islamic equity market.pdf
TRANSCRIPT
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ISLAMIC EQUITY MARKET, SHARIAH STOCK
SCREENING & PREFERENCE SHARES
Prof Dato’ Dr. Mohd Azmi Omar
Level 4 Administration Building, International Islamic University Malaysia
53100 Gombak
Selangor Malaysia
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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
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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
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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;
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Speculation & Gambling
“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 ]
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Speculation & Gambling
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
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Speculation & Gambling
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.
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Speculation & Gambling
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.
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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 .
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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.
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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)
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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)
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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
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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
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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
Development in the Malaysian Islamic Capital Market(source: Securities Commission Malaysia)
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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
Development in the Malaysian Islamic Capital Market(source: Securities Commission Malaysia)
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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
Development in the Malaysian Islamic Capital Market(source: Securities Commission Malaysia)
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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
Development in the Malaysian Islamic Capital Market(source: Securities Commission Malaysia)
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Development in the Malaysian Islamic Capital Market(source: Securities Commission Malaysia)
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
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Development in the Malaysian Islamic Capital Market(source: Securities Commission Malaysia)
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
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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%
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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
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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
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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
Sh i' h C li t St k i B M l i
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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
Consumer Products 126 135 93
Industrial Products 287 308 93
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
Close End Fund Nil 2 Nil
TOTAL 875 1,023 86
Sh i' h C li t St k i B M l i
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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
Consumer Products 122 133 92
Industrial Products 280 298 94
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
Close End Fund Nil 1 Nil
TOTAL 843 988 85
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Screening Methodology for Shari'ah-Compliant Stocks
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
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Screening Methodology for Shari'ah-Compliant Stocks
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
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Screening Methodology for Shari'ah-Compliant Stocks
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
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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
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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
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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
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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)
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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
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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
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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
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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
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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
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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
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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)
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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
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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
(Source: Nik Ruslin, SC)
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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%
(Source: Nik Ruslin, SC)
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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
Non-permissible activities
info :
Interest income : RM 220,000
SOP gaming : RM 24,000
Interest income
(Source: Nik Ruslin, SC)
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Case study 2 : Pre-compliance result
Benchmark for interest income : 10% of Group TO
Benchmark for gaming : 5% of Group TO / Group PBT
Pre-compliance result :
Non-approved (contribution from interest income exceeds the
benchmark)
Non-permissibles CalculationQuantitative
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%
(Source: Nik Ruslin, SC)
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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
Non-permissible activities
info :
TO liquor : RM 400,000
PBT liquor : RM 120,000
TO gaming : RM 200,000PBT gaming : RM100,000
Liquor business
(Source: Nik Ruslin, SC)
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Case study 3 : Pre-compliance result
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
Pre-compliance result :
Non-approved (contributions from non-approved activities [liquor & gaming] exceed the benchmark)
Non-permissibles CalculationQuantitative
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%
(Source: Nik Ruslin, SC)
Screening Process of Dow Jones Islamic Index
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(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
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(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 Trailing 12-Month
Moving Average Market
Capitalization 33%
•Account Receivables to Total
Asset Ratio 45%
•Cash + Interest Bearing
Securities to Trailing 12-Month
Moving Average Market
Capitalization 33%
Drop
Drop
No
NoPermissible
Yes
Yes
* List is updated every quarter
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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
Financial Institution
•Entertainment
•Arms, Defense
•Tobacco
•Activities Contrary
to Islam
Stage 1 Stage 2
Financial Ratio Filters•Total Debt to Trailing 12-Month
Moving Average Market
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
* List is updated every quarter
Sharia Non-compliant Business (Industry
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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
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Dow Jones Islamic Market Indexes
• 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
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Dow Jones Islamic Market Indexes
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
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Dow Jones Islamic Market Indexes
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
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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
Financial Institution
•Entertainment
•Arms, Defense
•Tobacco
•Activities Contrary
to Islam
Stage 1 Stage 2
Financial Ratio Filters
• Total Interest
Bearing Debt to
Total Asset Ratio
33.33%
Drop
Drop
No
Yes
No YesPermissible
Cleanse
tainted
dividend
* List is updated every quarter
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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
Financial Institution
•Entertainment
•Arms, Defense
•Tobacco
•Activities Contrary
to Islam
Stage 1 Stage 2
Financial Ratio Filters
• 5 ratios are
computed
Drop
Drop
No
Yes
No YesPermissible
Cleanse
tainted
dividend
* List is updated every quarter
5%
FTSE FINANCIAL FILTERS
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FTSE FINANCIAL FILTERS
FTSE GlI**
I LIQUIDITY
3 Acc Rec + Cash/Total Asset <
6 Cash + Int Bearing Sec/Total Assets <
II PROHIBITED INCOME
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
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FTSE Global Islamic Index Series
• Introduced in 2000.
• 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
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FTSE Global Islamic Index Series
• FTSE Global Islamic Index
• FTSE Americas Islamic Index
• FTSE Europe Islamic Index
• FTSE Pacific Basin Islamic Index
•
FTSE South Africa Islamic Index
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Screening Process of S P Shariah Indices
Activity, Industry
and Product
Excludes:
•Pork Production
• Non-Halal Food
Products
•Alcohol Beverages
•Gaming
•Interest based
Financial Institution
•Entertainment
•Arms, Defense
•Tobacco
•Gold & silver
trading as cash ondeferred basis
•Activities Contrary
to Islam
Stage 1 Stage 2
Financial Ratio Filters
• 4 ratios
Drop
Drop
No
Yes
No YesPermissible
Cleanse
tainted
dividend
* List is updated every quarter
S&P FINANCIAL FILTERS
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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
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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 index’s market cap.
• 3 indexes.
• Shariah Board with Ratings IntelligencePartners.
MSCI Shariah Index
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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
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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%
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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
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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%
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JSI consists of 30 stocks
List reviewed twice a year, every Januaryand July
AAOIFI Criteria for Shariah Compliant
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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%
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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
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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
II PROHIBITED INCOME
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
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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
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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
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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
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Factors in constructing or using an Index Representative? – composite, sectoral
Broad or narrow?
How is it constructed?
Construction of Indexes
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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
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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.
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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
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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-
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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
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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
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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
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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
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Weightage of DJIM:
(Source: Siddiqui, 2007)
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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
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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)
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DJIM vs DJWI Sectors (31/12/07)
(Source: Siddiqui, 2007)
Performance of Shariah Indices
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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
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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)
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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)
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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
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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.)
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( )
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
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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
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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
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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
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Wallahuwa’alam
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