Shariah Purification and Current Income
A Pakistani investor with a moderate risk profile is comparing a Shariah-compliant equity fund with a conventional income fund. The Shariah fund's offering document states that 3.5% of any cash distribution represents incidental non-compliant income, such as interest earned by investee companies, and must be purified by the investor by giving it to charity; the fund does not deduct it. The investor invests PKR 1,000,000 in the Shariah fund and receives a cash distribution of PKR 80,000 after one year. After the distribution, the fund's NAV is PKR 10.50, up from PKR 10.00 at purchase, and the investor still holds the units. The conventional income fund offers a distribution yield of 11% and has no purification requirement. The investor wants the highest permissible current income and is unwilling to borrow or use leverage. Ignore tax and zakat. Assume the Shariah fund's purification ratio applies only to the cash distribution, not to capital gains.
1. Calculate the purification amount and the investor's net cash distribution after purification. Show the effective distribution yield on the original PKR 1,000,000 investment.
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Purification = 3.5% x PKR 80,000 = PKR 2,800. Net cash distribution = PKR 80,000 - PKR 2,800 = PKR 77,200. Gross distribution yield = 80,000 / 1,000,000 = 8.00%. Net distribution yield after purification = 77,200 / 1,000,000 = 7.72%. The purification is not a fund expense or a fee; it is a charitable payment the investor must make to keep the income Shariah-compliant. It should be tracked separately and not treated as part of the investment return.
2. Compare the Shariah fund's total return before and after purification with the conventional income fund's 11% distribution yield. Which fund better meets the investor's stated goal? Explain the risk mismatch.
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Shariah fund total return before purification = cash distribution PKR 80,000 + NAV gain PKR 50,000 (from 10.00 to 10.50 on 100,000 units) = PKR 130,000, or 13.0%. After purification = 130,000 - 2,800 = PKR 127,200, or 12.72%. The conventional income fund offers an 11% distribution yield. If its NAV is assumed constant, its total return is about 11%.
On total return, the Shariah equity fund is higher by about 1.72 percentage points after purification. But the investor said they want the highest permissible current income. On current cash yield, the conventional fund is higher: 11% versus 7.72% net from the Shariah fund. The comparison is also not like-for-like: an equity fund has higher price volatility and can lose principal, while an income fund is usually lower-risk. If Shariah compliance is a personal requirement, the conventional fund is not permissible and the relevant comparison is with other Shariah-compliant income or money market funds. If it is not a requirement, the investor must decide whether the higher total return compensates for the equity risk and lower current cash.
3. If the investor needs PKR 90,000 in cash from the Shariah fund, what are the options and what should they check in the offering document?
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The Shariah fund's net distribution is PKR 77,200, so the shortfall is PKR 12,800. The investor can redeem units to raise the difference. At the stated post-distribution NAV of PKR 10.50, that is about 1,219 units (12,800 / 10.50), ignoring loads and taxes. After the sale the investor keeps the remaining units and has PKR 90,000 cash.
Before doing this, check the offering document for the exit load and minimum redemption amount, the redemption settlement period, and whether any capital gains tax applies. Check whether the fund's purification policy applies only to distributions or also to redeemed units; the question assumes only distributions. Check whether the fund has a systematic withdrawal plan that could reduce transaction timing risk. The investor should also compare this with holding a Shariah-compliant income fund or money market fund for the cash need, because selling equity units after a market fall can lock in a loss. Finally, the investor should not count the gross PKR 80,000 distribution as spendable cash; PKR 2,800 must be purified.