Islamic Mutual FundsApril 24, 2012

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OverviewOverview

1. Islamic Mutual Funds: Modus Operandi

2. Islamic Asset Management Industry in Pakistan

3. KSE-Meezan Index 30 (KMI-30)

Islamic Mutual Funds: Shariah Guidelines & Modus Operandi

Difference between Conventional & Islamic Mutual FundsDifference between Conventional & Islamic Mutual Funds• Presence and careful monitoring by the Shariah Board- It is ensured that all aspects of the Shariah are adhered to before, during and after an investment is carried

out in a Shariah Compliant manner

• Well defined and Specific Investment Avenues - Investment avenues are limited to those that comply with the Shariah

• Charity and Purification- Any investment/financing that is deemed to have an element of Riba becomes liable for Purification and

has to be given away as charity

• Asset Ownership- The ownership of an asset lies with the party that provides financing and bears the risk e.g. financing by a

bank, and assumption of all the risk (non recovery, etc) associated with it.

• Permissible transactions- Transactions have to be conducted according to the Shariah, e.g. no short sales

• Islamic Investment in only Shariah Compliant Avenues- For Islamic mutual funds and other Islamic Investors, investment can only be made in those securities

(equity, debt, etc) which comply with well defined screening ratios

Shariah Screening for Equity Shariah Screening for Equity Shariah compliance of stocks is done under the guidance of qualified and reputed Shariah experts. For stocks to be “Shariah compliant”, it must meet ALL the six key tests given below:

1.  Business of the Investee CompanyCore business of the company must be halal and in line with the dictates of Shariah. Hence, investment in securities of any company dealing in conventional banking, conventional insurance, alcoholic drinks, tobacco, pork production, arms manufacturing, pornography or related activities is not permissible.2. Debt to Total AssetsDebt to Asset ratio should be less than 37%. Debt, in this case, is classified as any interest bearing debts. Zero coupon bonds and preference shares are, both, by definition, part of debt.3. Non-compliant Investments to Total AssetsThe ratio of non compliant investments to total assets should be less than 33%. Investment in any non-compliant security shall be included for the calculation of this ratio.4. Non-complaint Income to Total revenue – Purification of Non-compliant incomeThe ratio of non compliant income to total revenue should be less than 5%. Total revenue includes Gross revenue plus any other income earned by the company. This amount is cleansed out as charity as a pro rata ratio of dividends issued by the company.5. Illiquid Assets to Total AssetsThe ratio of illiquid assets to total assets should be at least 20%. Illiquid asset, here, is defined as any asset that that Shariah permits to be traded at value other than the par.6. Net Liquid Assets to Share PriceThe market price per share should be greater than the net liquid assets per share calculated as: (Total Assets – Illiquid Assets – Total Liabilities) divided by number of shares

Trading Guidelines & Ready Buy Deferred TransactionsTrading Guidelines & Ready Buy Deferred TransactionsTrading Guidelines1. Same day purchase and selling of the same scrip is prohibited2. Shares should not be sold before settlement i.e. their possession has been transferred to the fund/owner3. Blank sale or short sale is not allowed

Ready Buy Deferred Sale TransactionsSame day trading and forward sale transaction of shares as practiced in stock market is not allowed in Shariah. However

as an alternative, following procedure may be adopted.

1. Day 1: Fund buys shares from stock market via broker. On the same day the broker enters into a unilateral promise to purchase these shares from Fund at the future date.(The broker will act as end buyer/Principal)

2. The format for unilateral promise to purchase will clearly state that this document represents only unilateral promise to purchase shares from bank and actual sale transaction may take place on future promised day.

3. Day 3: Fund receives the share in its CDC account as per settlement schedule of the stock market. (T+1)

4. Day X (Transaction Date):On the agreed day the actual sale transaction of the share take place between the fund and the broker and will be recorded with the help of sale advice issued by Fund.

5. Settlement Date: Fund would transfer the shares directly into brokers CDC account and will receive the payment from the broker against the shares sold.

Charity Account & Dividend PurificationCharity Account & Dividend Purification

Dividend Purification

• Dividend purification means eliminating prohibited income that is mixed up with the earnings of the company and the onus is on the owner of the shares.

• Dividend purification exercise are carried on periodic basis in accordance with Shariah standards.

• Dividend is purified by calculating percentage of non-compliant income to the gross revenue (Gross sales + Other Income) for each investee company. The resultant rate is called as Charity rate.

a. Charity rate for each investee company is multiplied with the dividend income from the respective company to get the amount to be transferred to charity account.

b. The whole process of income purification is verified by Shariah advisor who then issues a certificate to be included in the annual accounts of the funds.

Charity Account

• A separate Charity account is maintained for each Islamic Fund.

• All contributions to the charity account are recorded as Liability of the Fund.

• Donations from the charity Account are only made to charitable organizations/individuals as approved by the Shariah Advisor.

Islamic Asset Management Industry in Pakistan

50 Years of Mutual Funds in Pakistan50 Years of Mutual Funds in Pakistan

• Mutual funds were first introduced in Pakistan back in 1962, with the public offering of open ended National Investment Trust fund

- The fund remained at that time as the only open ended mutual fund in Pakistan for 30 years and was later followed by the establishment of Investment Corporation of Pakistan (ICP) in 1966

• In 1971, the Government allowed private sector close-ended funds to enter the industry by issuing the Investment Companies and Investment Advisors Rules (IC & IA Rules)

- This led to the launch of Golden Arrow, the first close-ended fund established in the private sector in 1983

• The biggest milestone for the industry was the promulgation of Asset Management Companies Rules, 1995

- This provided the necessary legal framework for launching and managing open-end funds by the private sector, and led to the launch of the first private sector mutual fund in Pakistan by ABAMCO

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2008

1962

Brief History of Mutual Funds in Pakistan

1962: The first open

ended mutual fund was launched --

National Investment

1971:Govt. allowed

private secotr closed- ended funds

1995: Promulgation of

Asset Management Companies Rules

1996:Formation of

MUFAP

1966: Establishment of

Investment Corporation Of Pakistan (ICP)

1983:Gloden Arrow was launched. It was the first closed - ended fund established in

1996:ABAMCO Limited was launched, the first private sector open ended funds

2002:Launch of UTP -Islamic Fund, the first Islamic open

1996:Launch of AMMF,

the first Islamic close ended fund

2008:Establishment of

NBFC Regulations

2002:Establishment of

NBFC Rules

Islamic Financial Industry in PakistanIslamic Financial Industry in Pakistan• Total Islamic Banks’ Deposits currently stand at Rs. 448.5 billion, which has grown

from Rs. 147 billion in 2007, representing a growth of 205.1%.- Meezan Bank is the pioneer in the Islamic Banking sector in Pakistan which started its operations in

2002. In 2012, its deposit base stands at Rs. 175 billion, which is 38% of the Islamic Banking sector in Pakistan.

• Total size of Islamic Assets have shown a significant increase- The total value of issued Ijarah stood at Rs. 333 billion at the end of March 2012.

• Total number of Islamic institutions has increased over the years- Number of Islamic banks stood at 5 while number of Islamic windows of Conventional Banks stood at 12

at the end of March 2012

Islamic Mutual Funds in PakistanIslamic Mutual Funds in Pakistan• In Pakistan, Asset Under Management of mutual funds are only 5% the banking deposit.

• Islamic asset management is one of the fastest growing sectors within the Islamic finance industry today

- The growth in AUM of Islamic Funds is commendable, witnessing a surge from PKR 14Bn in FY 07 to PKR 39Bn FY11, which translates into a CAGR of 29%.

• Inclination towards Islamic Mutual Funds is on the rise- Interestingly total AUMs for the entire Pakistani Mutual Fund Industry, since FY07 have remained flat, while

AUMs for Islamic Funds have increased and that for Conventional Funds have decreased. Thereby indicating that investors are switching from conventional funds to Islamic funds.

• Major room for growth in Islamic Fund evident- FY11 reveals Islamic Funds constitute only 15% of the total Mutual Fund Industry, which is a total pie of PKR

334 Bn. The low size indicates a massive untapped potential and possible growth in this area

• Al Meezan Investments is the biggest and the only full fledged Islamic AMC with Funds base of Rs. 39 billion which constitute 76% of the Islamic Mutual Fund Industry.

Mutual Funds Growth in AUMs –Past 5 YearsMutual Funds Growth in AUMs –Past 5 Years

Mutual Fund Industry5 Year

Growth3 Year

Growth FY07 FY09 FY11 3QFY12Total Industry 349,099 246,610 273,593 357,628 2.44% 45.02%Islamic Funds 14,135 19,682 39,433 51,128 261.70% 159.77%Islamic Market Share 4.05% 7.98% 14.41% 14.30%

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Total Fund Market Size Total Islamic Funds

Mutual Funds AUMs 5 YearsMutual Funds AUMs 5 Years

9%18%

13%60%

March 2012

Total Income Funds

Total Money Market Funds

Total Sovereign Funds

Total Equity Funds

23%

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32%

June 2011

Total Income Funds

Total Money Market Funds

Total Sovereign Funds

Total Equity Funds

Sovereign Fund Growth in AUMs –Past 5 YearsSovereign Fund Growth in AUMs –Past 5 Years

Sovereign Funds5 Year

Growth3 Year

Growth FY07 FY09 FY11 3QFY12Total Industry - 1,415 32,308 75,421 N/a 5230.13%Islamic Funds - - 15,108 23,540 N/a N/aIslamic Market Share N/a 0.00% 46.76% 31.21%

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Total Sovereign Funds Total Islamic Sovereign Funds

Money Market Fund Growth in AUMs –Past 5 YearsMoney Market Fund Growth in AUMs –Past 5 Years

Money Market Funds5 Year

Growth3 Year

Growth FY07 FY09 FY11 3QFY12Total Industry - 2,491 66,455 101,284 N/a 3966.34%Islamic Funds - 624 6,353 8,180 N/a 1211.15%Islamic Market Share N/a 25.05% 9.56% 8.08%

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Total Money Market Funds Total Islamic Money Market Funds

Income Fund Growth in AUMs –Past 5 YearsIncome Fund Growth in AUMs –Past 5 Years

Income Funds5 Year

Growth3 Year

Growth FY07 FY09 FY11 3QFY12Total Industry 112,240 84,372 50,261 53,743 -52.12% -36.30%Islamic Funds 3,162 7,854 5,673 6,279 98.57% -20.06%Islamic Market Share 2.82% 9.31% 11.29% 11.68%

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Total Income Funds Total Islamic Income Funds

Equity based Fund Growth in AUMs –Past 5 YearsEquity based Fund Growth in AUMs –Past 5 Years

Equity Funds5 Year

Growth3 Year

Growth FY07 FY09 FY11 3QFY12Total Industry 130,811 99,893 69,507 72,043 -44.93% -27.88%Islamic Funds 10,973 11,786 11,482 12,390 12.91% 5.12%Islamic Market Share 8.39% 11.80% 16.52% 17.20%

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Total Equity Funds Total Islamic Equity Funds

Pension Fund Growth in AUMs –Past 5 YearsPension Fund Growth in AUMs –Past 5 Years

Pension Funds5 Year

Growth3 Year

Growth FY07 FY09 FY11 3QFY12Total Industry - 877 1,555 2,107 N/a 140.11%Islamic Funds - 529 901 1,260 N/a 138.28%Islamic Market Share N/a 60.27% 57.94% 59.81%

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Total Pension Funds Total Islamic Pesion Funds

KSE-Meezan Index 30 (KMI 30)

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KMI-30 Technical Screening FiltersKMI-30 Technical Screening FiltersIn addition to the Shariah screening filters, the following filters are applied on stocks for them to be eligible for the KMI-30 index.

Screening Criteria # 1: •The Company which is on the Defaulters’ Counter and/or its trading is suspended, declared Non-Tradable (i.e. NT) in preceding 6 months from the date of re-composition shall NOT be considered for inclusion in KMI-30 Index

Screening Criteria # 2: •The Company will be eligible for KMI-30 Index if its securities are available in the Central Depository System

• Screening Criteria # 3 •The Company should have a formal listing history of at least two months on KSE

Screening Criteria # 4 •The company must have an operational track record of at least one financial year

Screening Criteria # 5 •The Company should have minimum free-float shares of 5% of total outstanding shares

Screening Criteria # 6 •The Company will be eligible for KMI-30 Index if its securities are traded for 75% of the total trading days

Screening Criteria # 7 Mutual Funds (both Open-Ended and Closed-Ended) are ineligible for inclusion in the KMI-30 Index

KMI-30 SelectionKMI-30 Selection• The KMI-30 uses free float methodology for inclusion of stocks according to the following calculation:

• From the list of Shariah compliant companies, securities are selected on the basis of Free Float and Impact Cost.

• While ranking the companies 50% weight is assigned to Free Float capitalization and the remaining 50% is allocated to Impact Cost, such that the companies with the Islamic Index highest Free Float and the lowest Impact Cost get the highest rank in the selection process.

• Top 30 ranked companies as per above criteria are included in Islamic Index.

Shariah Compliant StocksShariah Compliant Stocks• Al Meezan Investments receives a list of eligible stocks from KSE. Usually this list comprises of over 200

stocks and constituting over 90% of the entire market capitalization.

• This list is screened on Shariah filters and around 100 companies (as of last screening) remain as Shariah Compliant companies. These companies based on the last screening comprised of approximately 56% of the total market capitalization.

• Out of the above list, the top 30 stocks based on the methodology discussed are derived. As of the last screening, this list comprised of approximately 50% of the total market capitalization.

Performance of Islamic vs. Conventional Indices - PakistanPerformance of Islamic vs. Conventional Indices - Pakistan

Index Performance        

  FY09 FY10 FY11Cumulative

KSE Meezan - 30 Index -28% 34% 45% 41%Karachi Stock Exchange - 100 Index -41% 34% 25% -1%Karachi Stock Exchange - 30 Index -46% 24% 21% -19%

KSE Meezan 30 Index vs KSE 100 IndexKSE Meezan 30 Index vs KSE 100 Index

Thank You

Muhammad AsadChief Investment Officer

Al Meezan Investment Management LimitedKarachi.

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