your broker charges you to hold a fund. This is usually a fraction of a percentage but I suggest you check with your broker what their charges are to hold a fund in your account. This will obviously marginally eat into any profit so it’s important to bear this in mind. The costs associated with holding an ETF rather than individual stocks will generally be higher – but this is a price that you might be willing to pay for the ease and simplicity involved.

Another negative is the diversification. We also have this down as an advantage, but diversification can be bad too depending on what type of investor you are. I argued in this article that diversification is probably not the way to go if you are focussed on pure growth of your portfolio. Thus an ETF, which will be well-diversified, potentially stunts growth.

Are ETFs a halal investment?

Good question. The answer is in two parts.

  1. Some ETFs are certified as being sharia-compliant. These are undoubtedly ok.
  2. Other ETFs might also be halal to invest in but you will have to do some work to get to the answer. You will need a list of all the individual assets within the fund, and then you will need to do a manual analysis of them all. If all the individual assets within the fund are sharia-compliant, then the fund is halal. If there are a small number of haram companies in there, then the ETF is still halal to invest in but you should purify your profits by giving that % away in charity.

Conclusion

Sharia-compliant ETFs offer a really useful tool for the investor who does not have the time or appetite to individually analyse stocks. Whilst I am a big proponent of people doing this, I recognise that in our busy lives, we sometimes want to invest and are happy to pay ongoing administration fees into assets which give exposure to something we think will be profitable. For the more hands-on investor, ETFs probably are not your thing but they might also serve as a useful diversification tool within an existing portfolio of stocks. I would personally consider a sharia-compliant ETF to gain exposure to something which I would not be able to myself. For instance, if an ETF invested in halal global companies – something which is very difficult to do cheaply as an individual investor – I would certainly consider this sort of thing later down the line.

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  • Salaams Mohsin. Can I get a broker to get in touch with me regarding investing in ETF? I am interested. Thank you.

    Reply
  • Salaams Mohsin, love reading your articles, jazakum Allahu Khayran! I’ve two questions:

    1) Are there ETF’s with minimal diversification? I agree that too much diversification is not good but I also don’t have the time or aptitude to individually analyse stocks.

    2) I’m based in Australia, which broker would you recommend for me, ideally someone who is affiliated with IFG?

    Reply
    • Ws Shazil, thanks for reaching out and great to hear you’re finding the content useful alhamdulillah! To answer your questions using your numbering:

      1) Hmm, good question. I have come across a very small number of ETFs that have minimal diversification, and certainly no sharia-compliant ones. You’ll tend to find with ETFs that they are quite well-diversified because the nature of them is to act as low-cost, well-diversified, hands-off vehicles. Your particular circumstance represents a gap – i.e. people who want “risky” ETFs. I’m sure someone can correct me if I’ve missed something in the market but I’ve not come across something sharia-compliant that would fit your needs.

      2) I sadly don’t have close knowledge of the Australia share broker market. As a general comment, the key things to look out for are trading fees and custody fees (i.e. the ongoing fees just to keep your account open). I’m not sure if it’s available in Australia, but have you checked out Wahed? Our affiliated link for Wahed: https://campaign.wahedinvest.com/ifg.

      P.S thanks for your support, we really appreciate it.

      Reply
  • Salaam. There doesn’t seem to be many Shariah compliant ETFs though our UK brokers. The ones I found are below:

    ISUS – iShares MSCI USA Islamic
    ISWD – iShares MSCI World Islamic
    ISDE – iShares MSCI EM Islamic

    With ISDE having the most expensive TER at 0.88% and ISUS at 0.5%. Compared to Vanguard’s Total stock market index VTI which only has an expense ratio of 0.03%. So the Shariah alternatives do seem quite expensive.

    I will be interested to know if you know of any ethical ETF’s available that is Shariah compliant but having lower fees than above?

    Also I would like to say that this is a great blog and a great resource especially for educating Muslims in the UK about investing in a halal manner. Keep up the great work.

    Reply
    • Ws Amjad, good to hear from you, and some astute observations here.

      To answer your first point, I believe you’re right in saying that these are only ETFs I’ve seen available via the mainstream UK brokers. It’s a shame that we are lacking in different types of ETFs to give us genuine choice.

      In terms of expense: yes, relative to Vanguard, the iShares stuff does look a tad expensive. But then Vanguard is phenomenally cheap so perhaps it’s not a fair comparison. Looking at it in the round, I think the iShares ETFs are decent value to be honest.

      As an aside, it’s worth dropping Vanguard a line about offering something sharia-compliant. I reached out to them a while ago and they did seem receptive provided that there was enough demand being demonstrated. I might well do an article on this and see if we can drum up a little campaign.

      Thanks for the kind words, it’s great to hear you find our content useful. Please do share amongst your contacts!

      Reply
      • Hello Mohsin,

        regarding a campaign for an islamic etf in vanguard i was wondering if there is any updates because i read you guys are considering this in many articles i’ve read, i believe this is very important as its the only way we can invest passively in comparison to other methods of investing. As these aching expense ratio would cost well above 40 thousand after around 20 – 25 years on average in comparison to vanguard ones which might not cost more than 4000 in the long run. Its much easier for you guys to do so as mashallah you must have a great number of email subscribers. Please do consider that in the near future as i believe its very important and easy to do through one email.
        kind regards,
        Musa

        Reply
  • Salaam Br Amjad,
    Jazakallah khair for the informative post!
    One question that has been worrying me about ETFs that hold common stock is their high levels of liquidity. If the fund holds close to 100% liquid assets (I.e shares on the stock market), can it be traded on anything but par value of those stocks?

    Reply
    • The way to think about ETFs is that they hold shares in companies, and those companies hold assets (not all of which are liquid). So the par value element goes away by virtue of that.

      Reply
      • Thanks Mohsin! Apologies for getting your name wrong earlier I can see how that’s a different way to look at it.
        So the transaction is that when purchasing a share of an ETF, is it viewed as the sale of a portion of shares in multiple companies at the same time (entering into multiple musharaka agreements at the same time)?
        Or should it be viewed as an agency style transaction where the ETF fund manager takes on agency of the amount and invests it on behalf of them? While also allowing for deducting their fees for managing such a fund, thus the price / book value of the etf is always > value of just the shares it holds?
        So what I’m really asking is What intention should a person make when entering into buying an ETF, should it be entering multiple musharaka or is it mudaraba or something else altogether?

        Reply
  • Regarding ETFs, is it halal to invest or buy ETFs that short the market? I know it is haram to short a stock outright because you do not own the stock you are shorting (i.e., you are selling something that you do not own and then buying it at a lower price). But can you buy for example SQQQ to short the tech stocks because you actually are taking possession and therefore own the ETF (in other words the short ETF is in your possession)?

    Reply
    • No you shouldn’t buy ETFs that short stocks. They’re usually doing it by investing in derivatives that create that effect, or by actually shorting stocks. Either way is not permissible.

      Reply
      • I dont understand the difference between the nature of a derivative and the nature of an ETC. A derivative instrument derives value from changes in the underlying asset if I am correct. So then how is ETF any different as you don’t actually own any of the shares of the company, your returns are based on the changes in the index fund? Would this then not make this impermissible?

        Reply
  • Salaam Ibrahim: Further to my original question, can we buy ETFs that are not shorting stocks but are long stocks? For example, an ETF that is long a basket of oil stocks (i.e., the XLE or triple the leverage of XLE, the ERX)?

    Can we buy ETFs that are long a commodity? For example, if I want to buy natural gas or oil here in the states and we know that futures are haram can I buy the USO for oil and UNG for natural gas? How do we invest in these types of commodities the halal way?

    Also, is it impermissible to buy the volatility index? For example, the VXX etf that tracks volatility?

    Reply
  • Also, after taking the course about how to screen to see if a stock is halal, what should we do if we determine a current company is not sharia compliant? For example, the debt to asset ratio is 35-40% and we have held the stock for years and we have a loss in the stock. Do we sell and take the loss or do we wait until the stock rebounds to breakeven and then sell? Please advise as I bought the oil and gas stock because I thought it was halal and continued to add to my position and am sitting on a rather big loss.

    Reply
    • Salaam, what are your thoughts on leveraged ETFs that go long technology stocks or energy stocks? For example, ERX which goes three times long the XLE—which consists of blue chip energy stocks? For smaller accounts, buying ERX instead of the XLE is much more favorable. Anything wrong with this from a sharia perspective?

      Reply
  • Assalamualaikum. how would zakat be calculated on ETF’s?

    Reply
  • Al Salaam Alikom,

    Is it Halal to invest into UGAZ and DGAZ. They are ETF for Natural Gas. Please let me know as I already bought some ETF Stocks but I am not sure if its Halal or Haram. I really appreciate it.

    Reply
  • Salaam, what are your thoughts on leveraged ETFs that go long technology stocks or energy stocks? For example, ERX which goes three times long the XLE—which consists of blue chip energy stocks? For smaller accounts, buying ERX instead of the XLE is much more favorable. Anything wrong with this from a sharia perspective?

    Reply
  • Asalaamu alaikum, are investing in etfs that focus on silver and gold such as ishare slv considered halal? Thank you at IFG for all the hard work trying to help the lay Muslim.

    Reply
    • We’d typically avoid as ETFs that invest in commodities usually do not actually hold the commodity but get exposure to it via derivatives (which are impermissible).

      Reply
      • Hello,

        I am managing a fund for my family. I used to invest in ETFs tracking other indices performance/yield. Such as GDXJ.
        Are ETFs tracking other indices performance are ok to invest in from an Islamic point of view?

        Appreciate your help on this.

        Thanks,
        H

        Reply
  • Obaidullah Zadran
    April 8, 2020 2:15 pm

    salam brother I wanted to know if CFD trading is halal. now I’ve seen some answers online that say it’s not stating you do not hold the underlying asset, why is that haram and isn’t the contract for the difference that you hold technically an asset as it appreciates in value?

    Reply
  • Dear, is there a theologic backing for the statement that mixed ETFs are halal as long as you give the haram % in charity?

    Thanks in advance

    Reply
    • Sure – the AAOIFI standard allow for a 5% impermissible income source. This is for all stocks. ETFs are just a collection of a bunch of ETFs.

      Reply
  • AA,

    I was shocked to find SPUS, a recent issued sharia compliant ETF has above 50% non sharia compliant of its holding! I got this data from ETFdb where they all ETF parameters, which among them is sharia non compliant percentage.
    my question is there a criteria for sharia compliant percentage in certain ETF to consider it halal for investing?

    Reply
  • Is it permissible to buy physical metal etf such as i shares physical gold or physical platinum?

    Reply
  • Sallaam brother. How about ETFs concerned with oil. For example USO. And if they arent what you would consider as a halal option, then how would you suggest we could invest in oil in a halal way. Thanks

    Reply
  • Hello,

    I am managing a fund for my family. I used to invest in ETFs tracking other indices performance/yield. Such as GDXJ.
    Are ETFs tracking other indices performance are ok to invest in from an Islamic point of view?

    Appreciate your help on this.

    Thanks,
    H

    Reply
  • Hello,

    I am managing a fund for my family. I used to invest in ETFs tracking other indices performance/yield. Such as GDXJ.
    Are ETFs tracking other indices performance are ok to invest in from an Islamic point of view?

    Appreciate your help on this urgently

    Thanks,
    H

    Reply
  • What are your thoughts on investing in S&P 500 ETF while some companies are halal there are some that are clearly not. You mentioned on your article that this amount of profit should be given a way in charity. Is this an absolute requirement because it would be impossible to calculate this amount. Some argue as long as the majority of the profit generated is permissible then a small amount can be overlooked. Any advise would be greatly appreciated.

    Reply
  • Halal Food Gastronomy
    July 7, 2020 3:23 am

    Assalamualaykum

    Apart from AJ Bell & Wahed which trading services do you recommend for those who are UK based and want to invest in Halal Sharia compliant ETFs eg SPUS the 500 Sharia Industry Exclusions index.

    JazakAllah Khayra for the write up may Allah SWT reward you immensely in this world and the next Ameen

    Reply
    • Salam brother.
      Is 3x shares are halal in trading 212?
      I think ETF shares called 3x shares. Suppose if I am investing in apple company it will go up then I will recieve 3x profit if it goes down I will loose 3x money. Is it not gambling??
      JazakAllah

      Reply
  • Thanks for another informative web site. Where else could I get that kind of information written in such a perfect way? I’ve a project that I am just now working on, and I’ve been on the look out for such information.

    Reply
  • Thank you for sharing.

    Reply
  • Antoine Timmermans
    October 12, 2020 9:04 am

    Assalamualaikum,

    I am curious to know your opinion about the First actively managed sharia-compliant ETF, namely:
    The Almalia Sanlam Active Sharia Global Equity ETF
    I am hoping to see a review of this ETF. In addition, I hope this ETF will be discussed in the halal investing for busy professionals course

    Reply
  • I will be on the lookout for more of your work.

    Reply
  • AsSalaamuAlaikum. I have invested in Islamic Stocks & Shares ISA and am very much confused whether to use the 40% proxy or not as the investments are in ETFS Physical Gold as well as Sukuks. Following were the values on my statement on the date I calculate Zakaat:

    iShares MSCI World Islamic ETF Dist (USD) = Market value £5105
    HSBC Islamic Global Equity Index IC = Market value £3248
    Franklin Global Sukuk USD W Dis = Market value £2177
    ETFS Physical Gold (GBP) = Market value £1364
    iShares MSCI EM Islamic ETF Dist (USD) = Market value £1197
    Cash = £510

    JazakAllah khair

    Reply
  • Salam brother.
    Is 3x shares are halal in trading 212?
    I think ETF shares called 3x shares. Suppose if I am investing in apple company it will go up then I will recieve 3x profit if it goes down I will loose 3x money. Is it not gambling??
    JazakAllah

    Reply
  • Assalaamualaikum wa rahmatullah Brothers, May I know if we can invest in ETF SOXL. They deal in semiconductors.

    Reply
  • Assalamo alaikum.
    Of we invest in gold etf are we liable to pay zakat on etf.

    Reply
  • Please tell me whether there is Shariah based Gold ETF funds in India

    Reply
  • Salaam,

    Thank you for the great resources. I wonder if investing in an actively managed ETF is halal. I looked at all of its holdings and around 75% of them are shariah-compliant. However, this percentage may change daily since it is actively managed. Is it still halal to invest in and purify 25% of realized gain by giving away to charities?

    Thank you

    Reply
  • Hi,
    While searching about halal etfs, I have seen a site etfdb.com, with the list of shariah-compliant etfs. So, can I believe this site, for instance, they are saying that VIOO etf is halal compliant etf. Thank you, Best regards Rasul.

    Reply
  • Assalamu alaikum
    Can we invest in the below indexes
    VXX and SQQQ?
    Jzk

    Reply
  • As salamu Alaikum wa Rahmatullahi wa Barakatuh

    I have come across this ETF (Almalia Sanlam Active Shariah Global Equity), which claims that they are sharia friendly, ie within Islamic rules. But I have found out that they also trade with short-term interest rates, which you are not allowed to do in Islam.

    How does this add up? and is it an attempt to scam people?

    Reply
  • If an ETF has a collection of companies it is investing in, does the fund physically own the shares of those companies? Or is a fund typically speculating on the price of those shares in those companies?

    I think a lot has been spoken on commodities and if there is a physical exchange but not enough is spoken on physical acquisition of shares in companies. It’s presumed it happens but I’m dubious as to whether it actually does.

    Reply
  • Is VTSAX (a whole market index fund by vanguard) halal? if not, what percentage of profits will I have to cleanse? I’m trying to compare SPUS/HLAL vs cleansing VTSAX

    Reply

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