What are Shariah-compliant mutual funds?

Summary: Shariah-compliant mutual funds follow Islamic investing principles, which makes them work a bit differently from regular funds. This story breaks down what those rules mean in practice and why they can shape the kind of companies these funds invest in.

Shariah-compliant funds are mutual funds that invest according to Islamic principles rather than only conventional financial filters. In India, that means the fund universe is narrowed by sector exclusions, financial-ratio screens and a ban on many interest-linked instruments, so these funds are better understood as a constrained equity strategy rather than as a standard diversified equity fund.

How do Shariah funds work in practice?

A Shariah fund does not simply avoid investing in alcohol or tobacco-based businesses. It also limits exposure to businesses where interest income or interest-bearing debt becomes too significant, and it typically avoids conventional banking and many derivatives-led structures.

For instance, the Tata Ethical Fund’s scheme document says it will invest only in a ‘Shariah Compliant Universe' and exit a stock if its compliance status changes; Taurus Ethical Fund similarly defines its mandate around an ethical or Shariah-based equity universe.

That filtering changes portfolio construction in a very real way. Tata Ethical Fund’s current scheme information document shows 80 to 100 per cent of net assets in equity and equity-related instruments of Shariah-compliant companies, with up to 20 per cent in other Shariah-compliant instruments, including cash. In other words, this is still an equity fund, but with a narrower investable basket than a broad-market diversified equity scheme.

What options do investors currently have in India?

India’s listed Shariah-oriented mutual fund universe remains very small. Value Research’s explainer names three available options: Tata Ethical Fund, Taurus Ethical Fund and Nippon India ETF Nifty 50 Shariah BeES. Current AMFI-linked scheme documents and Value Research coverage confirm that Tata Ethical Fund and Taurus Ethical Fund remain active, while Value Research also tracked a 2025 fund-manager change for Nippon India ETF Nifty 50 Shariah BeES, indicating the ETF is still live.

That small menu matters because Shariah investing is not just a moral screen, but a structural choice. A recent Value Research review of Tata Ethical Fund notes that the fund excludes conventional financials, thereby missing a large part of India’s banking-led growth cycle. The article also showed that, from January 2016 to January 2026, the fund’s three-year rolling return outperformance was not decisive relative to either the Nifty 500 Shariah TRI or the broader Nifty 500 TRI.

Why do returns and diversification look different?

This is the most important trade-off to understand. Shariah compliance reduces the investable universe for Shariah-compliant funds, so diversification can look different from what investors see in a regular flexi-cap or broad-market index fund. 

NSE’s latest available Nifty 50 Shariah factsheet shows that the index had 18 constituents and was heavily tilted towards Information Technology, Healthcare and FMCG, with Infosys, TCS and Hindustan Unilever among the top weights. That helps explain why a Shariah ETF is not a plain substitute for a standard Nifty 50 product.

A second distinction is structure. Tata Ethical Fund and Taurus Ethical Fund are active mutual funds, while Nippon India ETF Nifty 50 Shariah BeES is an exchange-traded fund linked to a Shariah-screened index. For a DIY investor, the useful comparison is not “Which is best?” but “Am I comparing an active strategy with an index-tracking product, and do I understand the concentration and liquidity differences?” 

Value Research’s Fund Compare tool and Mutual Fund Screener are useful for a framework-led comparison.

How are Shariah mutual funds taxed?

From a tax perspective, Shariah funds are not a separate class under Indian law. The relevant question is whether the scheme qualifies as an equity-oriented fund. Under Section 112A of the Income-tax Act, an equity-oriented fund generally needs at least 65 per cent of its total proceeds invested in listed domestic equities; Section 111A uses the same definition for short-term gains on equity-oriented funds.

For sales on or after 23 July 2024, Value Research’s FY25 mutual fund tax explainer summarises the current equity-fund regime as 20 per cent for short-term capital gains and 12.5 per cent for long-term capital gains, with long-term gains exempt up to Rs 1.25 lakh in a financial year. The Union Budget 2024 highlights published by the Government also confirm the higher 20 per cent short-term rate, the 12.5 per cent long-term rate and the Rs 1.25 lakh exemption threshold on certain financial assets.

For active Shariah funds, costs still matter. SEBI’s investor education page states that regular plans include distributor commission in the expense ratio, while direct plans do not. Value Research’s recent direct-versus-regular illustration shows that a 1 percentage-point annual cost gap can create a corpus difference of about Rs 9.2 lakh over 20 years on a Rs 10,000 monthly SIP, assuming 12 per cent pre-expense returns. A SIP calculator or tax calculator can help readers model the effect, but the key point is educational: a narrow mandate plus higher ongoing costs can materially shape long-term outcomes.

Key takeaways

Shariah-compliant mutual funds are not just ‘ethical funds for Muslim investors’; they are equity products built on a much smaller and more tightly screened universe.

In India, the opportunity set remains limited, so product structure matters: active Shariah funds and a Shariah ETF should be compared on mandate, diversification, benchmark, and costs, not just on labels.

The hidden cost of Shariah investing is not only the expense ratio. It is also an opportunity cost, because sectors such as Financials are excluded by design.

Should you invest in Shariah-compliant mutual funds?

Given their limited investment universe and concentrated portfolios, it may be better to consider diversified equity funds such as flexi-cap funds and multi-cap funds. These funds invest across the market, providing you with wider exposure and better returns, provided you have a long investment horizon.

To know which diversified equity funds are best suited for your needs, subscribe to Value Research Fund Advisor. Here, you can get our list of analyst-recommended funds, build customised portfolios and track whether your investments are aligned with your financial goals.

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This article was originally published on December 20, 2022, and last updated on March 11, 2026.