Muslim advisors help observant clients invest the Islamic way

Shortly before the start of Ramadan—the Muslim holy month, marked by sunrise-to-sundown fasting, which fell in July this year—the calls to Naushad Virji's office started. His financial-planning clients were ready to make their large yearly donations to the poor, a practice called zakat.

Many prefer to do so during Ramadan, believing that acts of kindness are multiplied at that holy time. They needed Virji's help in calculating the appropriate amount, as Islamic law, or Shariah, obligates them to give 2.5 percent of their income. "We help them calculate that," Virji said.

It is just one of the services his financial-planning practice, Sharia Portfolio, provides. Virji, CEO of the firm, also constructs portfolios of individual stocks, mutual funds and bonds that adhere to Islamic law. And he researches mortgages that don't violate Islam's prohibition against interest and helps clients find suitable investments in their 401(k) plans.

"Many times people decide they want to work with someone who understands them better," said Virji.

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About three-quarters of his clients are Muslims now, and Virji estimates that 9 out of 10 of his new clients share his faith. When he started his firm in 2003, he reached out to his own network as potential clients and soon found that the Muslims he knew didn't have much experience working with a financial advisor. Nor did they invest in the market, believing that their religion barred them from owning stocks.

"Their values have prevented them from going to a broker before," he said.

With some 3 million Muslims in the United States, Virji and others believe they're tapping into a growth market. Income in the Muslim community roughly mirrors that of the general population, with 16 percent earning more than $100,000 a year.

That's what Naeem Randhawa, 43, was thinking when he became one of Virji's clients two years ago. Previously, the technology recruiter in Austin, Texas, had worked with a broker from Wells Fargo.

The broker had a number of Muslim clients and knew the basics: avoiding pork, tobacco, alcohol and gambling, for example. "He did a good job, but I wouldn't call him an expert," Randhawa said. Working with someone from his own religious community is different.

"It's a level of trust that's not really offered by conventional brokers," Randhawa said.

When Randhawa was growing up in Canada, his Pakistani-born parents knew little of investing, and they didn't impart much knowledge to him. "Their idea of investing is putting money in a bank account, which is the next best thing to keeping it under the mattress," he said.

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Once Randhawa started working two decades ago, he found that it was impossible to invest with a clear conscience. So many financial instruments, when examined closely, violated Shariah law. Not only were the investment options in his 401(k) plans full of forbidden categories but the bond funds went against the mandate against charging or paying interest.

Mortgages posed a problem, too, for the same reason, although Randhawa and his wife did buy a home in Dallas with a conventional mortgage. "I have friends who are much stricter than I am, and they don't participate in 401(k)s or own a home," he said.

Today Randhawa's portfolio is mostly stocks and mutual funds screened by Virji. He no longer owns a house; he and his wife sold their Dallas home when they moved to Austin, and they rent now. He has other real estate investments, but they are structured as partnerships of pooled money, not financed with loans.

Sheraz Iftikhar, managing partner and co-founder of Arch Global Advisors, has always served Muslim clients. A majority of his clients share his faith, though only about a third insist on Shariah compliance.

In addition to working with Muslims, Iftikhar has also built a niche with physicians, through an affiliation with the Association of Physicians of Pakistani Descent of North America.

"That gave us a great audience," he said. "They are all affluent, and they all require a high intensity of financial planning." Iftikhar sponsors information booths at the physicians' conferences and is invited to speak on investing.

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One of his clients, Dr. Naeem Khan, is a cardiologist in southern Illinois. For years, Khan had worked with other advisors, who were happy to screen stocks for him using his own guidelines. However, he was never completely certain that his wishes were carried out. "Shariah is something most Westerners don't understand," Khan, 63, said.

He wants to work with a financial advisor who has a deep knowledge. "I'm so busy that it's really difficult for me to track everything down," he said, regarding the research necessary to ensure that investments pass Shariah screenings.

His previous advisor had allocated about a third of his portfolio in bonds, which, given Khan's age, is understandable. But the cardiologist was worried that conventional bonds went against the prohibition on interest. "Advisors have a formula for how much has to be large-cap or small-cap or bonds," Khan said.

There are more and more financial options for observant Muslims, choices that didn't exist just a few years ago. Just a handful of fund families have portfolios that screen out stocks for activities that violate Shariah and work with boards of Islamic scholars to constantly monitor holdings.

Of these, the $2 billion Amana Growth Fund is the oldest and biggest. Then there are exchange-traded funds, such as the Dow Jones Islamic Market International Index Fund. IdealRatings provides stock screening for institutions and individual investors and even has a mobile app. The firm also compiles several Islamic indices. And soon a Shariah-compliant crowdfunding site, Halal Sky, will launch.

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On the banking side, Islamic-banking windows are popping up at banks in the Midwest, where there are large Muslim populations. And mortgages are being structured in such ways that they don't violate the Islamic prohibition against charging or paying interest. "If I compare that to what we had 10 years ago, the market is quite different, and now we have a wide variety of options," said Arch Global Advisors' Iftikhar.

To find the investments for the Amana funds, portfolio manager Nicholas Kaiser avoids forbidden sectors such as pork, pornography, gambling, alcohol and tobacco. The devil, as they say, is in the details.

Shariah-compliant investors avoid companies that get more than 5 percent of revenue from "haram," or forbidden, activities. However, if the company's main business touches on something forbidden, even if it contributes only a small amount to sales, then it's out.

Case in point: A few years ago, an analyst at Kaiser's firm, Saturna Capital, noticed alcohol for sale at a Target store in California. A few calls to the company revealed that the retail giant was testing out alcohol sales in the state. "If your business is buying wholesale and selling retail, then the alcohol is your business even if it's a small piece," said Kaiser. He booted Target.

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Similarly, Amazon began selling wine in 2012. Wine doesn't account for a big part of the Amazon's revenues, but "because they made such a big hoopla over it, we had to sell it," said Mohamad Nasir, general manager with Allied Asset Advisors, which runs the $60 million Iman Fund.

Next there is the murky issue of interest, or "riba."

Shariah portfolios exclude highly leveraged companies, setting the threshold for debt at no more than a third (33 percent) of a company's market cap. During the recession, said Nasir, the Iman fund made a number of changes to its lineup. As stock prices fell, companies' market caps did, too, but their debt remained the same, leading to a higher ratio of debt to market cap, he noted.

Banks, which by their very nature are in the business of lending money, cannot be owned. The Amana funds also don't hold utilities, because they tend to load up on debt.

Companies that maintain a mountain of cash are out because they are earning interest from that money. So again, funds must decide whether how much cash is acceptable and what its purpose is.

"Apple has a lot of cash, but it also happens to buy 20 companies, so that cash has a business purpose," Kaiser said. "They're not relying on the interest income."

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Investors say that the Shariah guidelines do not hamper a manager's investment decisions. If anything, the prohibition against leverage leads to owning stronger companies, even if those types of stocks tend to lag during a recovery.

"I'm personally a value investor," said Virji. "If you're focusing on value, Shariah compliance rules out a significant number of stocks that you would not want anyway."

—By Ilana Polyak, special to CNBC.com