LONDON, 12 May 2008 — Islamic equity indices are outperforming conventional indexes 2:1 in the regional equities sector, confirms Rushdi Siddiqui, Global Director of Dow Jones Islamic Market (DJIM) Indexes. This is because Islamic equities have no exposure to the conventional financial sector stocks, which have been dogged by the credit crunch due to the subprime mortgage crisis in the US.
“This hasn’t been articulated to the wider market, but it should be. The problem is the current market perception of Islamic equity investments. The impression is that Islamic equity investments are basically about not investing in pork production and processing. Performance does not really care about a spiritual or secular basis,” adds Siddiqui, who has been the architect of Dow Jones Indexes 90-plus series of Shariah-compliant indices, which were launched way back in 1999.
In recent months there has been a proliferation of Islamic equity indexes by the ‘Big Four’ global index providers, led by Dow Jones, but ensured by FTSE, Standard & Poor’s (S&P) and MSCI, all of which have now entered the market aggressively.
Dow Jones is not unduly worried. “An index provider is a commoditized business. Our indexes are based on rules and all of us index providers have the same figures. The key issue is what distinguishes us as an Islamic index provider from others who have entered this space. Do you have people from the FTSE, S&P, MSCI and others who go to Islamic finance events to talk about Islamic finance and capital markets; or where Islamic indexes fit in. Or do these index providers just talk about Shariah screening of stocks. We have our own Shariah board, while they have outsourced the Shariah functions. That is an issue of financial commitment. Since we have been in this space for almost 10 years we have dealt with almost every question that has been asked in the market place. Whatever we are bringing to the marketplace is a function of these inputs over the last decade,” explains Siddiqui.
Dow Jones is planning to expand the bandwidth of Islamic asset classes. As such, it last year launched a Sukuk Index and an Islamic Sustainability Index. Although it is not possible to apply equity screens to other asset classes, such as REITS (real estate investment trusts), for instance, Dow Jones believes that it is trying to provide a path to an Islamic capital markets, and the signs on that path to that Islamic capital markets.
At the latest count, Dow Jones has $7 billion of money managed against its Islamic indexes. There may also be a further chunk of funds on the private banking side that is not disclosed to the index provider. In terms of the variety of funds available, Islamic finance is largely actively managed funds. There is a perception out there that one must do something to a portfolio to add value. But the concept of index funds is slowly catching on and the Islamic ETF space is slowly catching on.
But Siddiqui warns that the proliferation of Islamic equity indexes could backfire. “The danger is that it could become an academic exercise. It is an issue of the marketplace saying ‘Are they just here to absorb the liquidity, or are they in the marketplace to contribute to the liquidity?’ But the value added in the sector is slowly developing. DJIM has already seen three Islamic ETFs (exchange traded funds) launched against its indexes in Turkey, the Gulf and Malaysia. Dow Jones is also working with other ETF providers to launch an Islamic fund on the London Stock Exchange (LSE).
In January this year, ValueCap, an investment arm of the Malaysian Finance Ministry in cooperation with Bursa Malaysia and DJIM, sponsored an Islamic ETF off the DJIM Malaysia 25 Titans Index. The fund attracted contributions of $250 million, reflecting market demand, and is by far the largest Islamic ETF to date. It is expected to rise to $1bn in funds under management by end 2008.
“ValueCap organized a great launch. On that day Malaysia was truly a hub for global Islamic finance. Prime Minister Abdullah Badawi said in a speech in 2007 that an Islamic ETF is a part of the national agenda for Islamic finance. The Malaysian government has really pushed this project forward through the coordination and participation of the various stakeholders for this thing to happen. What is interesting about this phenomenon is the beginning of the maturity and sophistication of the marketplace in the Islamic finance space,” stresses Siddiqui.
Dow Jones pipped FTSE to the ETF despite the fact that Bursa Malaysia and FTSE have a cooperation relationship. “This development,” says Dow Jones, “is because of our commitment; because of the profile we have in the Gulf Cooperation Council (GCC) states; and because of the opportunity to tap GCC money into Malaysia. With the DJIM underlying index, the likelihood of that happening is greater. I don’t see ETFs from other index providers.”
To put the Islamic ETF market in perspective, the size of conventional ETF market according to Morgan Stanley research, is about 647 billion. It is expected to reach the $1 trillion mark in the next couple of years. The Islamic space in this respect has a huge catch up to do.
An ETF is basically an index that is listed on an exchange and trades like a stock throughout the day. So if investors are trading in Emaar or Amlak, they can get coverage or exposure to the total particular market through the ETF vehicle. It is tradable like a stock. An ETF is a stable trading vehicle which fits nicely with the investor profile in the Gulf, especially of those who like to trade.
Currenrly index providers have equity-only exposures. But all of them report that they are also interested in working with people with vision on other asset classes such as commodities; Islamic REITS; and even Islamic private equity.
But what about developing a rental benchmark for the rapidly growing Islamic mortgage market? Siddiqui is sanguine about this challenge: “We really can’t do this because it is a function of getting access to data. But the methodology does exist. We need access to quality data that has to be regularly updated. If that data exists and given to us on a consistent basis, then creating such an index is possible.”
Even if Islamic finance is 40 years old, it is up against a conventional industry that is 400 years old. In reality it is only five years old, because of this surge of petrodollar liquidity. Experts such as Siddiqui stress that it is unfair to expect the Islamic finance sector to have the efficiencies and product range of the conventional industry.
DJIM launched an Islamic China Offshore Index in 2007. It licensed Hang Seng in Hong Kong, to launch an index fund off that index. Within the first five weeks, the fund amassed $50 million. DJIM last year also launched an Islamic BRIC; Islamic China Offshore; and Islamic India indices.
Siddiqui would like to see the launch of an Islamic Muslim Country Index. Partly to stem “Shariah-compliant capital flight” “I would like to see an Islamic global Muslim country index — for the sake of raising the issues; for the sake of regulators and Shariah scholars. We may need another set of screens for Muslim countries to give them time to mature. In the Sukuk sector, we should seriously consider what has been happening in Malaysia because they have a robust secondary market. A Sukuk index and a Sukuk fund of that index is a greater likelihood here than out of the GCC,” he stresses.
And in the current credit crunch market is there any lesson the Islamic finance sector can impart to the conventional banking sector? “The best lesson the conventional sector can learn from the Islamic sector,” says Siddiqui, “is if you do asset-based financing there should be real tangible assets and full disclosure of the underlying assets. You should not be bringing out exotic investment vehicles based on mortgages where people were given mortgages where they cannot afford the step-up on the interest rate adjustment.”
