Islamic equity market.pdf

8/14/2019 Islamic equity market.pdf

http://slidepdf.com/reader/full/islamic-equity-marketpdf 1/96

ISLAMIC EQUITY MARKET, SHARIAH STOCK

SCREENING & PREFERENCE SHARES

Prof Dato’ Dr. Mohd Azmi Omar

[email protected]

Level 4 Administration Building, International Islamic University Malaysia

53100 Gombak

Selangor Malaysia



2

Contents

Principles of Islamic equity investment

Islamic view on Ordinary share

Development in the Malaysian Islamic Capital Market

Islamic Equity Market Shari'ah Compliant stocks in Bursa Malaysia

Screening Methodology for Shari'ah-Compliant Stocks

Securities Commission of Malaysia

Dow Jones Islamic Market Indexes

Dow Jones-RHB Islamic Malaysia Index

FTSE Global Islamic Index Series

S&P Shariah Indices Guidelines on investment in Non-Shari'ah compliant securities

Preference shares

Convertible bonds



3

Principles of Islamic equity investment

Prohibition of riba (no guaranteed fixed return)Prohibition of gharar (uncertainty withy deceit)

and maysir (gambling)

Primary business activity must be in line withShari’ah

Majority of assets must be illiquid

Non-permissible income must be below a

specified threshold



4

Speculation & Gambling

Stock Market provides the avenue for firms toraise funds, for investor to invest their surplusfunds.

One needs to predict the future value of stock

prior to making any decision to buy or sell thestocks

Is speculation gambling?The Quran clearly prohibit us from gambling as

illustrated by the following verses relating togames of chance or gambling, referred to in Arabic as maysir ; Allah SWT says;



5


“They will ask thee about intoxicants and games ofchance. Say: In both there is great evil as well as somebenefit for man; but the evil which they cause is greaterthan the benefit which they bring." Quran (2: 219)

The Messenger of Allah (SAW) also forbade us fromgambling as illustrated in the following Hadith ;

From Abu Hurayrah (RA), that he said, "The Messenger

of God (S) forbade the 'sale of the pebble' [hasah ] [saleof an object chosen or determined by the throwing of apebble], and the sale of al-gharar. [Sahih Muslim ]



6


Ibn Taymiyah’s opinion on the above Hadith is thatgharar as the consequence of which is unknown andgoes further to claim that selling it involves maysir , whichis gambling. Maysir or gambling is prohibited in Islam

because it causes enmity and hatred and also involvesconsuming property bi-al-batil , which is a type ofoppression. Being given the obvious prohibition ofgambling in both the Quran and the Hadith of the

Prophet (SAW ), it is of utmost importance to determinewhether speculation in the stock market is similar togambling




Kamali (1996) defines speculation as consisting of "theintelligent and rational forecasting of future price trends on thebasis of evidence and knowledge of past and presentconditions".

Based on the Quranic verses and the Hadith of the Prophet

(SAW ), Ibn Taymiyah (ra) pointed out that if a sale containsgharar and devours the property of others, it is the same asgambling, which is clearly forbidden. Therefore, for atransaction to be equated to gambling, it must involve thedevouring and unlawful appropriation of the property of others.

Speculative risk taking in commerce, which involves theinvestment of assets, skills and labor is not similar to gambling.This is because the buyer is engaged in a transaction aimed atmaking profit through trading and not through dishonestappropriation of the property of others.




El-Ashkar (1995) defined speculation as "the practice of a) using available information tob) anticipate future price movements of securities so thatc) an action of buying or selling securities may be taken with a

view tod) buying or selling securities in order toe) realize capital gains and/or maximize the capitalized value of

security-holdings.

It is a process that relies on the analysis of a lot of economic and financial data, companies' financial reports,

political decisions, information about management skill andaptitude and the personal profile of the decision makers.That is to say, speculation is an activity that requires a greatdeal of knowledge and skills. Therefore, speculation instock markets cannot be equated to gambling.



The sale of gharar is said to lead to maysir (gambling) which leads to oppression and istherefore prohibited in Islam. It is evident thatgharar is not present in speculation in stockmarkets as each party is clear to the quantity,specification, price, time and place of delivery of the object. Moreover, the object of the transaction,which is the purchased security, is available in themarket at the time of transaction and is, bound to

be available at the time of delivery. Therefore,speculation has no element of gharar and, hence,does not lead to maysir .



Pro and Cons of Speculation

The above discussion has proved that althoughspeculation in the stock markets may look like gambling,yet it is by no means similar to gambling.

Its positive side is that it can help stabilize prices andactivate a market where there is thin trading. It can also

provide signals to less-informed investors upon which toact.

The negative effect of speculation is that excessiveamount of it may cause volatile price movements in themarket. It can thus be concluded that excessivespeculation should not be allowed, but a reasonabledegree of it be permitted. Quantitative limits on dailytrading volume and legislative guidelines may helpcontain speculation within healthy bounds.



What is an Ordinary Share?

A share is a document evidencingownership of the shareholder in the capitalof the corporation

It represents an undivided share in thecorporation assets and rights associatedwith it upon conversion of the capital into

tangible things, benefits, debts and so on(AAOIFI, Sharia Standard No.21)



Fiqh View of Investing in Ordinary Shares

Permissible

if the main business of the company is incompliant with Shari’ah rulings, then to

purchase, hold or sell its shares is permissibleeven if the company was to undertakeprohibited activities such as borrowing moneyand/or invest its money on the basis of interest,

the company can still be invested provided theyfulfil certain criteria. (Islamic Fiqh Academy,1992)



13

Each and every action of the company cannot beattributed to every shareholder in his/her individualcapacity

A shareholder may raise his objections to certaincompany transactions that may run contrary to Shari’ah

during the annual general meeting but these objectionsmay be overruled by the majority of the shareholders

the responsibility of committing a non-hala l activity suchas borrowing and investing money on the basis of

interest lies with those who commit such acts, it does notrender the whole company to be non-halal or non-permissible



14

Development in the Malaysian Islamic Capital Market(source: Securities Commission Malaysia)

YEAR MILESTONES

1990 Shell MDS Sdn Bhd issued the first Islamic bond

1993 Arab-Malaysian Unit Trust Bhd issued the firstIslamic equity unit trust fund (Arab-MalaysianTabung Ittikal)

1994 BIMB Securities Sdn Bhd, the first full-fledgedIslamic stockbroking company, was established



15

1995 Securities Commission (SC) Malaysia established the Islamic

Capital Market Unit

1996 SC established the Shari'ah Advisory Council (SAC)

Rashid Hussain Bhd (RHB) launched Malaysia’s first Islamic

equity index, comprising Shari'ah compliant shares of BursaMalaysia main board companies

1997 Khazanah Nasional Bhd launched the Khazanah MurabahahBond, which is a zero coupon bond based on murabahah andbai’ al-dayn concepts

SC launched an official SAC list of Shari'ah compliantsecurities that are traded on Bursa Malaysia. The list isupdated every April and October




16

1999 Bursa Malaysia launched Malaysia’s second Islamic equity

index, the Kuala Lumpur Shari'ah Index (KLSI), comprisingall Shari'ah compliant shares of Main Board companies

2000 SC imposed the requirement for issuers of Islamic bonds to

engage independent Shari'ah advisers, as stipulated in theGuidelines on the Offering of Private Debt Securities

RHB Unit Trust Management Bhd launched the first Islamicbond fund

SC launched a dedicated Islamic Capital Market section on

its website2001 The Capital Market Masterplan was launched. One of the

strategic initiatives was to establish Malaysia as aninternational Islamic capital market centre




17

2002 Kumpulan Guthrie Bhd issued a US$150 million sukuk ijarah;

the first global corporate bond issue. It was listed on theLabuan International Financial Exchange

Malaysian government issued a world’s first global sovereign

Islamic bond, sukuk ijarah, worth US600 million

SC imposed the requirement for the registration of Shari'ahindividuals/advisers for Islamic unit trust funds

MBf Unit Trust Management Bhd launched the first Shari'ahindex fund

SC published a book: Resolutions of the Securities

Commission Shari'ah Advisory Council




18

2002 Malaysian government, in its Federal Budget 2003, allowed

tax deduction for 5 years on expenses incurred in theissuance of Islamic bonds, based on the Shari'ah principles ofijarah, mudharabah and musharakah

2003 Malaysian government, in its Federal Budget 2004, allowed

tax deduction for 5 years on expenses incurred in theissuance of Islamic bonds, based on the Shari'ah principle ofistisna

2004 The International Organization of Securities Commission(IOSCO)’s Islamic Capital Market Task Force, chaired by SC

Malaysia, released the Islamic Capital Market Fact FindingReport as an IOSCO public document in July 2004

SC released the Guidelines on the Offering of Islamic

Securities




19


2004 Ingress Corp Bhd issued the first domestic corporate Islamicbond, which was modelled on the Malaysian Global Sukuk

Sarawak Corporate Sukuk Inc, a special purpose vehicleestablished by the Sarawak Economic DevelopmentCorporation launched a maiden 5-year US$350 million global

Sukuk Ijarah in the form of floating rate trust certificates that willmature in 2009. The sukuk is listed and traded on LFX

International finance Corp (IFC), the private arm of the WorldBank issued RM500 million Islamic bonds, which was the firstissuance of ringgit-denominated Islamic bonds by a

supranational body



20


2004 Additional tax measures were announced in the Budget 2005to remove any tax or duty on Islamic capital market products,provided such products were approved by the SAC of the SC

2005 The World Bank issued RM760 million Islamic bonds that willmature in 2010. This ringgit-denominated issue is the largestsupranational deal in the ringgit bond market



21

Islamic Equity Market

Islamic equity market in Malaysia showedtremendous progress

The number of Shari’ah compliant shares

has increased significantly from 371 in1997 to 826 in April 2005

In terms of percentage of Shari’ah

compliant stocks in Bursa Malaysia, 1997recorded only 57% whilst in April 2005 thepercentage has increased to 84%



22

Shari’ah compliant stocks in Bursa Malaysia

Number of Shari'ah Compliant Stocks in Bursa

Malaysia

371 476 531 542 543 541 544 585 636 677 699 778 826

280204

197 188 193 198 213 210 176

188 207185 159

0

200

400

600

800

1000

1200

Jun-

97

Dec-

97

May-

98

Sep-

98

Jan-

99

May-

99

Sep-

99

Sep-

00

Sep-

01

Sep-

02

Sep-

03

Sep-

04

Apr-

05

Year

N u m b e r o f S t o c k s

No of Shariah Compliant Stocks No of Non Shariah Compliant Stocks



23

Shari'ah Compliant Stocks in Bursa Malaysia

Percentage

of Non

Syariah-

Compliant

Stocks16%

Percentageof Syariah-

Compliant

Stocks

84%

As of April 2005

Sh i' h C li t St k i B M l i



24

Shari'ah Compliant Stocks in Bursa Malaysia(As of April 2005)

Main Board / Second Board /MESDAQ

ApprovedSecurities

TotalSecurities

Percentage of

ApprovedSecurities

Consumer Products 126 137 92

Industrial Products 279 301 93

Mining Nil 1 Nil

Construction 62 63 98Trading/Services 157 196 80

Properties 83 102 81

Plantation 41 44 93

Technology 64 68 94

Infrastructure (IPC) 7 9 98

Finance 5 55 9

Hotel Nil 5 Nil

Trusts 2 3 67

Close End Fund Nil 1 Nil

TOTAL 826 985 84




25

Shari'ah Compliant Stocks in Bursa Malaysia(As of 25 May 2007)

Main Board / Second Board /

MESDAQ

Approved

Securities

Total

Securities

Percentage of

Approved

Securities



Mining 1 1 100

Construction 57 59 97

Trading/Services 166 204 81

Properties 80 100 80

Plantation 41 47 87

Technology 104 106 98

Infrastructure (IPC) 8 9 89Finance 5 47 11

Hotel Nil 5 Nil


TOTAL 875 1,023 86




26

Shari'ah Compliant Stocks in Bursa Malaysia(As of 30 May 2008)

Main Board / Second Board /

MESDAQ

Approved

Securities

Total

Securities

Percentage of

Approved

Securities



Mining Nil 1 Nil

Construction 51 55 93

Trading/Services 168 204 82

Properties 72 92 78

Plantation 38 45 84

Technology 101 104 97

Infrastructure (IPC) 6 8 75Finance 5 42 12

Hotel Nil 5 Nil


TOTAL 843 988 85



27


Currently there is no international Shari'ah standard forstock screening

Different funds or fund managers utilise differentstandards based on their respective Shari'ah councils

In Malaysia we have the list issued by Syariah AdvisoryCouncil of Securities Commission, Dow Jones-RHBIslamic Malaysia Index and FTSE Bursa Malaysianamely FBM Hijrah Shariah Index and FBM EMASShariah Index

At the global level we have the Dow Jones IslamicMarket Indexes, FTSE Global Islamic Index Series andS&P Islamic Index Series and MSCI Islamic IndexSeries

http://a/SCREENING%20RATIOS.xls

http://a/SCREENING%20RATIOS.xls



28


Rules to ensure that ordinary shares are Shari'ahcompliant

The stock screening process is divided into two stages: Evaluation in terms of company activities, products and industry –

Negative screen

Computation of a set of financial ratios & compare them against

specified benchmarks

The screening process begins by screening thecompany in terms of its activity, products and industry

alcohol, tobacco, pork-related products, conventionalfinancial services, weapon and defense, entertainment(hotels, casinos/gambling, cinema, pornography, music,etc.) are excluded



29


Next, a set of measures called financial filters is also used to

refine the selection. The filters use a number of financial ratios and compare

them against their respective benchmarks to weed out non-Shari’ah compliant stocks

The data for ratios are obatined from Balance Sheet andIncome Statement. Dow Jones and S&P Indexes use stockmarket data as well

In general these ratios can be grouped into 3; liquid assets,interest income and leverage

The ratio benchmark ranges from: Liquid asset: 17% to 70%

Interest income and/or Income from Shariah Non-compliantactivities : 5% to 15%

Leverage: 30% to 33%

S i M th d l f Sh i' h C li t St k



30

Screening Methodology for Shari'ah-Compliant Stocks :

Securities Commission of Malaysia

Securities Commission of Malaysia applied additional

criteria to companies which are involved in multiplebusiness, i.e., companies whose business activitiescomprise both Shari'ah permissible and non-permissibleelements. The analysis is done at the holding company,subsidiary company and associate company levels. Theadditional criteria include: Core activities of the company are activities not against the

Shari'ah principles as mentioned earlier Haram element is small compared to core activities, i.e.,

compared against benchmark Public image/perception of company is good

Core activities of the company are important and of publicinterest (maslahah) to the muslim ummah and the country Proportion of haram element is small and in matters such as

umum balwa (common plight), ‘uruf (customs) and the rights ofthe non-Muslim community which are accepted by Islam



31

Screening Methodology for Shari'ah-Compliant StocksSecurities Commission of Malaysia

It maybe possible that a company’s main business is

Shari’ah compliant but the revenue from the subsidiary

whose activities are not Shari’ah compliant may lead to

that company being considered as non-Shari’ahcompliant



32

Screening Process of SAC, Securities Commission, Malaysia

Activity, Industry

& Product

•

Financial servicesbased on riba (interest)

• Gambling/gaming

• Manufacture and / or

sale of non-halal

products

• Manufacture or sale of

tobacco-based products

or related products

• Conventionalinsurance (gharar)

• Entertainment

• Stockbroking or share

trading in Shari’ah non-

compliant securities

•Other activities

deemed non-

permissible

Quantitative Analysis

•

TO and PBT of non-approved activities

•SOP of non-approved

securities

•Interest Income

•Dividend received

from investment in

non-approved

securities

•All of the above must

be below certain

threshold

Image – public

perception or image of

the company,

importance of the

companies to ummah,

uruf (custom), umum

balwa (common

plight), rights of non-

muslims etc.

P e r mi s s i b l

e

Stage 1 Stage2 Stage 3

No Yes Yes

Drop

DropDrop

Yes

No

No

Qualitative Analysis

•List is updated every end of May and end of Nov. Previously it was

• end of April and October



33

1. Group TO2. Group PBT

1. TO and PBT of non approved activities2. SOP of non approved activities3. Interest income4. Dividend received from investment in non approved securities

Consolidate information on :

1. TO and PBT of non permissible activities vs group TO and PBT2. SOP of non permissible activities vs group PBT3. Interest income vs group TO4. Dividend received from investment in non approved securities vs group PBT

Compute percentage of contribution :

Non-approved if exceeds financial benchmark

Compare the percentages against financial benchmark

SC Stage 2 : Quantitative Analysis

(Source: Nik Ruslin, SC)



34

SC - Financial benchmarks

The 5-percent benchmark to assess the level of mixed contributions from the

activities that are clearly prohibited such as riba(interest-based companies like conventional banks),gambling, liquor and pork

The 10-percent benchmark

to assess the level of mixed contributions from theactivities that involve the element of ‘umum balwa’ which

is prohibited element affecting most people and difficultto avoid e.g interest income from fixed deposits inconventional banks and tobacco-related activities



35

The 20-percent benchmarkThis benchmark is used to asses the level of

contribution of mixed rental payment from Shariah non-compliant activities, such as rental payments frompremises used in gambling, sale of liquor, etc.

The 25-percent benchmark to assess the level of mixed contributions from the

activities that are generally permissible according toShari’ah and have an element of maslahah to the public,but there are other elements that may effect the Shari’ah

compliance status of these activities for e.g hotel andresort operations, share trading, stockbroking, as theseactivities may also involve other activities that aredeemed non-permissible to the Shari’ah



36

Financial Filters of SAC, SC Malaysia

II PROHIBITED INCOME

1 Interest Income/Group Turnover

7 Non Permissible Income other than Interest Income/Revenue

8 Income from Tobacco/Revenue

11 PBTof Subs or Asso Co(non-halal activity)/PBT of Group

12 PBTof Subs or Asso Co(mixed rental income)/PBT of Group

13 PBTax of Subs or Asso Co(hotel & resort)/PBT of Group

14 Turnover of Subs or Asso Co(non-halal activity)/Turnover of Group 15 Turnover of Subs or Asso Co(mixed rental income)/Turnover of Gro

16 Turnover of Subs or Asso Co(hotel & resort)/Turnover of Group

Fiqh Justification for Shariáh benchmarks



37

Fiqh Justification for Shariáh benchmarks(source: SC Malaysia)

Status of mixed business companiesNo historical precedent

Cited Ibnu Subki in Al-Ashbah wa al-Naza’ir – “to rule as

prohibited something that is a mix of the permissible andthe prohibited is ihtiyat (precautionary measure) and it isnot necessarily prohibited”.

SC Malaysia took into accounts other Fiqh principles tosupport their case

These include maslahah, ‘umum balwa, ‘urf khas minasalib iqtisodiyah, fasaduz zaman and huquq ghairmuslimin

Fiqh Justification for Shariáh benchmarks



38

Fiqh Justification for Shariáh benchmarks(source: SC Malaysia) (cont…)

In addition they also cited Ibnu Qayyim whowrote in his book “Bada’ie al-Fawa’id” about thenature of prohibited property which is of 2 kinds:Prohibited because of its zat (nature), for, e.g., pork,

liquor. Hence mixing of meat slaughtered by Muslim andNon Ahli Kitab is prohibited.

Prohibited due to other reasons such as the means orway it is earned or acquired. For e.g. money in itself isokay but the manner it is acquired such as by robbery isnot acceptable. Shares of companies are by natureacceptable but shares of mixed business companiesmay not be acceptable



39

Shariah Benchmark

50% ruleUtilize the fatwa concerning silk mixed with

common thread. This is based on the hadith ofthe Prophet saw:

“The Prophet saw took a piece of silk and placed iton his right. He took some gold and placed it on hisleft. Then he said: “Both these things are prohibited

unto men among my followers, but permissible forthe women”

If it is pure silk then it is prohibited for men towear the silk cloth but if the cloth is mixed with50% or less silk and the remaining common

thread then it is permissible



40

Shariah Benchmark (cont..)

One Third rule

Utilize the analogy of hibah (gift) where aperson can bequeath a maximum of one third of

his property as gift to an unrelated personBenchmark based on Ghabn Fahish

(extraordinary margin or profit or gain)

Describes gain through cheating andmanipulation (tanajush)



41

Shariah Benchmark (cont..)

Ghabn fahish accompanied with tanajush is notpermissible

Hanafi mazhab ruled that the upper limits for

ghabn fahish are as follows:5% for ordinary goods

10% for animals used for riding and

20% for fixed assets



42

Case Study 1 : Kaya Raya Holdings Berhad

Principal activity – Construction and civil engineering

Associated

Kaya Raya

Holdings Berhad

KRH Cons.Sdn. Bhd

Subsidiary Lai KuaySdn. Bhd

Strong HeartSdn. Bhd

Kapur Barus

Sdn. Bhd

Kejuruteraan

Siaga Sdn. Bhd

Tobacco business

Related information

Group info :

Group TO : RM10 millionGroup PBT : RM 5 million

Non-permissible activities

info :

TO tobacco : RM 900,000

PBT tobacco : RM 400,000




43

Case study 1 : Pre-compliance result

Benchmark for tobacco : 10% of Group TO or Group PBT

Pre-compliance result :

Approved (contribution from tobacco below the benchmark)

Non-permissibles CalculationQuantitative

result

Percentage of tobaccoto Group TO

RM900,000 / RM10.0 mil 9%

Percentage of tobaccoto Group PBT

RM400,000 / RM5.0 mil 8%




44

Case Study 2 : Teguh Tegap Holdings Berhad

Principal activity – Manufacturing of furniture and other related industry

Associated

Teguh Tegap

Holdings Berhad

Cengal BiruSdn. Bhd

Subsidiary Nyatoh TuaSdn. Bhd

Merbau SiamSdn. Bhd

Plywood

Sdn. Bhd

Nasib Baik

Sdn. Bhd

Gaming business

Related information

Group info :

Group TO : RM 2 millionGroup PBT : RM 500,000


info :

Interest income : RM 220,000

SOP gaming : RM 24,000

Interest income




45


Benchmark for interest income : 10% of Group TO

Benchmark for gaming : 5% of Group TO / Group PBT


Non-approved (contribution from interest income exceeds the

benchmark)


result

Percentage of interestincome to Group TO

RM220,000 / RM2.0 mil 11%

Percentage of gamingto Group PBT (SOP)

RM24,000 / RM500,000 4.8%




46

Case Study 3 : Blind Spot Berhad

Principal activity – Construction

Associated

Blind Spot

Berhad

Go AheadSdn. Bhd

Subsidiary Ho HapSdn. Bhd

Gantang Besar Sdn. Bhd

Hud Hud

Sdn. Bhd

Garuda

Sdn. Bhd

Gaming business

Related information

Group info :

Group TO : RM 10 million

Group PBT : RM 5 million


info :

TO liquor : RM 400,000

PBT liquor : RM 120,000

TO gaming : RM 200,000PBT gaming : RM100,000

Liquor business




47


Benchmark for liquor and gaming : 5% of Group TO / Group PBT

Contribution from non-approved activities :

Group TO : (4% + 2%) = 6%

Group PBT : (2.4% + 2) = 4.4


Non-approved (contributions from non-approved activities [liquor & gaming] exceed the benchmark)


result

Percentage of liquor toGroup TO

RM400,000 / RM10.0 mil 4%

Percentage of liquor toGroup PBT

RM120,000 / RM5.0 mil 2.4%

Percentage of gaming toGroup TO

RM200,000 / RM10.0 mil 2%

Percentage of gaming toGroup PBT

RM100,000 / RM5.0 mil 2%


Screening Process of Dow Jones Islamic Index



48

(before 2001)

Activity, Industry

and Product Non-Permissible

Activities:

•Pork Production

• Non-Halal Food

Products

•

Alcohol Beverages•Gaming

•Interest based

Financial Institution

•Entertainment

•Arms, Defense

•Tobacco

•Activities Contraryto Islam

Stage 1 Stage 2

Financial Ratio Filters

•Total Debt to Total

Asset Ratio 33%

•Account Receivables

to Total Asset Ratio

47%

• Non-Operating

Interest Income to

Operating Income

9%

Drop

Drop

No

Yes

No YesPermissible

* List is updated every quarter

Screening Process of Dow Jones Islamic Index



49

(2001)

Activity, Industry

and Product

Non-Permissible

Activities:

•Pork Production

• Non-Halal Food

Products

•Alcohol Beverages•Gaming

•Interest based


•Entertainment

•Arms, Defense

•Tobacco

•Activities Contrary

to Islam

Stage 1 Stage 2


•Total Debt to Trailing 12-Month

Moving Average Market

Capitalization 33%

•Account Receivables to Total

Asset Ratio 45%

•Cash + Interest Bearing

Securities to Trailing 12-Month


Capitalization 33%

Drop

Drop

No

NoPermissible

Yes

Yes




50

Screening Process of Dow Jones Islamic Index (2003)

Activity, Industry

and Product

Non-Permissible

Activities:

•Pork Production

• Non-Halal Food

Products

•Alcohol Beverages•Gaming

•Interest based


•Entertainment

•Arms, Defense

•Tobacco


to Islam

Stage 1 Stage 2

Financial Ratio Filters•Total Debt to Trailing 12-Month


Capitalization 33%

•Account Receivables to Trailing

12-Month Moving Average Market

Capitalization 33%

•Cash + Interest Bearing Securities

to Trailing 12-Month Moving

Average Market Capitalization

33%

Drop

Drop

No

NoPermissible

Yes

Yes


Sharia Non-compliant Business (Industry



51

Sharia Non compliant Business (IndustryClassification Benchmark, ICB)

2717 Defense

3535 Distillers & Vintners 3577 Food Products

3745 Recreational Products

3785 Tobacco

5337 Food Retailers &Wholesalers

5553 Broadcasting &Entertainment

5555 Media Agencies

5752 Gambling 5753 Hotels

5755 Recreational Services

5757 Restaurants & Bars

8355 Banks

8532 Full Line Insurance 8534 Insurance Brokers

8536 Property & CasualtyInsurance

8538 Reinsurance

8575 Life Insurance

8733 Real Estate Holding &Development

8773 Consumer Finance

8775 Specialty Finance 8777 Investment Services

8779 Mortgage Finance

D J I l i M k t I d



52


• Introduced in 1999.

• Subset of Dow Jones Global Indexes.

40% of DJ Global Index’s market cap.

• 60 indexes.

• 6 Islamic scholars.

D J I l i M k t I d



53


The DJIMI family includes global, regional, country,

industry, and market-cap-based indexes.

Global Indexes

DJIMI

DJIM Large-Cap IndexDJIM Mid-Cap Index

DJIM Small-Cap Index

DJIM - Ex. U.S. Index

DJIM Developed Index

DJIM Developed - Ex. U.S. Index

DJIM Emerging Markets Index

Global Industry Indexes

DJIM Basic Materials Index

DJIM Consumer Goods IndexDJIM Consumer Services Index

DJIM Oil & Gas Index

DJIM Financials Index

DJIM Health Care Index

DJIM Industrials Index

DJIM Technology Index

DJIM Telecommunications Index

DJIM Utilities IndexTitans (Blue-Chip) Indexes

DJIM Titans 100 Index

DJIM Europe Titans 25 Index

DJIM Asia/Pacific Titans25Index

DJIM U.S. Titans 50 Index

D J I l i M k t I d



54


U.S. Indexes

DJIM U.S. Index

DJIM U.S. Large-Cap Index

DJIM U.S. Mid-Cap Index

DJIM U.S. Small-Cap Index

Europe and Eurozone Indexes

DJIM Europe Index

DJIM Europe Large-Cap Index

DJIM Europe Mid-Cap Index

DJIM Europe Small-Cap Index

DJIM Euro IndexDJIM Euro Large-Cap Index

DJIM Euro Mid-Cap Index

DJIM Euro Small-Cap Index

Asia/Pacific Indexes

DJIM Amana Sri Lanka Index

DJIM Asia/Pacific Index

DJIM Asia/Pacific Large-Cap Index

DJIM Asia/Pacific Mid-Cap Index

DJIM Asia/Pacific Small-Cap Index

DJ-JS Pakistan Islamic IndexDJ-RHB Islamic Malaysia Index

Other Country/Regional Indexes

DJIM Canada IndexDJIM U.K. Index

DJIM Japan Index

DJIM BRIC Index

DJIM China Offshore Index

DJIM Turkey Index

Specialty Indexes

DJIM Sustainability Index

DJ DFM Index

DJ DFM Titans 10 Index



55

Screening Process of FTSE Global Islamic Index Series

(In collobration with TII prior to 2006)

Activity, Industry

and Product

Non-Permissible

Activities:

•Pork Production

• Non-Halal Food

Products

•Alcohol Beverages

•Gaming

•Interest based


•Entertainment

•Arms, Defense

•Tobacco


to Islam

Stage 1 Stage 2


• Total Interest

Bearing Debt to

Total Asset Ratio

33.33%

Drop

Drop

No

Yes

No YesPermissible

Cleanse

tainted

dividend




56

Screening Process of FTSE Global Islamic Index Series

(In collobration with Yasaar, 2006 onwards )

Activity, Industry

and Product

Non-Permissible

Activities:

•Pork Production

• Non-Halal Food

Products


•Gaming

•Interest based


•Entertainment

•Arms, Defense

•Tobacco


to Islam

Stage 1 Stage 2


• 5 ratios are

computed

Drop

Drop

No

Yes

No YesPermissible

Cleanse

tainted

dividend


5%

FTSE FINANCIAL FILTERS



57

FTSE FINANCIAL FILTERS

FTSE GlI**

I LIQUIDITY

3 Acc Rec + Cash/Total Asset <

6 Cash + Int Bearing Sec/Total Assets <


1 Interest Income/Group Turnover < 5%

7 Non Permissible Income other than Interest Income/Revenue < 5%

III DEBT

2 Total Debt/Total Asset <

FTSE Gl b l I l i I d S i



58



• Subset of FTSE All-World Index universe.

• 5 indexes.

• Shariah Board with Yasaar Research Inc.

FTSE Gl b l I l i I d S i



59


• FTSE Global Islamic Index

• FTSE Americas Islamic Index

• FTSE Europe Islamic Index

• FTSE Pacific Basin Islamic Index

•

FTSE South Africa Islamic Index



60

Screening Process of S P Shariah Indices

Activity, Industry

and Product

Excludes:

•Pork Production

• Non-Halal Food

Products


•Gaming

•Interest based


•Entertainment

•Arms, Defense

•Tobacco

•Gold & silver

trading as cash ondeferred basis


to Islam

Stage 1 Stage 2


• 4 ratios

Drop

Drop

No

Yes

No YesPermissible

Cleanse

tainted

dividend


S&P FINANCIAL FILTERS



61

S&P FINANCIAL FILTERS

S&P SI

I LIQUIDITY

2 Acc Rec/12 Mth MA Market Cap < 49%

5 Cash + Int Bearing Sec/12 Mth MA Market Cap. < 33%II PROHIBITED INCOME

7 Non Permissible Income other than Interest Income/Revenue < 5%

III DEBT

1 Total Debt/12 Mth MA Market Cap <

S&P Shariah Indices



62

S&P Shariah Indices


• Subset of S&P 500, S&P Europe 350, and

S&P Japan 500 universes.

60% of parent index’s market cap.

• 3 indexes.

• Shariah Board with Ratings IntelligencePartners.

MSCI Shariah Index



63

MSCI Shariah Index

Established in May 2007

Stage 1: Core Business – Negative Screen: Alcohol

Tobacco

Pork-related products

Financial services

Defense/weapons

Gambling

Music

Hotels Cinema

Adult Entertainment



64

Stage 2: Financial Filters

Stage 3: Dividend Purification

Argues that part of company’s total income isderived from interest income. Hence a portionof dividend paid out to shareholders must bededucted and given out to charity

Ratio Benchmark

Total Debt/Total Assets < 33.33%

Cash + Interest-bearing securities / Total Assets

< 33.33%

Account Receivables / Total Assets < 70%



65

Dividend adjustment factor is used todetermine “clean dividends”

Calculated as follows:

(Total Earnings – Interest Income) / Total EarningsNote that Total earnings are defined as gross

income, and interest income as operating andnon-operating interest

Jakarta Shariah Index



66

Jakarta Shariah Index

Stage 1: Core Business Selection-Negative

ScreenGambling

Conventional financial institutions

Production, distribution, provision and trading ofproducts and services that are prohibited byShariah

Stage 2: Financial Filters

Interest-bearing debt/Total Equity : <45%:55% or81.82%

Interest Income & Income from Non-Shariahcompliant business activities/Total Revenue: ≤ 10%



67

JSI consists of 30 stocks

List reviewed twice a year, every Januaryand July

AAOIFI Criteria for Shariah Compliant



68

pShares

Requirement for main business ofcompany not to engage in prohibitedbusiness according to Shariah

Financial filters and their respectivebenchmarks are as follows:Ratio Benchmark

Total Interest -based Debt/Total Asset 30%

Income from prohibited activity/Total Income 5%



69

Screening Process Of Islamiq.com

Activity, Industry

& Product Non-Permissible

Activities:

- Pork Production

- Non-Halal food

Products

- Alcoholic Beverages

- Gaming

- Interest-based

Financial Institutions

- Entertainment

- Arms, Defense

- Tobacco

- Activities contrary

to Islam

Interest Income

•Total Interest

Income 5% of

company Gross

Total Revenues

Note: Interestexpense should

not be deducted

from this amount

Leverage & Asset

Liquidity

Total conventional

Debt to Equity

ratio 30%

Cash and short term

investments to Total

Assets Ratio 45%

P e r mi s s i

b l e

Stage 1 Stage2 Stage 3

No Yes Yes

Drop

DropDrop

Yes

No No

Financial Filters



70

Financial Filters

SC M'sia DJIM*** FTSE GlI** S&P SI MSCI AAOIFI JSI Meezan

I LIQUIDITY

1 Acc Rec/Total Asset < 70%2 Acc Rec/12 Mth MA Market Cap < < 49%

3 Acc Rec + Cash/Total Asset <

4 Cash + Int Bearing Sec + Acc Rec/Total Assets

5 Cash + Int Bearing Sec/12 Mth MA Market Cap. < < 33%

6 Cash + Int Bearing Sec/Total Assets < < .

7 Total Illiquid Asset/Total Asset ≥10%

8 Net Liquid Asset (CA-CL) Per share/Market Price Per share < 1


1 Interest Income/Group Turnover < 5%

2 Interest Income/Gross Total Revenue3 Interest Income/Net Income

4 Interest Income/Net Sales

5 Interest Income/Total Income

6 Non Operating Interest Income/Operating Income

7 Non Permissible Income other than Interest Income/Revenue < 5% < 5%

8 Income from Tobacco/Revenue

9 Income from Shariah Non-compliant Investment/Gross Revenue

10 Income fom Shariah Non-compliant Activities/Total Income or Revenue < 5% < 5% <10%

11 PBTof Subs or Asso Co(non-halal activity)/PBT of Group

12 PBTof Subs or Asso Co(mixed rental income)/PBT of Group

13 PBTax of Subs or Asso Co(hotel & resort)/PBT of Group

14 Turnover of Subs or Asso Co(non-halal activity)/Turnover of Group

15 Turnover of Subs or Asso Co(mixed rental income)/Turnover of Gro

16 Turnover of Subs or Asso Co(hotel & resort)/Turnover of Group

III DEBT

1 Total Debt/12 Mth MA Market Cap < <

2 Total Debt/Total Asset < < . < ≤45%

3 Total Debt/Total Equity <81.82%

Islamic Stock Indices Comparison



71

Islamic Stock Indices Comparison

Dow Jones

Index MarketFTSE SI S&P SI

Index Review Annual review in June Annual review inSeptember

Semi-annual review inMarch and September

Composition Review Quarterly reviewChanges implemented

on the 3rd

Friday inMarch, June,September andDecember

Quarterly reviewChanges implemented

on the 3rd

or the 2nd

Friday in March, June,September, December(2nd Friday onlyapplicable for S&PJapan 500 Shariah)

Semi-annually reviewChanges implemented

on the 3rd

Friday inMarch andSeptember.

Component

Weightings Review

Quarterly update

Changes > 10% innumber of shares,updated Immediately

Quarterly update

Changes > 5% innumber of shares,updated immediately

Semi-annually update

Computation Float-adjusted value-weighted

Float-adjusted Value-weighted

omparison between Shari’ah compliant securities of S Malaysia and



72

Dow Jones-RHB Islamic Malaysia as of May 2005

Number ofShari’ah

CompliantStocks

Number ofStocks in BursaMalaysia

Percentage ofShari’ah

CompliantStocks

SC 826 985 84%

DJ-RHB 45 985 4.6%

Stock Indexes



73

Stock Indexes

Uses

Track average returnsMeasure relative performance of fund/fund

managers relative to benchmark

Base of derivatives

Market’s way of rewarding and punishing

fund managers

Monitoring flow of asset accumulation and

redemption Advertising campaign for fund sponsors



74

Factors in constructing or using an Index Representative? – composite, sectoral

Broad or narrow?

How is it constructed?

Construction of Indexes



75

Construction of Indexes

How are stocks weighted?Price weighted (NST Indexes, DJIA)

Market-value weighted (KLSE CI, S&P 500,DJIM, S&P Shariah Index)

Equal weighted (Value Line Index)

Sample size (KLCI: 100, DJIA:30)

Representativeness – composite, sectoralConvenience units

Value-weighted methods



76

76

Value-weighted methods

t

t

t

t

USD

iii

n

it

USD

it it it

n

it

D

M basevalue

B

M basevalue

X q pC

X q p Index

)(

)(

0001

1

where:

n : the number of stocks in the index

pi0 : the closing price of stock (i) at the base date (31/12/1998)qi0 : the number of free float shares of stock (i) at the base date (31/12/1998)

pit : the price of stock (i) at time (t)

qit : the number of free float shares of stock (i) at time (t)

Ct : the adjustment factor for the base date market capitalization

t : the time the index is computed

Mt : free float market capitalization of the index at time (t)

Bt : adjusted base date market capitalization of the index at time (t)

X : cross rate: domestic currency in USD of company (i) at time (t) {applies only to companies that are not traded in USD}

USD

it

The continuity in index values is maintained by adjusting the divisor for all changes in

the constituents’ share capital after the base date. This includes additions and

deletions to the index, rights issues, share buybacks and issuances, and spin-offs.



77

HYPOTHETICAL STOCK INDEX DATA

Quarter-End

0 1 2 3 4Price per Share

A* 5 2.5 3.5 2.1 2.5

B 5 5 6 6.5 7

C 5 5 5.5 6 5.7

D 5 5 8 10 9.5

E 5 5 8 10 9.5

Shares Outstand in g

A* 1,000 2,000 2,000 4,000 4,000

B 1,000 1,000 1,000 1,000 1,000 C 1,000 1,000 1,000 1,000 1,000

D 200 200 200 200 200

E 200 200 200 200 200

M ark et Capi tal ization RM

A* 5,000 5,000 7,000 8,400 10,000

B 5,000 5,000 6,000 6,500 7,000

C 5,000 5,000 5,500 6,000 5,700

D 1,000 1,000 1,600 2,000 1,900

E 1,000 1,000 1,600 2,000 1,900

Total sample 17,000 17,000 21,700 24,900 26,500

All other stocks 13,000 14,000 20,000 23,000 25,000

Total all stocks 30,000 31,000 41,700 47,900 51,500

Dividend Distr ibu tions

Total A-E NA 170 185 210 240

All other stocks NA 70 90 110 125

Total all stocks NA 240 275 320 365

* Two for one split at end of quarters 1 and 3



78

Market Value Weighted

Index = Aggregate Market Value of Component Stocks on date tBase AMV at date 0

= Σ P1 Q1

Σ P0 Q0

Where Σ P1

Q1

= Current AMV

Σ P0 Q0 = Base AMV

Date Market Value Weighted Index Calculation

0 RM17,000/17,000 = 100

1 RM17,000/17,000 = 100

2 RM21,700/17,000 = 127.65

3 RM24,900/17,000 = 146.474 RM26,500/17,000 = 155.88

Index Computation Method: Free-



79

79

Float Weighting

Free Float Weighting ≠ Full Market Capitalization weighting

1. Trade investments in an index constituent.2. Significant long-term holdings by founders, their families, and/or

directors.

3. Employee Share Ownership Plans

4. Government holdings.

5. Portfolio investments subject to a lock-in clause, for the duration of that

clause.

Index Computation Method: Free-FloatW i h i



80

80

Weighting

Non Free-float (%) = ______________restricted factors_________________Total number of shares outstanding excl. treasury shares

Free-Float (%) = 100% - Non Free-float (%)

Example Issuer A Issuer B

Total shares listed 100 130

Treasury shares - 30

Shares outstanding – net of T/S 100 100

Restricted factors (non free-float) 15 27

Free-Float holding 85 73

Free-Float % 85% 73%

Index Computation Method: Free-FloatW i hti



81

81

Weighting

Amount of Free-Float % Free-Float

15% Not eligible

15% - 20% 20%

20% - 30% 30%

30% - 40% 40%

40% - 50% 50%

50% - 75% 75%

75% 100%

Issuer Current

weighting

Free-

float

Free-Float

weighting

A 2.5% 100% 2.5%

B 0.5% 75% 0.375%

Issues in Shariah Filters



82

Issues in Shariah Filters

Impact of Liquidity ratio filter on Islamicbanks and Islamic financial institutions –

will they be included in the list of Shariahcompliant companies

Global Indices favors firms from USA,Europe and advanced countries – whatabout companies in the Muslim world

Negative screen only- provides a list ofnon-Shariah compliant activities



83

Weightage of DJIM:

(Source: Siddiqui, 2007)



84

What about positive screen? – Concern for the

environment, corporate governance, contribution to theeconomic development of Muslim countries /communities, etc, see for e.g., DJ Dharma Index(Buddhist index)

Source: Siddiqui, 2007



85

Limitations on assets diversification.

Higher fee (monitoring costs).

Early warning signal.

Absence of uniform prudential regulation.

Restrictions of some hedging techniques

Advantages of Shariah Index:

Shariah compliance.

Competitive performance.

DJIM vs DJWI Sectors (31/12/07)



86

DJIM vs DJWI Sectors (31/12/07)

(Source: Siddiqui, 2007)

Performance of Shariah Indices



87

87

Performance of Shariah Indices

Atta (2000) DJIMI outperformed the unscreened indexduring bull period (‘96-’99).

Hussain (2004) FTSE GIIS performed at least as good as

FTSE All-World Index.Bull market: FTSE GIIS performed better.

Bear market: FTSE GIIS performed lower.

Hakim & Rashidian (2004) investors Islamic index are notworse-off (DJIMI is in line with other indexes).

DJIMI outperforms unscreened index.

DJIMI outperformed by non-Islamic ethical index.

Performance Shariah Indices



88

88

Performance Shariah Indices

Better performance during Bull period probably due to the

Non-Shariah characteristics of Islamic index:

Small caps, technology, growth stocks.

Low interest income productive use of cash surplus.

Low receivables efficient working capital management.

General expectation:

screened index will performed poorly than unscreened index.

Preference Shares (saham Preferen)



89

e e e ce S a es (sa a e e e )

Malaysian Companies Act 1965 hasdefined preference share as a share thatdoes not give a right to the shareholders to

vote at its general meeting or any right toparticipate in any distribution of thecompany that has stated the amount,

whether through dividends, redemption,dissolution or otherwise

Preference Shares (saham Preferen)



90

The characteristics of a preference shares

are as follows: Predetermined or fixed rate of dividend very

much similar to bond

Has higher priority of claims over ordinaryshareholders in dividend payment and assets if business is liquidated. However stands belowcreditors or debt holders in claim of assets if

business is liquidated No voting rights unlike ordinary shareholders

Types of Preference Shares



91

Cumulative preference shares

Dividend payment is fixed and predetermined

In the event that the company fails to paydividend in one year, that dividend will be

accumulated and paid in the following year Non-cumulative preference shares

Dividend payment is fixed and predetermined

In the event that the company fails to paydividend in one year, that dividend will not beaccumulated and therefore not paid in thefollowing year

Preference Shares (cont.)



92

( )

OIC Fiqh academy ruled that (both typesof ) preference shares are not permissible

However the Shariah Advisory Council of

Malaysian Securities Commission ruledthat non-cumulative preference shares arepermissible based on tanazul where theright to profit of the ordinary shareholder isgiven willingly to a preference shareholder.

Convertible Stocks/Bonds



93

Preference shares or bonds that will beconverted into ordinary shares after apredetermined period

Value of future conversion is uncertain althoughthe conversion ratio, i.e., the number of ordinaryshares that will be given upon conversion, isfixed

No formal fatwa given although most Shari’ah scholars are concerned about element of gharar

Shareholder Rewards



94

Cash dividends No objections from Shari’ah

Bonus issue or stock dividend

Shares in lieu of cash No objections from Shari’ah

Rights issues Current shareholders given special right to

purchase new shares at below market price

Acceptable to Shari’ah



95

Shareholder benefits or perks

Rewards given to shareholder in kind ratherthan cash, for e.g., free food or food coupon,

hotel stays etc Acceptable to Shari’ah



Wallahuwa’alam

Thank [email protected]

Islamic equity market.pdf

Documents

Transcript of Islamic equity market.pdf