Islamic Equity Market PDF

ISLAMIC EQUITY MARKET, SHARIAH STOCK
SCREENING & PREFERENCE SHARES

Prof Dato Dr. Mohd Azmi Omar
azmiomar@iium.edu.my
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 with
Shariah
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 to
raise funds, for investor to invest their surplus
funds.
One needs to predict the future value of stock
prior to making any decision to buy or sell the
stocks
Is speculation gambling?
The Quran clearly prohibit us from gambling as
illustrated by the following verses relating to
games of chance or gambling, referred to in
Arabic as maysir; Allah SWT says;
5
They will ask thee about intoxicants and games of
chance. Say: In both there is great evil as well as some
benefit for man; but the evil which they cause is greater
than the benefit which they bring." Quran (2: 219)
The Messenger of Allah (SAW) also forbade us from
gambling 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] [sale
of an object chosen or determined by the throwing of a
pebble], and the sale of al-gharar. [Sahih Muslim]
6
Ibn Taymiyahs opinion on the above Hadith is that
gharar as the consequence of which is unknown and
goes further to claim that selling it involves maysir, which
is gambling. Maysir or gambling is prohibited in Islam
because it causes enmity and hatred and also involves
consuming property bi-al-batil, which is a type of
oppression. Being given the obvious prohibition of
gambling in both the Quran and the Hadith of the
Prophet (SAW), it is of utmost importance to determine
whether speculation in the stock market is similar to
gambling
7
Kamali (1996) defines speculation as consisting of "the
intelligent and rational forecasting of future price trends on the
basis of evidence and knowledge of past and present
conditions".
Based on the Quranic verses and the Hadith of the Prophet
(SAW), Ibn Taymiyah (ra) pointed out that if a sale contains
gharar and devours the property of others, it is the same as
gambling, which is clearly forbidden. Therefore, for a
transaction to be equated to gambling, it must involve the
devouring and unlawful appropriation of the property of others.
Speculative risk taking in commerce, which involves the
investment of assets, skills and labor is not similar to gambling.
This is because the buyer is engaged in a transaction aimed at
making profit through trading and not through dishonest
appropriation of the property of others.
8
El-Ashkar (1995) defined speculation as "the practice of
a) using available information to
b) anticipate future price movements of securities so that
c) an action of buying or selling securities may be taken with a
view to
d) buying or selling securities in order to
e) 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 and
aptitude and the personal profile of the decision makers.
That is to say, speculation is an activity that requires a great
deal of knowledge and skills. Therefore, speculation in
stock markets cannot be equated to gambling.
9
The sale of gharar is said to lead to maysir
(gambling) which leads to oppression and is
therefore prohibited in Islam. It is evident that
gharar is not present in speculation in stock
markets 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 the
market 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.
10
Pro and Cons of Speculation
The above discussion has proved that although
speculation 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 and
activate a market where there is thin trading. It can also
provide signals to less-informed investors upon which to
act.
The negative effect of speculation is that excessive
amount of it may cause volatile price movements in the
market. It can thus be concluded that excessive
speculation should not be allowed, but a reasonable
degree of it be permitted. Quantitative limits on daily
trading volume and legislative guidelines may help
contain speculation within healthy bounds.
11
What is an Ordinary Share?
A share is a document evidencing
ownership of the shareholder in the capital
of the corporation
It represents an undivided share in the
corporation assets and rights associated
with it upon conversion of the capital into
tangible things, benefits, debts and so on
(AAOIFI, Sharia Standard No.21)
12
Fiqh View of Investing in Ordinary Shares
Permissible
if the main business of the company is in
compliant with Shariah rulings, then to
purchase, hold or sell its shares is permissible
even if the company was to undertake
prohibited activities such as borrowing money
and/or invest its money on the basis of interest,
the company can still be invested provided they
fulfil certain criteria. (Islamic Fiqh Academy,
1992)
13
Each and every action of the company cannot be
attributed to every shareholder in his/her individual
capacity
A shareholder may raise his objections to certain
company transactions that may run contrary to Shariah
during the annual general meeting but these objections
may be overruled by the majority of the shareholders
the responsibility of committing a non-halal activity such
as borrowing and investing money on the basis of
interest lies with those who commit such acts, it does not
render the whole company to be non-halal or non-
permissible
14
(source: Securities Commission Malaysia)
YEAR MILESTONES
1990 Shell MDS Sdn Bhd issued the first Islamic bond
1993 Arab-Malaysian Unit Trust Bhd issued the first
Islamic equity unit trust fund (Arab-Malaysian
Tabung Ittikal)
1994 BIMB Securities Sdn Bhd, the first full-fledged
Islamic 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 Malaysias first Islamic
equity index, comprising Shari'ah compliant shares of Bursa
Malaysia main board companies
1997 Khazanah Nasional Bhd launched the Khazanah Murabahah
Bond, which is a zero coupon bond based on murabahah and
bai al-dayn concepts
SC launched an official SAC list of Shari'ah compliant
securities that are traded on Bursa Malaysia. The list is
updated every April and October
16
1999 Bursa Malaysia launched Malaysias second Islamic equity
index, the Kuala Lumpur Shari'ah Index (KLSI), comprising
all 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 the
Guidelines on the Offering of Private Debt Securities
RHB Unit Trust Management Bhd launched the first Islamic
bond fund
SC launched a dedicated Islamic Capital Market section on
its website
2001 The Capital Market Masterplan was launched. One of the
strategic initiatives was to establish Malaysia as an
international 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 the
Labuan International Financial Exchange
Malaysian government issued a worlds first global sovereign
Islamic bond, sukuk ijarah, worth US600 million
SC imposed the requirement for the registration of Shari'ah
individuals/advisers for Islamic unit trust funds
MBf Unit Trust Management Bhd launched the first Shari'ah
index 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 the
issuance of Islamic bonds, based on the Shari'ah principles of
ijarah, mudharabah and musharakah
2003 Malaysian government, in its Federal Budget 2004, allowed
tax deduction for 5 years on expenses incurred in the
issuance of Islamic bonds, based on the Shari'ah principle of
istisna
2004 The International Organization of Securities Commission
(IOSCO)s Islamic Capital Market Task Force, chaired by SC
Malaysia, released the Islamic Capital Market Fact Finding
Report 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 Islamic
bond, which was modelled on the Malaysian Global Sukuk
Sarawak Corporate Sukuk Inc, a special purpose vehicle
established by the Sarawak Economic Development
Corporation launched a maiden 5-year US$350 million global
Sukuk Ijarah in the form of floating rate trust certificates that will
mature in 2009. The sukuk is listed and traded on LFX
International finance Corp (IFC), the private arm of the World
Bank issued RM500 million Islamic bonds, which was the first
issuance of ringgit-denominated Islamic bonds by a
supranational body
20
2004 Additional tax measures were announced in the Budget 2005
to 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 will
mature in 2010. This ringgit-denominated issue is the largest
supranational deal in the ringgit bond market
21
Islamic Equity Market
Islamic equity market in Malaysia showed
tremendous progress
The number of Shariah compliant shares
has increased significantly from 371 in
1997 to 826 in April 2005
In terms of percentage of Shariah
compliant stocks in Bursa Malaysia, 1997
recorded only 57% whilst in April 2005 the
percentage has increased to 84%
22
Shariah 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
280
204
197
188 193 198
213
210
176
188
207
185
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
Stocks
16%
Percentage
of Syariah-
Compliant
Stocks
84%
As of April 2005
24
(As of April 2005)
Main Board / Second Board /
MESDAQ
Approved
Securities
Total
Securities
Percentage of
Approved
Securities
Consumer Products 126 137 92
Industrial Products 279 301 93
Mining Nil 1 Nil
Construction 62 63 98
Trading/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
(As of 25 May 2007)
MESDAQ
Approved
Securities
Total
Securities
Percentage of
Approved
Securities
Mining 1 1 100
Properties 80 100 80
Plantation 41 47 87
Technology 104 106 98
Finance 5 47 11
Hotel Nil 5 Nil
TOTAL 875 1,023 86
26
(As of 30 May 2008)
MESDAQ
Approved
Securities
Total
Securities
Percentage of
Approved
Securities
Mining Nil 1 Nil
Properties 72 92 78
Plantation 38 45 84
Technology 101 104 97
Finance 5 42 12
Hotel Nil 5 Nil
TOTAL 843 988 85
27
Currently there is no international Shari'ah standard for
stock screening
Different funds or fund managers utilise different
standards based on their respective Shari'ah councils
In Malaysia we have the list issued by Syariah Advisory
Council of Securities Commission, Dow Jones-RHB
Islamic Malaysia Index and FTSE Bursa Malaysia
namely FBM Hijrah Shariah Index and FBM EMAS
Shariah Index
At the global level we have the Dow Jones Islamic
Market Indexes, FTSE Global Islamic Index Series and
S&P Islamic Index Series and MSCI Islamic Index
Series
28
Rules to ensure that ordinary shares are Shari'ah
compliant
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 the
company in terms of its activity, products and industry
alcohol, tobacco, pork-related products, conventional
financial 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-
Shariah compliant stocks
The data for ratios are obatined from Balance Sheet and
Income Statement. Dow Jones and S&P Indexes use stock
market 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-compliant
activities : 5% to 15%
Leverage: 30% to 33%
30
Screening Methodology for Shari'ah-Compliant Stocks :
Securities Commission of Malaysia applied additional
criteria to companies which are involved in multiple
business, i.e., companies whose business activities
comprise both Shari'ah permissible and non-permissible
elements. The analysis is done at the holding company,
subsidiary company and associate company levels. The
additional 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 public
interest (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 of
the non-Muslim community which are accepted by Islam
31
It maybe possible that a companys main business is
Shariah compliant but the revenue from the subsidiary
whose activities are not Shariah compliant may lead to
that company being considered as non-Shariah
compliant
32
Screening Process of SAC, Securities Commission, Malaysia
Activity, Industry
& Product
Financial services
based on riba (interest)
Gambling/gaming
Manufacture and / or
sale of non-halal
products
Manufacture or sale of
tobacco-based products
or related products
Conventional
insurance (gharar)
Entertainment
Stockbroking or share
trading in Shariah 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
m
i
s
s
i
b
l
e
Stage 1 Stage2 Stage 3
No Yes Yes
Drop
Drop
Drop
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 TO
2. Group PBT
1. TO and PBT of non approved activities
2. SOP of non approved activities
3. Interest income
4. Dividend received from investment in non approved securities
Consolidate information on :
1. TO and PBT of non permissible activities vs group TO and PBT
2. SOP of non permissible activities vs group PBT
3. Interest income vs group TO
4. 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
activities that involve the element of umum balwa which
is prohibited element affecting most people and difficult
to avoid e.g interest income from fixed deposits in
conventional banks and tobacco-related activities
35
This benchmark is used to asses the level of
contribution of mixed rental payment from Shariah non-
compliant activities, such as rental payments from
premises used in gambling, sale of liquor, etc.
activities that are generally permissible according to
Shariah and have an element of maslahah to the public,
but there are other elements that may effect the Shariah
compliance status of these activities for e.g hotel and
resort operations, share trading, stockbroking, as these
activities may also involve other activities that are
deemed non-permissible to the Shariah
36
Financial Filters of SAC, SC Malaysia
II PROHIBITED INCOME
1 Interest Income/Group Turnover s 10
7 Non Permissible Income other than Interest Income/Revenue s 5
8 Income from Tobacco/Revenue s 10
11 PBTof Subs or Asso Co(non-halal activity)/PBT of Group s 5
12 PBTof Subs or Asso Co(mixed rental income)/PBT of Group s 20
13 PBTax of Subs or Asso Co(hotel & resort)/PBT of Group s 25
14 Turnover of Subs or Asso Co(non-halal activity)/Turnover of Group s 5
15 Turnover of Subs or Asso Co(mixed rental income)/Turnover of Groups 20
16 Turnover of Subs or Asso Co(hotel & resort)/Turnover of Group s 25
37
Fiqh Justification for Sharih benchmarks
(source: SC Malaysia)
Status of mixed business companies
No historical precedent
Cited Ibnu Subki in Al-Ashbah wa al-Nazair to rule as
prohibited something that is a mix of the permissible and
the prohibited is ihtiyat (precautionary measure) and it is
not necessarily prohibited.
SC Malaysia took into accounts other Fiqh principles to
support their case
These include maslahah, umum balwa, urf khas min
asalib iqtisodiyah, fasaduz zaman and huquq ghair
muslimin
38
Fiqh Justification for Sharih benchmarks
(source: SC Malaysia) (cont)
In addition they also cited Ibnu Qayyim who
wrote in his book Badaie al-Fawaid about the
nature 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 and
Non Ahli Kitab is prohibited.
Prohibited due to other reasons such as the means or
way it is earned or acquired. For e.g. money in itself is
okay but the manner it is acquired such as by robbery is
not acceptable. Shares of companies are by nature
acceptable but shares of mixed business companies
may not be acceptable
39
Shariah Benchmark
50% rule
Utilize the fatwa concerning silk mixed with
common thread. This is based on the hadith of
the Prophet saw:
The Prophet saw took a piece of silk and placed it
on his right. He took some gold and placed it on his
left. Then he said: Both these things are prohibited
unto men among my followers, but permissible for
the women
If it is pure silk then it is prohibited for men to
wear the silk cloth but if the cloth is mixed with
50% 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 a
person can bequeath a maximum of one third of
his property as gift to an unrelated person
Benchmark based on Ghabn Fahish
(extraordinary margin or profit or gain)
Describes gain through cheating and
manipulation (tanajush)
41
Shariah Benchmark (cont..)
Ghabn fahish accompanied with tanajush is not
permissible
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 Kuay
Sdn. Bhd
Strong Heart
Sdn. Bhd
Kapur Barus
Sdn. Bhd
Kejuruteraan
Siaga Sdn. Bhd
Tobacco business
Related information
Group info :
Group TO : RM10 million
Group 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 Calculation
Quantitative
result
Percentage of tobacco
to Group TO
RM900,000 / RM10.0 mil 9%
Percentage of tobacco
to 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 Biru
Sdn. Bhd
Subsidiary
Nyatoh Tua
Sdn. Bhd
Merbau Siam
Sdn. Bhd
Plywood
Sdn. Bhd
Nasib Baik
Sdn. Bhd
Gaming business
Related information
Group info :
Group TO : RM 2 million
Group 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)
Quantitative
result
Percentage of interest
income to Group TO
RM220,000 / RM2.0 mil 11%
Percentage of gaming
to Group PBT (SOP)
RM24,000 / RM500,000 4.8%
46
Case Study 3 : Blind Spot Berhad
Principal activity Construction
Associated
Blind Spot
Berhad
Go Ahead
Sdn. Bhd
Subsidiary
Ho Hap
Sdn. 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 200,000
PBT 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)
Quantitative
result
Percentage of liquor to
Group TO
RM400,000 / RM10.0 mil 4%
Percentage of liquor to
Group PBT
RM120,000 / RM5.0 mil 2.4%
Percentage of gaming to
Group TO
RM200,000 / RM10.0 mil 2%
Percentage of gaming to
Group PBT
RM100,000 / RM5.0 mil 2%
48
Screening Process of Dow Jones Islamic Index
(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 Contrary
to Islam
Stage 1 Stage 2
Financial Ratio Filters
Total Debt to Total
Asset Ratio s 33%
Account Receivables
to Total Asset Ratio
s 47%
Non-Operating
Interest Income to
Operating Income
s 9%
Drop
Drop
No
Yes
No Yes
Permissible
* List is updated every quarter
49
Screening Process of Dow Jones Islamic Index
(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 s 33%
Account Receivables to Total
Asset Ratio s 45%
Cash + Interest Bearing
Securities to Trailing 12-Month
Drop
Drop
No
No
Permissible
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
Activities Contrary
to Islam
Stage 1 Stage 2
Total Debt to Trailing 12-Month
Account Receivables to Trailing
12-Month Moving Average Market
Cash + Interest Bearing Securities
to Trailing 12-Month Moving
Average Market Capitalization s
33%
Drop
Drop
No
No
Permissible
Yes
Yes
51
Sharia Non-compliant Business (Industry
Classification 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 & Casualty
Insurance
8538 Reinsurance
8575 Life Insurance
8733 Real Estate Holding &
Development
8773 Consumer Finance
8775 Specialty Finance
8777 Investment Services
8779 Mortgage Finance
52
Introduced in 1999.
Subset of Dow Jones Global Indexes.
40%of DJ Global Indexs market cap.
60 indexes.
6 Islamic scholars.
53
The DJIMI family includes global, regional, country,
industry, and market-cap-based indexes.
Global Indexes
-DJIMI
-DJIM Large-Cap Index
-DJIM 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 Index
-DJIM 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 Index
Titans (Blue-Chip) Indexes
-DJIM Titans 100 Index
-DJIM Europe Titans 25 Index
-DJIM Asia/Pacific Titans25Index
-DJIM U.S. Titans 50 Index
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 Index
-DJIM 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 Index
-DJ-RHB Islamic Malaysia Index
Other Country/Regional Indexes
-DJIM Canada Index
-DJIM 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
Activities Contrary
to Islam
Stage 1 Stage 2
Total Interest
Bearing Debt to
Total Asset Ratio s
33.33%
Drop
Drop
No
Yes
No Yes
Permissible
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
Alcohol Beverages
Gaming
Interest based
Entertainment
Arms, Defense
Tobacco
Activities Contrary
to Islam
Stage 1 Stage 2
5 ratios are
computed
Drop
Drop
No
Yes
No Yes
Permissible
Cleanse
tainted
dividend
5%
57
FTSE FINANCIAL FILTERS
FTSE GlI**
I LIQUIDITY
3 Acc Rec + Cash/Total Asset < 50
6 Cash + Int Bearing Sec/Total Assets < 33
1 Interest Income/Group Turnover < 5%
7 Non Permissible Income other than Interest Income/Revenue < 5%
III DEBT
2 Total Debt/Total Asset < 33
58
Introduced in 2000.
Subset of FTSE All-World Index universe.
5 indexes.
Shariah Board with Yasaar Research Inc.
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
Alcohol Beverages
Gaming
Interest based
Entertainment
Arms, Defense
Tobacco
Gold & silver
trading as cash on
deferred basis
Activities Contrary
to Islam
Stage 1 Stage 2
4 ratios
Drop
Drop
No
Yes
No Yes
Permissible
Cleanse
tainted
dividend
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%
7 Non Permissible Income other than Interest Income/Revenue < 5%
III DEBT
1 Total Debt/12 Mth MA Market Cap < 33
62
S&P Shariah Indices
Introduced in 2006.
Subset of S&P 500, S&P Europe 350, and
S&P Japan 500 universes.
60%of parent indexs market cap.
3 indexes.
Shariah Board with Ratings Intelligence
Partners.
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 companys total income is
derived from interest income. Hence a portion
of dividend paid out to shareholders must be
deducted 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 to
determine clean dividends
Calculated as follows:
(Total Earnings Interest Income) / Total Earnings
Note that Total earnings are defined as gross
income, and interest income as operating and
non-operating interest
66
Jakarta Shariah Index
Stage 1: Core Business Selection-Negative
Screen
Gambling
Conventional financial institutions
Production, distribution, provision and trading of
products and services that are prohibited by
Shariah
Stage 2: Financial Filters
Interest-bearing debt/Total Equity : <45%:55% or
81.82%
Interest Income & Income from Non-Shariah
compliant business activities/Total Revenue: 10%
67
JSI consists of 30 stocks
List reviewed twice a year, every January
and July
68
AAOIFI Criteria for Shariah Compliant
Shares
Requirement for main business of
company not to engage in prohibited
business according to Shariah
Financial filters and their respective
benchmarks 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 s 5% of
company Gross
Total Revenues
Note: Interest
expense should
not be deducted
from this amount
Leverage & Asset
Liquidity
Total conventional
Debt to Equity
ratio s 30%
Cash and short term
investments to Total
Assets Ratio s 45%
P
e
r
m
i
s
s
i
b
l
e
Stage 1 Stage2 Stage 3
No Yes Yes
Drop
Drop
Drop
Yes
No
No
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 < 33 < 49%
3 Acc Rec + Cash/Total Asset < 50
4 Cash + Int Bearing Sec + Acc Rec/Total Assets
5 Cash + Int Bearing Sec/12 Mth MA Market Cap. < 33 < 33%
6 Cash + Int Bearing Sec/Total Assets < 33 < 33.33
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 s 10 < 5%
2 Interest Income/Gross Total Revenue
3 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 s 5 < 5% < 5%
8 Income from Tobacco/Revenue s 10
9 Income from Shariah Non-compliant Investment/Gross Revenue s 5
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 s 5
12 PBTof Subs or Asso Co(mixed rental income)/PBT of Group s 20
13 PBTax of Subs or Asso Co(hotel & resort)/PBT of Group s 25
14 Turnover of Subs or Asso Co(non-halal activity)/Turnover of Group s 5
15 Turnover of Subs or Asso Co(mixed rental income)/Turnover of Group s 20
16 Turnover of Subs or Asso Co(hotel & resort)/Turnover of Group s 25
III DEBT
1 Total Debt/12 Mth MA Market Cap < 33 < 33
2 Total Debt/Total Asset < 33 < 33.33 < 30 45%
3 Total Debt/Total Equity <81.82%
71
Islamic Stock Indices Comparison
Dow Jones
Index Market
FTSE SI S&P SI
Index Review Annual review in June Annual review in
September
Semi-annual review in
March and September
Composition Review Quarterly review
Changes implemented
on the 3
rd
Friday in
March, June,
September and
December
Quarterly review
Changes implemented
on the 3
rd
or the 2
nd
Friday in March, June,
September, December
(2
nd
Friday only
applicable for S&P
Japan 500 Shariah)
Semi-annually review
Changes implemented
on the 3
rd
Friday in
March and
September.
Component
Weightings Review
Quarterly update
Changes > 10% in
number of shares,
updated Immediately
Quarterly update
Changes > 5% in
number of shares,
updated immediately
Semi-annually update
Computation Float-adjusted value-
weighted
Float-adjusted Value-weighted
72
Comparison between Shariah compliant securities of SC Malaysia and
Dow Jones-RHB Islamic Malaysia as of May 2005
Number of
Shariah
Compliant
Stocks
Number of
Stocks in Bursa
Malaysia
Percentage of
Shariah
Compliant
Stocks
SC 826 985 84%
DJ-RHB 45 985 4.6%
73
Stock Indexes
Uses
Track average returns
Measure relative performance of fund/fund
managers relative to benchmark
Base of derivatives
Markets 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?
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, sectoral
Convenience units
76
76
Value-weighted methods
t
t
t
t
USD
i i i
n
i
t
USD
it it it
n
i
t
D
M
basevalue
B
M
basevalue
X q p C
X q p
Index = =

=
=
=
) (
) (
0 0 0
1
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 4
Price 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 Outstanding
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
Market Capitalization 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 Distributions
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 t
Base AMV at date 0

= P
1
Q
1

P
0
Q
0

Where P
1
Q
1
= Current AMV
P
0
Q
0
= 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 = 146.47
4 RM26,500/17,000 = 155.88
79
79
Index Computation Method: Free-
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.
80
80
Index Computation Method: Free-Float
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%
81
81
Index Computation Method: Free-Float
Weighting
Amount of Free-Float % Free-Float
s 15% Not eligible
> 15% - s 20% 20%
> 20% - s 30% 30%
> 30% - s 40% 40%
> 40% - s 50% 50%
> 50% - s 75% 75%
> 75% 100%
Issuer Current
weighting
Free-
float
Free-Float
weighting
A 2.5% 100% 2.5%
B 0.5% 75% 0.375%
82
Issues in Shariah Filters
Impact of Liquidity ratio filter on Islamic
banks and Islamic financial institutions
will they be included in the list of Shariah
compliant companies
Global Indices favors firms from USA,
Europe and advanced countries what
about companies in the Muslim world
Negative screen only- provides a list of
non-Shariah compliant activities
83
Weightage of DJIM:
(Source: Siddiqui, 2007)
84
What about positive screen? Concern for the
environment, corporate governance, contribution to the
economic 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.
86
DJIM vs DJWI Sectors (31/12/07)
(Source: Siddiqui, 2007)
87
87
Performance of Shariah Indices
Atta (2000) DJIMI outperformed the unscreened index
during 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 not
worse-off (DJIMI is in line with other indexes).
DJIMI outperforms unscreened index.
DJIMI outperformed by non-Islamic ethical index.
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.
89
Preference Shares (saham Preferen)
Malaysian Companies Act 1965 has
defined preference share as a share that
does not give a right to the shareholders to
vote at its general meeting or any right to
participate in any distribution of the
company that has stated the amount,
whether through dividends, redemption,
dissolution or otherwise
90
Preference Shares (saham Preferen)
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 ordinary
shareholders in dividend payment and assets if
business is liquidated. However stands below
creditors or debt holders in claim of assets if
business is liquidated
No voting rights unlike ordinary shareholders
91
Types of Preference Shares
Cumulative preference shares
Dividend payment is fixed and predetermined
In the event that the company fails to pay
dividend 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 pay
dividend in one year, that dividend will not be
accumulated and therefore not paid in the
following year
92
Preference Shares (cont.)
OIC Fiqh academy ruled that (both types
of ) preference shares are not permissible
However the Shariah Advisory Council of
Malaysian Securities Commission ruled
that non-cumulative preference shares are
permissible based on tanazul where the
right to profit of the ordinary shareholder is
given willingly to a preference shareholder.
93
Convertible Stocks/Bonds
Preference shares or bonds that will be
converted into ordinary shares after a
predetermined period
Value of future conversion is uncertain although
the conversion ratio, i.e., the number of ordinary
shares that will be given upon conversion, is
fixed
No formal fatwa given although most Shariah
scholars are concerned about element of gharar
94
Shareholder Rewards
Cash dividends
No objections from Shariah
Bonus issue or stock dividend
Shares in lieu of cash
No objections from Shariah
Rights issues
Current shareholders given special right to
purchase new shares at below market price
Acceptable to Shariah
95
Shareholder benefits or perks
Rewards given to shareholder in kind rather
than cash, for e.g., free food or food coupon,
hotel stays etc
Acceptable to Shariah
Wallahuwaalam
Thank You
azmiomar@iiu.edu.my

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ISLAMIC EQUITY MARKET, SHARIAH STOCK

SCREENING & PREFERENCE SHARES

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