Shariah-compliant vehicles: screening and funds

This is the longest lesson here, and it is one lesson rather than three because the three questions it answers are really one question asked at increasing scale: can I actually buy this? First a single company, then a verdict on that company, then a fund holding hundreds of them. The asset class that is supposed to sit alongside shares, and largely does not exist here, has its own lesson: sukuk, and the missing half of the portfolio.

The business-screen lesson covered the first half of screening: what the company does, assessed qualitatively, applied first, not offsettable. This lesson starts with the other half, which is the part people find strange, because it puts numbers on something that sounds like it should be absolute.

Part one: how the screening actually works

The standard this site uses

There is no single global regulator of Islamic finance, which means there is no single screening standard either. Three dominate: AAOIFI (the Accounting and Auditing Organisation for Islamic Financial Institutions), S&P Dow Jones Islamic Market, and MSCI Islamic.

They agree almost entirely on the business-activity list. They differ on the financial ratios, specifically on what the ratios are measured against. This site uses AAOIFI Shariah Standard No. 21, which is the strictest of the three, and says so openly on the Methodology page along with the primary source documents.

The four financial tests

Under AAOIFI, three balance-sheet ratios are each measured against market capitalisation (the total market value of all a company's shares), plus one test on the composition of income. A company must clear all four.

Market capitalisation is simply the share price multiplied by the number of shares: what the market currently says the whole company is worth. It is used as the denominator because it reflects what you are actually paying for a slice of the business, rather than an accounting figure.

Why a threshold exists at all

The business-screen lesson gave the structural version of this answer: zero contamination is not a stricter standard, it is an exit from public markets, because essentially every large listed company holds cash somewhere earning interest.

The specific thresholds have a different basis again, and honesty requires saying what it is. The 30% figure and the 5% figure are not derived from an explicit text. They come from scholarly reasoning, in part drawing on juristic concepts around what constitutes a dominant versus a subordinate portion, and from the practical judgment of the Shariah boards that wrote the standards. Different boards reached different figures: AAOIFI uses 30% against market cap, S&P Dow Jones uses 33% against a trailing 24-month average market cap, MSCI uses 33.33% against total assets.

That disagreement is not a reason to dismiss the framework. It is a normal feature of applied fiqh, where scholars agree on the principle and differ on how to operationalise it. But it does mean two things for you: a stock can pass one standard and fail another legitimately, and the specific number is a considered judgment rather than a revealed one.

The three standards are compared side by side, including a real ASX example where the receivables test changes the answer, in the guide on AAOIFI vs DJIM vs MSCI.

What the screen does not do

• It does not tell you a company is a good investment. A stock can pass every screen and still be overpriced, poorly run or in a dying industry. Compliance and quality are unrelated questions, and everything in the investing fundamentals modules still applies.
• It does not remove your obligation to purify. Passing the 5% income test means the impermissible income is tolerable, not that it is zero. What to do about the remainder is the purification lesson.
• It does not stay true. Ratios move with the share price and with every reporting period. A screen is a dated snapshot, not a permanent certification.
• It does not resolve genuine judgment calls. Which is what the review verdict, in the next part of this lesson, exists to say out loud.

• Know which standard you are applying. An app that gives you a green tick without naming its standard and thresholds is asking you to trust a black box.
• Check the date on the figures. Market-cap ratios from two years ago tell you very little.
• Look at how close to the line it sits. A company at 28% debt is one bad quarter from failing. A company at 5% is not.
• Treat the screen as the floor. The tayyib (good and wholesome, not merely permitted) lesson is the reason that sentence keeps recurring.

Part two: reading a real verdict

Four real results from this site's own ASX Screener, using its published figures. All ratios below are against market capitalisation as at the screener's stated data date, and every one of them will have moved since. Check the live page for current numbers.

A clean pass: BHP

Nothing is close to a line. Note what a pass does and does not say: BHP sells commodities to industrial customers, which is a straightforward business, and its balance sheet is comfortably inside the limits. Whether it is a good investment at today's price, and whether you are comfortable with coal specifically, are your questions and the screen is silent on both.

A clean fail on a ratio: Woolworths

Woolworths carries debt at 33.8% of market cap against a 30% ceiling. That is the whole verdict. Its supermarket business is not an excluded activity, its cash position is unremarkable at 3.1%, and it fails anyway because one ratio is over.

Two things follow. A ratio failure is arithmetic, not a judgment about the company. And it can reverse: if Woolworths repaid debt, or if its share price rose enough to lift the denominator, it would pass. This is exactly the instability flagged above, and it is why the date on a verdict matters.

A fail on income, not on ratios: Computershare

This is the most instructive result on the whole screener, because everything on the balance sheet looks fine. Debt at 8.3%, cash at 6.4%. All three ratio tests pass comfortably.

It fails on the fourth test. Computershare is a share registry business, and it holds very large client cash balances in trust. It earns interest on those balances, and it reports that interest as its own headline metric under the name margin income: $748.7 million in FY26 against $3,257.5 million of total management revenue, which is about 23% of revenue.

AAOIFI's impermissible-income ceiling is 5% of revenue. Computershare is at roughly 4.6 times that ceiling, taken from the company's own reported results rather than estimated.

The honest middle: Wesfarmers, and what review means

Wesfarmers: debt 14.6%, cash 0.6%, receivables 2.5%. Every ratio passes, and not narrowly. It is still marked review rather than pass.

The reason is the business-activity screen, not the numbers. Wesfarmers is a diversified conglomerate spanning seven-plus segments, retail, chemicals, health and industrial supply among them, and none of them is an obviously prohibited category on its own. The review verdict is not about a known problem. It is that owning a company this diversified means owning several businesses at once, and any one of them could carry a revenue line that would not show up in a top-line split. Verifying that properly means reading the segment breakdown yourself rather than trusting a single verdict.

The other family of review cases

Review is not only for conglomerates. The screener also flags pre-revenue explorers this way, and the reasoning connects directly to the speculation lesson.

Deep Yellow, a uranium developer, shows debt at 0.2% and cash at 11.5% of market cap. Immaculate ratios. But its reported revenue is around $20,000 against roughly $187 million of cash, which means essentially all of its recorded income is likely interest earned on capital-raise proceeds sitting in deposits. Predictive Discovery, a gold explorer, has the same shape: about $170,000 of revenue against $32.5 million of cash.

For companies like these the impermissible-income ratio could be close to 100%, not the near-zero a balance-sheet screen would imply. They are flagged rather than failed outright because the exact income composition is not confirmed in their disclosures, and stating an unconfirmed fail as a fail would be dishonest in the other direction.

• Read the note, not just the colour. Every entry says why: a fail on debt and a fail on business activity are completely different situations.
• Check the date, and check the margin. A stock sitting at 28% debt is one bad quarter from a different answer.
• Treat review as work to do, not as a result. It means a human judgment is required and the screener is declining to make it for you.
• Verify anything that matters to you against the company's own annual report. Segment revenue and any disclosed income metrics are the two places the real answer usually lives.

Part three: funds, where the label does the talking

The ETF lesson made the general case: broad, cheap, boring funds beat stock picking for almost everyone, and the evidence is not close. That conclusion has a problem attached, though, because a standard ASX 200 fund holds the major banks among its largest positions.

A fund is a container. You own units in the container, and the container owns shares in companies. Your exposure is exactly the sum of what it holds, in the proportions it holds them. Which means every test above applies to every single holding. If a fund holds 200 companies, you own fractions of 200 businesses and inherit 200 sets of business activities and balance sheets. The fund's name has no bearing on that.

Why the label is not the guarantee

A fund described as Islamic, Shariah-compliant or ethical can still differ from your expectation in three specific ways, and none of them involve anyone lying.

1. It may use a different standard. A fund screening to MSCI Islamic thresholds (33.33% against total assets) will hold companies an AAOIFI screen (30% against market cap) would exclude. Both are legitimate and defended by qualified scholars. They are not the same universe, for the reasons set out above.
2. Ethical is not Shariah. An ESG or ethical fund screens for environmental and social criteria. It may exclude tobacco and weapons while holding every major bank, because conventional banking is not an ESG exclusion. These are different frameworks that overlap partially and are frequently confused.
3. The fund's own operations may differ from its holdings. How it handles uninvested cash, whether it lends securities, and what it does with incidental non-compliant income are properties of the fund, not of the companies in it.

Purification, and why a fund should have a policy

Even a properly screened fund holds companies with some impermissible income, because the standard tolerates up to 5% of revenue rather than requiring zero. Some of that flows to you inside your distributions.

Purification (calculating the tainted portion of your return and giving it away) is the response: you work out the proportion attributable to non-compliant sources and donate it, without taking it as a benefit and without treating it as charity you get credit for.

What you want from a fund is not zero impermissible income, which is not achievable. It is a stated policy. Good ones publish a purification ratio, often as cents per unit or a percentage of distributions, so you can calculate your own figure. A fund that cannot tell you its purification ratio has either not thought about it or is not screening as tightly as its name suggests.

How to actually calculate and pay purification, and the scholarly differences on what counts and whether capital gains are included, is the lesson on purifying non-compliant income.

What to check, in order

• Which standard does it screen to, and who certifies it? Named standard, named Shariah board or adviser. If neither is stated, that is the answer.
• Read the top ten holdings, then download the full list. One minute, and it settles more than the marketing does. If you recognise a name you would not buy directly, you have found your answer.
• Find the purification policy and ratio. Published, calculable, ideally per distribution.
• Check the fee. Screened funds generally cost more than broad index funds, because screening and certification are real costs. The ETF lesson explained why the fee is the one number in the brochure that is certain, and that applies here too.
• Check what it is actually diversified across. A screened fund excludes the financials sector entirely, so concentration in the remaining sectors is higher by construction. The diversification lesson flagged this specifically.
• Check how large the fund is and how it trades. A very small fund carries the risk of closure, which forces a sale at a time you did not choose.

The Australian reality, and the build-your-own alternative

The set of options available to an Australian retail investor is genuinely narrow. There are a small number of ASX-listed Shariah-screened equity products, some global rather than Australian in focus, and a small number of Islamic super options. That is most of it. Fees are higher than a broad unscreened index fund, and a narrow product set means you may be concentrating in a single issuer's judgment about screening as well as in the market itself. Neither is a reason not to invest. Both are reasons to read the methodology document rather than the brochure.

You can also skip funds and buy screened individual shares directly, using something like this site's screener. It gives you full control and avoids fund-level fees and methodology risk. The costs are real though: you take on the rebalancing, the ongoing re-screening as ratios move, the brokerage on every trade, the capital gains tax (tax on the profit when you sell) consequences of every sale, and the decision about when to sell a winner. For most people a screened fund plus a read of its methodology is the better trade. For someone with a larger balance and genuine interest, direct holding is defensible.

The site maintains a current review of what is actually available in the guide on halal ETFs on the ASX, and the super equivalent in is my super halal. Those are kept up to date; this lesson deliberately does not name equity products, because the list changes and a dated list is worse than none.