CONVENTIONAL VERSUS ISLAMIC ETF

Exchange Traded Funds (ETFs) have emerged in 1993 in the US originally to provide a more efficient way for investors to track equity markets. In view of the increasing complexity of financial markets, investors resort to look for dynamic and innovative investment instruments that could be used to diversify their portfolio and ETF becomes an immediate attraction due to its feature that combines many of the best characteristics of stocks and mutual funds.

Several definitions of an ETF are as follows :

a) ETFs are index funds that trade on a stock exchange. Like a mutual fund, they represent a collection of stocks, but unlike a mutual fund, they trade throughout the day like a stock. This is similar to a closed-end fund, but unlike a closed-end fund, ETFs do not have a limited number of shares and they trade very close to their underlying net asset value

b) ETFs invest in a group of stocks or bonds or other instruments which track the performance of an index. ETFs are listed and traded on a stock exchange

c) An ETF is a pooled investment whose value is linked to an index which itself is based on a basket of assets. The index may be based on equity markets, specific sectors, bonds, commodities or even currencies, allowing a great diversity of investment opportunities

Most ETFs are passively managed index funds although there is ongoing work being done to create enhanced and actively managed ETFs. In the managing of index funds passively, managers do not pick stocks based on fundamental analysis. Instead, managers aim to track the performance of a benchmark index.

At the end of May 2009, the Global ETF industry had 1,660 ETFs with 3,008 listings, assets of US$775.20 billion, from 90 providers on 42 exchanges around the world (Barclays Global Investors, May 2009).

So what about Islamic ETF? Well, let us see….

The methodologies used by index providers to create appropriate Shariah compliant indices have shown all the main indices have broadly similar methodologies regarding business activity screening, financial ratio screening and dividend purification. Thus, these new indices have allowed investors to follow equity markets in a way that is consistent with their underlying Shariah principles and rigorous in its structure and methodology. Shariah complaint indexes give investors exposure to an index based on a screening and selection process, which combines the index design with Islamic principles. Investors are able to access a market segment that is in line with Islamic rules and way of life.

The Dow Jones Islamic Market (DJIM) Index was introduced in 1999 as the first index intended to measure the global universe of investable equities that pass screens for Shariah compliance and most importantly, the Dow Jones financial ratios have been accepted by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). The DJIM’s Shariah Advisory Committee comprised of the following scholars :

a) Shaykh Abdul Sattar Abu Ghuddah (Syria)

Dr. Abu Ghuddah is a senior Shar’ah Advisor to Albaraka Investment Co. of Saudi Arabia. He holds a PhD in Islamic Law. Dr. Abu Ghuddah has published many books on Islamic Financial transactions. He was an advisor for Islamic Law Encyclopeadia (Kuwait Awqaf Ministry). Dr. Abu Ghuddah is a member and chairman of several reputed Islamic Shariah Boards.

b) Shaykh Nizam Yaquby (Bahrain)

Mr. Yaquby is a member of the Islamic supervisory boards for several Islamic institutions, including the Arab Islamic Bank and the Abu Dhabi Islamic Bank. His work has appeared in the following publications: Risalah Fi al–Tawbah, Qurrat al–’Ainayn fi Fada il Birr al–Walidayn, Irshad al–’Uqala’ila Hukun al–Qira’h min al–Mushaf fi al–Salah, Tahqia al–Amal fi Ikhraj Zakat al–Fitr bi al–Mal.

c) Shaykh Dr. Mohamed A. Elgari (Saudi Arabia)

Dr. Elgari is an associate professor of Islamic Economics and the director of the Center for Research in Islamic Economics at King Abdulaziz University in Saudi Arabia. He is an expert at the Islamic Jurisprudence Academy (OIC), Economics. He is also an advisor to several Islamic financial institutions worldwide and the author of many books on Islamic banking.

d) Shaykh Yusuf Talal DeLorenzo (United States)

Mr. DeLorenzo is considered a leading Islamic scholar in the United States. He has translated over twenty books from Arabic, Persian, and Urdu for publication in English and has been commissioned to prepare a new translation of the Quran. Mr. DeLorenzo compiled the first English translation of legal rulings issued by Shariah supervisory boards on the operations of Islamic banks. since 1989, Mr. DeLorenzo has served as secretary of the Fiqh Council of North America. He is also a Shariah consultant to several Islamic financial institutions and was an advisor on Islamic education to the government of Pakistan.

e) Shaykh Dr. Mohd Daud Bakar (Malaysia)

Dr. Bakar is currently a member of the Shariah Advisory Council of many financial institutions in Malaysia and around the world, including the Central Bank of Malaysia, Securities Commission of Malaysia, International Islamic Financial Market in Bahrain, Accounting and Auditing Organization for Islamic Financial Institutions in Bahrain and HSBC (Malaysia).

The prospects for Islamic ETFs are bright as there is a shortage of good Islamic investment instruments to cater for the rising global demand for such products. An Islamic ETF only tracks an Islamic benchmark index where the index constituents comprise of companies which are Shariah compliant. On 22 January 2008, Malaysia launched the region’s first Shariah compliant ETF.