Stock investing from an Islamic perspective and the uncertainty of gharar
Gharar (excessive risk or uncertainty) is prohibited in Islam and its presence in financial contracts makes these contracts null and void. The prohibition of gharar can also extend to investing in stocks. Very few studies have investigated how gharar affects stocks in investing. Consequently, very few studies suggest tactics and strategies that can be employed for gharar reduction in the case of stock investing. The thesis attempts to investigate the topic of gharar in terms of stock investing. The thesis is far from developing a theory of gharar in terms of stock investing, however it is an attempt to establish the foundation for rationalising and understanding gharar in terms of stock investing. For this purpose, the thesis employs qualitative analysis, and depends on different types of secondary sources of information. The thesis extensively interprets and presents findings, and analyses the data derived from scholarly writings on the topic of gharar, which can be found in journal articles, books and several conference papers. The thesis also examines a sample of the screening criteria of Islamic Equity Funds (IEFs), since it is the only indicator explaining the guidelines Muslims pursue when tending to invest in stocks. In this regard, the sampling strategy employed is Critical Case Sampling. The thesis examined all Islamic Equity Indexes and a number of the major Islamic Equity Funds. It has been found that the screening criteria of Islamic Equity Funds is limited to two matters: (1) excluding firms that are associated with impermissible activities and operations e.g. financial services firms and casinos, and (2) excluding firms highly involved with interest-rate based transactions. Despite the fact that screening criteria of Islamic Equity funds are supposed to be strictly derived from the basic tenets of Islamic law, thus far, gharar is excluded from these screens. For the purpose of incorporating gharar into the screening criteria of Islamic Equity Funds, the thesis first suggests a definition of gharar in terms of stock investing, which is based on the commonalties found in the different interpretations of Muslim scholars of gharar. Muslims need to focus on avoidable (controllable) risk in a proper manner, and attempt not to rely on pure chance in achieving the desired profit or return. Secondly, the thesis suggests a number of conventional strategies for risk reduction that can be successfully used for gharar reduction. Thirdly, the thesis explores the different conventional stock valuation models e.g. Value Investing, Modern Portfolio Theory (MPT) and Derivatives. It has been observed that the different types of derivatives in Islam are prohibited for several reasons. Several tactics and ratios derived from Value Investing and MPT can be successfully used to for gharar reduction purposes. In regards to Value Investing, the following ratios and tactics can be used for gharar reduction: different Multiple ratios, long-term investing, intrinsic value and fundamental analysis. Two main issues can be beneficially derived from MPT: the portfolio approach and beta ratio. However, note that several modifications have been performed on these suggested ratios and tactics in order to comply with the basic tenets of Islamic contract law. Last but not the least, both the Value Investing and MPT fall short of assessing any non-financial but nevertheless fundamental activities of the firm.