ISLAMIC INVESTMENT

Mahyuddin Khalidemkay@

salam.uitm

.edu.my

Islamic Fund Management

Topic Outline

Investment Fund Unit Trust Classification of Investment Funds Type of Funds by Investment Portfolio Real Estate Investment Trust (REIT) Exchange Traded Funds (ETF)

2

Investment Fund

AAOIFI define Investment fund as

Funds are investment vehicles• Which are financially independent of the institutions that

establish them.

Funds take the form of equal participating shares/units

• Which represent the shareholders’/unitholders’ share of the assets,

• Entitled to profits or losses. The funds are managed on the basis of either

mudharabah or wakalah (agency )contract

3

Investment Fund

The definition continues by setting out the Shariah ruling that governs Islamic investment funds:• Investment funds are permissible by Shariah. • Because funds are a form of collective investment that continue

throughout their term, the rights and duties of participants are defined and restricted by the common interest, since they relate to third parties’ rights.

• Hence, in cases where the fund is managed on the basis of agency the shareholders/unitholders waive their right to management, redemption or liquidation except in accordance with the limitations and conditions set out in the statutes and by-laws.The term “investment funds” may include unit

investment trust, unit trust, collective investment vehicle (CIS), mutual funds and other funds.

4

Unit Trust

Shariah-based unit trust funds give investors the opportunity to invest in a diversified portfolio of Islamic securities that are managed by professional

managers in accordance with the Shariah.

Unit Trust can be defined asA pooled investment plan where the capital

contributions of investors are combined into a legally

formed trust fund

Then invested by professional fund managers,

acting on behalf of the investors, in a portfolio of

marketable securities

5

Unit Trust

One important feature of unit trust is that professional fund managers are employed to

manage the funds.

• They are highly qualified and experienced in investments.

• It is done at minimal cost, minimizing, liquidity, and capital appreciation

Investors money will be pooled together to be invested in a single diversified

investment portfolio which comprise

stocks, bonds and others in accordance with the investment

objective.

Unit Trust investment offers

a reasonable amount of return

with minimal risk.

6

7

Key Differences between Islamic and Conventional Funds

Investible Universe

Purification

Role of Shariah Advisor

Fee structure

How a Unit Trust Work?

• An agreement that binds 3 parties (namely, Unit Trust Management Company, the trustee and the unit trust fund’s investors – also called as unit holders) to the deed.

• The trust deed will have to be registered with the Securities Commission. A copy of the trust deed can be bought at the management company.

Trust deed

• A trustee is generally reputable financial institution appointed by a deed of Trust to look after the interest of the unit holders.

• As the legal owner of the assets of the fund, the trustee is responsible to ensure that the fund is complying with shariah, fund objectives and common law.

• According to SC, role of trustee in fund management is:• Manage funds according to fund deed• Provide adequate supervision and vigilance to ensure fund operating company is operating the fund in accordance to the deed, prospectus and acceptable business practice.

Trustee

8

How a Unit Trust Work?

• The promoter of the fund to the public and provides investment expertise to manage the fund and has the primary responsibility of investing the funds according to the objectives.

• The Management Company also acts as the Registrar of the fund maintaining the records of the unit holders

Management Company

• The providers of funds through purchase of unit trusts from the management company would expect to receive benefits from the investment.

• If it is an Open-end Fund, the investors can buy units at anytime, as long as the fund has not reached its maximum approved size.

• They can also sell the unit trusts back to the management company,.

Investors or Unit holders 

• Responsible to safe guarding the interests of the investors who make investments in unit trusts.

• SEC formulates regulations for the operation of unit trusts and has the necessary power to ensure the proper conduct of the business.

• It also has the power to license or suspend the licenses of Management Company to operate unit trusts.

The Securities Commission 

9

Regulatory Approach for Islamic Unit Trust in Malaysia

Securities Commission (SC)

adopts 2 tier regulation for Islamic

unit trusts

1st tier – Regulation that applies to all unit trusts

2nd tier – Additional regulation required for Islamic unit trusts

Additional regulation required for Islamic

unit trusts:Appointment of Shariah Committee /

Advisory Board / Adviser

Appointment of 2 Muslim Investment Committee Member

Appointment of a designated compliance officer for Islamic unit

trusts

Enhanced disclosures in offering documents

Reports by Shariah Committee / Advisory Board / Adviser in annual and

interim reports to unitholders.

10

Regulatory Approach for Islamic Unit Trust in Malaysia

The Securities Commission regulates the establishment and

operations of unit trusts in Malaysia under:

• Capital Markets And Services Act 2007

• Securities Commission Act 1993

• SC Guidelines and other relevant securities law

This requires, among other things, that the unit trust fund manager and the trustee create a deed and register it

with the Securities Commission. A copy of the deed may be inspected

at the unit trust fund manager's office.

In addition, the Securities Commission

has placed severe requirements in the

appointment of the unit trust manager, the

trustee, the unit trust manager's directors,

chief executive officer, investment committee

and Committee Members/ Shariah

Advisers.

The appointment of all these

parties must be approved by the

Securities Commission.

11

Classification of Investment Fund

Open-Ended Funds Close-Ended FundsIs a collective investment which can issue and redeem units at any time.I.e.: Unit trusts

Feature Is a company (investment company) structure where the company will issue shares for subscriptions. I.e.: share and stock

An investor can purchase units in such fund directly from the unit trusts company, or through authorized agents (individual and bank)

Is another type of collective investment but with a limited number of units.

Refers to a fund operated by the fund manager that makes offers to the public and invests the proceeds in a group of assets, in accordance with the fund’s objectives.

Character It refers to a fund with a fixed number of units outstanding, and one which does not redeem units as open-ended funds. It behaves more like stock.

Buying and selling through unit trust company

Trading Buying and selling take place in secondary market i.e. Stock exchange

Price: Computed on a daily basis by :(Fund’s Total Asset – Liabilities)/No. of Units Outstanding.

Price Price: Share determined entirely by market demand. Often higher or lower than the NAV per share.

12

Types of Funds by Investment Portfolio

Equity Funds Fixed Income Funds Money Market Funds Balanced Funds

Islamic/ Shariah Funds Sukuk Funds

Real Estate Investment Trust

Funds Exchange Traded

Funds

13

Types of Funds by Investment Portfolio

Equity Fund Primarily invest in the stock market. High level of risk and are expected to provide a high return

in the long term. 3 kinds of Equity Funds

Index Fund Invest in companies with higher capital growth potential but associated

with higher risk Aggressive Growth Fund

highly speculative mutual fund that seeks large profits from capital gains

Invest in small, unseasoned companies with high price/earnings ratios High risk investments for very aggressive investors

International Equity Fund Invest primarily in overseas share markets

14

Types of Funds by Investment Portfolio

Income funds Invest mainly in government securities, corporate bonds

and money market instruments. It produces high level of current income- invest in high-

grade shares that pay good dividend. Established companies and generally viewed as low-risk.

Money Market funds Operates in similar way to a bank account- the unit price is

normally set at a fixed amount. Invest in low risk money market instruments.

15

Types of Funds by Investment Portfolio

Balanced funds Generates a balanced return of both current income and long-term

capital gains Invest in blend of fixed-income securities and common stocks, with

30% to 40% in fixed income Less risky investments for relatively conservative investors looking for

moderate growth Islamic Fund

Fund will invest in shares which complies with Shariah principles. The Shariah Principles distinguishes between ‘halal’ and ‘non halal’ type

of business activities. The returns received would depend on whether investment objective

is for growth, current income or a combination of growth and current. Sukuk Funds

Funds will be invest in diversified portfolio of sukuk to secure and distribute annual income to unit holders

Might include government, corporate, municipal, convertible sukuk etc.

16

Types of Funds by Investment Portfolio

REITs Funds  Special type of close-end fund where it invests mainly in real

property rather than in shares or bonds. Provides the investor opportunity to participate in property

market Because of the nature of the investment, the returns are

highly speculative. ETFs

Exchange Traded Funds (ETF) is linked unit trust fund whose investment objectives is to achieve the same return as particular market index

ETF often have low expense ratio and can be traded throughout trading day

17

Types of Funds

TYPES OBJECTIVES STRUCTURE/UNDERLIER

Money Market Funds

To invest in money market.

Short term debt instrument, mostly treasury bills

Income FundsTo provide current income on a steady basis.

Government and corporate debt, stocks and bonds

Balance FundsTo provide a balance mixture of safety, income and capital appreciation.

Mixture of fixed incomes and equity

Index FundsTo replicate the performance of a broad market index.

Market Index

Investment-Linked Funds

To provide balanced income for specific life insurance or family takaful plans.

Stock and bonds

18

Advantages of Unit Trust

Many investors lack sufficient resources to establish an adequate diversification on their own.

DiversificationDifferent types of funds are created for different investment objectives. So investors should have no problem finding funds that meet their objectives in terms of return and risk

Funds with variety of objectives

The management company maintains and administers the records of shareholder’s activity for a given year. This is a great convenience for the investors.

Record keeping services.

Fund managers who are knowledgeable about investment and they have good track records of performance, high integrity, etc.

Professional management

Unit trust can be bought and sold easily. Thus they do not suffer from liquidity risk.

High liquidityOnly a small amount of money is needed to participate in a portfolio of investment which enjoys the same benefits as in direct investment which requires large amount capital.

Affordability

19

Disadvantages of Unit Trust

Load fee

• This is sales charge added to the fund’s NAV when unit trust is sold. It is as high as 10%.   

High annual

expense

• The operating expenses like accounting, legal, postage, management fees have to be borne by the investors.

Transaction costs

• Management companies must also pay transaction costs to buy and sell securities even though they trade in large blocks.

20

Does the Price of Unit Trust fluctuate?

Unit prices could rise or fall due to value changes of the underlying securities owned by the Trust Fund. 

The value of equity fluctuates due to changes in the share prices in the Malaysian Stock Exchange.

The value of fixed income securities will change due to change in interest rates in the market.

Returns on Unit Trust can be determined using the below measurement. Holding period = Selling price – Purchased price + dividend Return Purchased price

Return of the fund = new NAV – old NAV Based on NAV old NAV

Market returns = new KLCI – old KLCI Old KLCI

Changes of funds return = Return on NAV Relative to market return market return

21

Determination of Price for Unit Trust

Price for Unit Trust is determined by Net Asset Value (NAV) of the funds managing the portfolio excluding any liabilities incurred and the number of units in circulation.

NAV represents the underlying value of a unit share of stock in a particular unit trust.

NAV is found by taking the total market value of all securities held by the fund, less any liabilities and divided by the number of units on issue.

NAV = Value of Assets - liabilities No. of units outstanding

22

Real Estate Investment Trusts (REIT)

Definition• “An investment vehicle that invests or proposes to invest at least 50% of its total

assets in real estate. An investment in real estate may be by way of direct ownership or a shareholding in a single-purpose company whose principal assets comprise real estate”• Note: Real estate means physical land and those human-made items which are

attached to the landClosed-end investment company that invests in mortgages and various types of real estate investments

Provide high dividends along with capital appreciation potential

Types of REITs• Property/equity REITs invest in shopping centers, hotels, apartments, office

buildings and other real estate• Mortgage REITs invest in mortgages• Hybrid REITS invest in both properties and mortgages

23

Islamic REIT

Definition• Islamic REIT is a collective investment scheme in real estate,

in which the tenant(s) operates permissible activities according to the Shariah”

For real estate investment to be Shariah compliant, regards should be given to the following:• Utilization of the real estate must be Shariah compliant,

including tenancies & sub-tenancies• Financing of the acquisition / development of the real estate

should be Shariah Compliant• Investment of cash / liquidity must be made in Shariah

compliant instruments• Insurance scheme for protecting the real estate should also

be Shariah compliant

24

Islamic REIT vis-à-vis Conventional REIT?

• Not much difference

Fundamentally

• Very similar to Conventional REIT

Objective, administration and structure

• How the incomes of the Islamic REIT are derived and how the fund is being managed, e.g: • Type of tenants• Islamic REIT – tenants in a property acquired must operate in businesses that

comply with Shariah principles• Conventional REIT – no such requirement

• Proportion of rental• Islamic REIT – fund must be managed in Shariah compliant manner• Conventional REIT – no such requirement

Key difference

• Derived from the tenants

Income

25

Malaysian SC’s Guidelines for Islamic REITs

Non-permissible rental activitiesFinancial services based on riba (interest)

Gambling/gaming

Manufacture or sale of non-halal products or related products

Conventional insuranceEntertainment activities that are non-permissible according to the

ShariahManufacture or sale of tobacco-based products or related products

Stockbroking or share trading in Shariah non-compliant securities

Hotels and resorts

26

Malaysian SC’s Guidelines for Islamic REITs

• If there are “mixed” tenants – the proportion of rentals from the operation of non-permissible activities to total turnover of the Islamic REIT in any current financial year must not exceed 20%

Rental from tenant carries out mixed activities.

• Some acceptable approach e.g. utilisation of space occupied, hours of services or other technics determined by shariah advisor can be used for calculating ratio of the rental of non-permissible activities.

Technique of calculating the ratio of rental non-permissible activities.

• A building where all the tenants operates only non-permissible activities cannot be included in an Islamic REIT even if the total rental complies with the 20% ruling

Acquisition of real estate

27

Malaysian SC’s Guidelines for Islamic REITs

• For new tenant(s) – the Shariah committee / adviser must advise the Islamic REIT manager against accepting new tenant(s) who operate activities that are fully non-permissible

Renting out to a new tenant

• The Islamic REIT manager must ensure that all forms of investments, deposits and financing instruments comply with Shariah principles

Instrument used in investment, deposit and financing

• Takaful schemes must be used to insure the real estate

Takaful Coverage

• The Islamic REIT allowed to take part in forward sales or purchase of currency for risk management purposes.

• Note: Unless otherwise approved by the trustee and the SC, the total borrowings of the fund to acquire properties shall not exceed 50% of the total asset value of the fund at the time the borrowings are incurred

Risk Management

28

How would a Malaysian Islamic REIT be administered ?

All REITs are governed by multiple levels of stakeholders to ensure maximum investors’ protection:• Unit holders• Manager• Shariah committee/adviser• Trustee• Regulatory authoritiesIslamic REITs – must comply with both SC Guidelines on REITs and SC Guidelines for Islamic REITsAll REITs are established through a Deed of Trust executed by the trustee who acts on behalf of the unit holders. The Deed of Trust governs the REITs and the roles of the trustee and the management company

29

30

Structure of an Islamic REIT

Shariah Committee/

Adviser

ManagementCompany

Property Manager

ISLAMICREIT

Properties

Trustee

Units subscribed in IPO and/or acquired

in the open market

Management fees

Management services

Property Management

Services

Direct Ownership of

Properties

Net PropertyIncome

Property Management

Fees

Unit holders Appoint Trustee

Income

Acts on behalf of Unit Holder

OverseeShari`ah

Compliance

Unit Holders

Exchange Traded Funds (ETF)

Exchange Traded Funds (ETF) can be defined as

A listed index-tracking fund

Structured as a unit trust scheme

Whose primary objective is to achieve the same return as a particular market index

By investing all (full replication) or substantially all (strategic sampling) of its assets

In the constituent securities of the index.

31

Features of ETF

An ETF is listed • Its units can be bought and sold anytime during stock exchange

trading hours.

Investors buy and sell ETF units through stockbrokers rather than unit trust agents.

An ETF is an index tracking fund.

Most ETFs are passively managed index funds • Managers do not pick stocks based on fundamental analysis.• Instead, managers track the performance of a benchmark index.

32

Nature of ETF with Respect to Stocks and Unit Trusts

ETF on the other hand resembles the feature of a unit trust.• E.g.; An investor purchases 1 unit of the unit trust. It

is as good as holding the various stocks on the Exchange/Bursa.

• Likewise when an investor purchases 1 unit, it is as if the investor is holding several top stocks. In addition, unit trust

involves active management where the fund managers pick the stocks that will generate a higher return than the

market return.

33

Comparison of Investment Fund

ETFS Stocks Unit TrustsNature Units that

represent basket of stocks

Shares Units that represent underlying basket of stocks

Traded on Exchange

Yes Yes No

Fund Information

Market price and trading activity data readily available

Market price and trading activity data readily available

Information available from fund manager and fund’s appointed agents

Diversification

Yes Yes No

Traded through Broker

Yes Yes No (via Agent)

34

Advantages of ETF

• Similar to index funds, ETFs provide investors with similar diversification benefits derived from holding the benchmark index's constituent stocks without having to invest in each of the stocks directly.Diversification

• As a passively managed fund, ETF incurs lower management fee and lower transaction costs as compared to an actively manage fund.Lower expense ratio

• ETF units are bought and sold at the same transaction cost as those charged for trading shares on the stock exchange. Buying and selling of normal unit trusts are subjected to transaction costs which are generally higher.Lower transaction cost

• ETF units can be bought and sold at anytime during trading hours of the stock exchange.Tradability

• ETF prices are disseminated throughout trading hours on the stock exchange. The constituentstocks of the index which the ETF tracks are normally published on the fund or indexprovider's websites.

Transparency

• As for Islamic ETFs, an additional benefit is its conformity to the Shariah principles and

practices, which is important to Muslims. Non-Muslims may also wish to invest in suchfunds based on Shariah principles.

Shariah-compliant investment

35

Disadvantages of ETF

ETF are bound to the ups and downs of the

market

• The performance of the ETF may be directly affected by the performance of its component stocks/securities represented in the benchmark index• ETF fluctuate a lot.

The risk of tracking error

• The performance of ETF is not representative of the performance of the benchmark index.

• Moreover, frequent trading of ETFs could be significantly increase commissions and other costs such that they may offset any savings from low fees or costs.

36

Islamic Exchange Traded Funds (I-ETF)

An Islamic ETF and

conventional ETF share common

characteristics

The main difference between a

conventional ETF and Islamic

ETF isThe benchmark index that the

Islamic ETF tracks.

An Islamic ETF only tracks an Islamic benchmark index where the index

constituents comprise of

companies which are Shariah-compliant.

An Islamic ETF is also required

to appoint a Shariah

adviser/committee

To provide expertise and

guidance to ensure its structure,

investment and all matters related to

the funds’ activities are comply with

Shariah.

37

The Operation of Islamic ETF

Diagram 1 : Basic Structure of an Islamic ETF38

Summary

In this chapter

you have learned about:

Investment Fund

Unit Trust

Real Estate Investment Trust

(REIT)

Exchange Traded Funds (ETF)

39

40 Thank you