Emergence of Shariah compliant stock indices
Now that the advantages of dealing with an Islamic asset manager are clear to readers, I would like to have a deep dive with you on how the Islamic funds operate and what the role of an asset manager is in handling investors’ money and to get them decent Halal returns periodically, and at times a windfall.
I will commence with the structure of an Islamic mutual fund where the investors pool the money and hand it over to an asset manager (also called fund manager). The asset manager is responsible to invest the funds as a trustee in a Shariah compliant manner to achieve the common investment goals, ie getting the desired Halal profit to investors from time to time, and to return to them the capital at their demand, or upon completion of the agreed investment period.
A mutual fund may invest in any asset class provided it is Shariah compliant and has been approved by its Shariah board. For my discussion purposes, I will opt for the fund which invests in publicly listed shares appearing in an Islamic stock index.
A stock index represents the aggregate current market value of the select publicly traded shares of companies from a cross-section of economic fields. The daily index tracks the changes in the value of a hypothetical portfolio of shares of these companies during a trading day.
The weight of an individual stock in the overall portfolio is equal to the proportion of the portfolio invested in that stock. The percentage increase or decrease in the value of an index is usually equal to the increase or decrease in the total value of the stocks constituting the index on that day.
Investors worldwide reap rewards by investing in publicly traded shares of joint stock companies. They cash the investments when the market value of the invested shares increases. Also, they are entitled to earn dividends while their funds remain invested.
However, such investment is also laden with the risk of losing the capital partly or fully amid a stock market crash, which has been observed many times in different markets all over the world.
Many wealthy Muslim investors were skeptical about investing in shares as they were not sure from the religious point of view. Clear faith-based guidance was needed on which companies to choose from and when to exit. Those who had invested were equally concerned whether the activity is Shariah compliant.
In this backdrop, a most innovative development took place for Muslim investors during late 1990s when Dow Jones, world’s leading stock market index provider, constituted the first Islamic securities Index in the world with the approval from a panel of renowned Shariah scholars.
The idea was simply based on the Shariah guidelines of investing Muslim money in Islamically permitted trading activities. That means the shares of companies dealing with alcohol, pork, casinos, music, interest-based banks and financial institutions, besides conventional insurance companies, were not considered appropriate for investment by Muslims since these activities are considered unethical and forbidden under Shariah.
Though shares related to manufacturers and traders of tobacco and weapons and ammunition are not clearly forbidden, on the recommendation of scholars, these were also excluded for consideration due to the harmful and fatal impacts these industries are known to leave on society.
After a thorough review and their own scrutiny and examination, the scholars felt the necessity for such an index. A Shariah board was constituted by Dow Jones which comprised renowned Shariah personalities from Islamic world. The endorsement of the idea of an Islamic index by reputable Shariah scholars provided a much-needed fillip to an ordinary Muslim investor.
Were the criteria of activity considered enough to include certain stocks into an Islamic index? No, there were other stringent measures to qualify. I will explain them later.
The first Islamic index was launched by Dow Jones in Bahrain in September 1999. Riding on the wave of success, Dow Jones has so far taken out other Islamic indices, comprising thousands of Shariah compliant companies from a cross-section of economic sectors. These stocks are periodically screened to verify that they continue to remain compliant.
The large-scale acceptability and success of the Dow Jones Islamic indices gave rise to the emergence of a series of such other indices, prominent ones being IdealRatings, Financial Times Stock Index or FTSI (also known as Footsie), Morgan Stanley known as the MSCI Index and others.
The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.
Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at sazubairi1979@gmail.com.
Next week: Criteria of an eligible stock.
