listening post

GROWING

POPULARITY FOR ISLAMIC INDEXES

islamic market indexes are designed to strip out stocks which dont comply with sharia principles. so where can one find fiscal value in such an acutely regulated environment? can it compete against its conventional counterparts?

ince the launch of the Dow Jones Islamic Market (DJIM) World Index in 1999, the DJIM family has expanded to provide a wide variety of benchmarks tracking Sharia-compliant securities including indexes for 69 countries, across both developed and emerging markets. The family also includes regional, industry sector and market capitalisation indexes. By screening investments for compliance with Sharia law, the indexes help to reduce research costs and compliance concerns that Muslim investors would otherwise face in constructing Islamic investment portfolios. Qatar Today caught up with the Director of Islamic Market Indexes for Dow Jones,

by RoRy C oe n
Tariq Al-Rifai, and gathered his thoughts on a range of issues regarding Shariacompliant investments and how productive the DJIM World Index is against more unrestricted indexes. In many cases it performs better, argued Al-Rifai. Weve gone back in history and weve noticed that in developed markets, such as Europe and the US, Islamic indexes perform better. There are a few cases where they didnt one was when the dotcom bubble burst, for instance. Islamic indexes tend to be high technology and healthcare, and these were hit badly during the dotcom bubble, so prices fell harder than the regular indexes. But during the recent financial crisis the Islamic indexes held on better because there arent any financial or insurance companies included. The highs and lows are similar but the severity is different. Foundation of the indexes Dow Jones founded the indexes in 1999, seeing a rising awareness of Islamic finance and Islamic investments asset managers wanted to have a world-renowned

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theres a misconception about islamic indexes. an islamic index is one which is permissible for muslims to invest in. it doesnt mean that one must only invest in Qatar islamic bank or dubai islamic bank. its investing in companies which are permissible to invest in.

benchmark. Before 1999, if you had an Islamic fund you didnt have a measure or a gauge to compare it against, which made it difficult to estimate how your portfolio was performing. There were of course the conventional indexes, but they used different rules and regulations. From 1999, Islamic investing really took off, said Al-Rifai. Our main index the DJIM World Index represents the worlds markets and its weighted according to how many companies are in each market and how big the markets are. Theres a misconception about Islamic indexes. Its investing in companies which are permissible for Muslims to invest in. For example, Evian produce bottled water; theyre an American company without any discernible ties to Islam. However investing in them is permissible. Some of the high profile companies which make up its Islamic Market World Index include Apple, Microsoft, IBM and Google in the Technology sector; Exxon Mobil and Chevron in Oil and Gas; and Johnson & Johnson and Pfiser in Healthcare. Screening The selection universe for the DJIM indexes includes the components of 69 countrylevel benchmark indexes. To determine their eligibility for the DJIM indexes, the stocks are screened to ensure that each meets the standards set out by the Sharia regulatory board. A company must meet Sharia requirements for acceptable products, business activities, and interest and income expenses. After eliminating companies that profit from unacceptable business activities, the DJIM Index Sharia board evaluates those that remain using several financial ratios, which are established to exclude companies that have unacceptable levels of debt or earn impure interest income. Liquidity is an additional criterion for inclusion, and the in-

vest in alcohol, tobacco, gaming, conventional banking and insurance companies are not permissible. Then we put financial ratio screens on the resulting universe to minimise companies which have a high level of debt, because this means that they are paying a lot of interest, which is not acceptable. The resulting universe includes the companies which make up the index. So for instance, a company might go to the market to raise a conventional bond. This is no good because they broke through the leverage ratio so we remove it at the next review. Another reason would be if a chicken producer decided to buy a pork producer they have a line of business now thats no longer permissible so we must drop them also, he explained. Tool for fund managers So who are these Islamic indexes aimed at? The average man on the street who wants to earn a quick buck whilst adhering to Sharia principles, or a fund manager at an investment bank? The indexes collate data and get averages, but how do they help to make strategic investment decisions? Our investor is not the average man on the street, explained Al-Rifai. Its the fund manager that manages the fund or the bank that launches a product to attract a fund. So why would they choose us as a customer? If youre a fund manager you need to be able to gauge yourself to see how well you are doing against others, and how is this done? These investment managers work with a benchmark theyll choose an index and say: Were going to launch a GCC equity fund, so we need a GCC index. We also want it to be Islamic. That wont only be their benchmark, but theyll also be able to see what stocks are permissible. We also work with fund managers in creating exchange-traded funds (ETF) or exchange-traded products, which are essentially funds which behave in their

Tariq al-rifai
Director of islamic market inDexes
Dow Jones

dexes include only actively traded stocks that are easily accessible to investors. The DJIM World Index has about 2,600 companies this number fluctuates every quarter when we add or remove companies, said Al-Rifai. There are three reasons why we might drop a company from an index. The simplest one is if it is acquired or it merges this has nothing to do with Sharia principles, its just no longer traded on the market. Then there is Sharia screening. We look at the world markets which have thousands of companies and we apply two screens to determine Shariah compliance. The first one is industry screening. There are obvious industries which we cannot in-

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Qatar today 35

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dJim world index sector allocation

technology oil & gas healthcare industrials basic materials consumer goods others

%
country allocation
us

12
uk

17 7

16
Japan

14
canada

13 3

9 3

9
others

switzerland australia

54

21
(as at 30/5/2012)

characteristics as a stock you buy it and sell it on the stock market like a stock but its actually investing in a basket of stocks based on an index. Thats a bit more technical, but they need an index to do this structure, he explained. Trends in the market In a practical sense, where are we seeing the indexes help investors make decisions? Are we seeing any discernible trends in the marketplace? On the back of the results which the indexes throw up, where are asset managers and investment banks placing their chips? Right now were looking at three trends in the market, said Al-Rifai. First off were seeing a lot of growth and interest especially since the financial crisis in fixed-income products such as bonds or the money market. It gives you ongoing income while limiting the downside potential. Volatile stocks and real estate are where investors have got hurt the most, but bonds are popular now, theyre almost like a deposit and every month you get a tidy return. In 2006 we launched the first ever Sukuk Index sukuk are Islamic bond equivalents. That has been going well, but the major issue is that the sukuk market is still relatively small compared to the demand thats there its not widely traded, so there are liquidity issues. Secondly, investors are looking for something which gives them an income, gives them some comfort and minimises the downside. Seeing this, we launched the Dow Jones Select Dividend Index, which measures the stock performance of the worlds top dividend-paying companies maybe 3-4% returns. For investors, and particularly Islamic investors, this kind of return gives them the solution theyre looking for

which is something thats liquid, something they can trade in and out whenever they want and at the same time its generating an income for them. Thirdly, we see that there is a lot of interest in commodities oil, precious metals, grains and things like that. But commodities, such as oil and natural gas, are traded on futures pricing, which is not Sharia compliant. As such, Islamic investors have shied away from this sector. However, there is another way these investors can gain exposure to commodities. This is what we did at Dow Jones Indexes. We took the companies that are in our Dow Jones Islamic Market World Index and selected the ones that are commodity producers (such as Exxon Mobil, Total, BHP Billiton, Newmont Mining, etc.) and we made an index of these companies (i.e. an index of commodity-producing companies not direct commodities). This is the solution we came up with to solve one of the dilemmas in the Islamic finance industry. Another solution would be to develop Sharia-compliant pricing for commodities directly, but this is out of our scope so we will leave it up to others, he said. The DJIM Global Equity Commodity Index intends to measure the stock performance of companies engaged in the exploration or production of scarce and renewable commodities, as well as companies that provide related services. Only companies that pass rules-based screens for Sharia compliance are included in the index. The commodity sectors represented are agriculture, energy, metals, precious metals and water. Easy accessibility Liquidity is an additional criterion for inclusion in the DJIM indexes, and they include only actively traded stocks that are

easily accessible to investors. The selection universe expressly excludes the very smallest and most thinly traded stocks. So does this rule out the likes of China, where some stocks may be difficult to access? We have indexes for China, said Al Rifai. In fact in Asia we launched a Greater China Index, which is China, Hong Kong and Taiwan. It basically offers exposure to that market. What we launched recently for GCC-based asset managers is the CHIME Index for China, India and the Middle East. We made this index for those asset managers who want to invest in companies in these countries, and we launched a fund with a Qatari company to do Islamic CHIME. From our perspective we have no problem getting pricing in China, or otherwise we wouldnt have done an index. Regulations A five-member independent Shariah supervisory board advises Dow Jones Indexes on the methodology of the DJIM Indexes. With Sharia being largely based on interpretation, how difficult is it to gain a consensus on contentious matters which may be understood differently depending on the country you are in? In 1999 there wasnt any consensus, said Al Rifai. Were a global index provider we wanted to make sure we had a methodology that we could use to screen whats universally accepted. So if you look at our board members, its pretty diverse. We have an American, a Syrian, a Bahraini, a Saudi and a Malaysian, so I think we have a good representation of the schools of thought. Obviously the standards that we developed are widely used today, but when you look to invest in the stock market the concepts, the methodology and the screening they are all fairly universal right now

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