The concept of Islamic finance, banking and economics has gained
tremendous popularity of late. It is appreciated and implemented
not only in countries where Islam is the dominant religion, but
also in non-Islamic nations. The basic premise of Islamic finance,
banking and economics is based on 'hygienic' ways of doing business
as prescribed by the Islamic Law or
What is a
Compliant financial product?
compliant financial product (mutual funds, ETFs etc) is an
investment avenue that is fully compliant with the principles of
Let's have a look at some of the concepts and guidelines of this
law. Islamic law basically divides actions into three broad
categories. These are
rules of doing business, therefore concentrates only on
but strictly excludes
. Companies whose business involves interest on debt, gambling,
alcohol, pork-related products, pornography or armaments are
prohibited. Since interest on debt
is prohibited, it automatically implies that a conventional
commercial bank fails to qualify as permissible business under the
So does it mean that Islamic banks and financial institutions
are charitable bodies that lend money without any expectation of
The answer is that a NO
is what drives the income streams of these banks. Fee-based
financing can be the result of safe deposits, fund transfer, trade
financing, property sales and purchases or handling investments.
Profit sharing involves partnerships (in businesses funded by the
banks) and sharing of profits and losses. This means that in order
to comply, the creation of debt is not facilitated through direct
lending and borrowing, but through sale or lease of a real asset
which is expected to provide a regular cash flow stream for the
Debt financing is indispensable for any company or economy. Even
companies that qualify under
and countries governed by the
law, have to resort to debt financing. They do this by the issuance
of special types of Islamic bonds. These are
bonds. These bonds do not consider interest to be the focus of any
bonds signify ownership of assets which are tied up to a lease
contract between the borrower and lender. These bonds (similarly to
conventional bonds) are highly flexible and can be traded in the
also prevents a person from selling what the individual does not
compliant financial institutions abstain from short selling
The demand for
compliant financial products is not limited to a particular
community or a group of countries but involves participation of
investors all around the world. Investment managers and fund
managers worldwide are constantly looking for
compliant stocks in order to include them in their portfolio.
Mutual funds and exchange traded funds are also fast gaining
popularity in this niche segment of the financial world and have
constantly witnessed an increase in their assets under management.
A recent study by Ernst and Young (
Islamic Funds and Investment Report
) shows that Islamic funds all across the globe witnessed 7% growth
in their AUM as of 2011.
A number of
compliant mutual funds and exchange traded funds are being launched
all around the world. The world's leading stock market index
provider Standard and Poor (S&P) has a wide range of
investable and benchmark indexes to meet an array of investor
needs. There are 15
, all of which bear testimony to the fact that
Compliant financial products have come of age.
The portfolio of
indexes comprises only of stocks of those companies whose
businesses are in alignment with that of the
law. Therefore it is prudent to note that the portfolio of the
would significantly differ from that of the broader market index.
Heavyweight sectors such as financials will be ruled out of the
portfolio of the
So does this mean that investments in
-compliant financial products will act as a perfect hedge against
investments in traditional financial products during economic
downturn when the market turns south?
Unfortunately, the answer is no. The broad-based
S&P 500 Index
correlation of 0.99
for a period of three years. The graph below shows the relative
movement of the two indexes.
The S&P 500
Index includes stocks of companies whose businesses are in
alignment with that of the
law as well as fulfilling the following criteria on a 36 month
average basis: 1) A Debt/ Market Value of Equity ratio of <
0.33, 2) Accounts receivable/ Market Value of Equity ratio <
0.49 and 3) (Cash +Interest Bearing securities)/ Market Value of
Equity ratio <0.33.
compliant financial products are flexible instruments which are
open to investments across all investor classes, irrespective of
their religious beliefs. Therefore, an ETF approach is always a
better alternative for a targeted bet on any market index.
Unfortunately, domestic investors cannot boast of many choices in
this segment as far as exchange traded funds are concerned.
We would like to discuss a particular fund targeting this space
which ceases to exist as of today due to lack of popularity.
JETS Dow Jones Islamic Market International Index
) intended to match the before-expenses price and yield performance
Dow Jones Islamic Market International Titans 100
. The product intended to provide investors with an option to play
growth story. it also provided an exposure to
-compliant companies. The ETF debuted in the year 2009 and held 94
securities in all with 31.91% of its assets in the top 10
According to Brint Frith, the president and founder of Javelin
(The fund managers), they
"found it difficult to reach target investors
through the marketing channels typically used by ETFs".
This clearly shows that the fund was targeted at a particular
section of the community, rather than the public at large. It was
probably the reason why the product failed.
The article does not intend to compare the ethical and the
unethical. Neither does it intend to identify a better investment
avenue. But it does aim to highlight
compliant investments as an asset, solely from a returns and
coverage point of view without any geo-political comment.
Nevertheless, given the growth and popularity of
compliant financial products, we can only infer that
ETFs are to be looked out for.
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