Report card of Islamic indices

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Report card of Islamic indices

Report card of Islamic indices

By Rushdi Siddiqui Available at:

Islamic equity indices, 1.0, became a global ‘instrument’ in 1999, with the launch of the Dow Jones Islamic Market Index (DJIM). But, what progress, if any, has been made in the last 11 years on Islamic indexing? (Full disclosure: I was fortunate enough to lead a team for the DJIM.) But, first, a step back to better understand the function and role of indices.

The reason indices are important is because they are the DNA of investing, be it conventional, ethical or faith based. Trillions of dollars are managed/benchmarked to indices in the form of active funds, passive funds and exchange traded funds for the man on the street to funds to sovereign wealth funds.

Indices serve three major functions;
* provide a pulse of the health of the market place (in theory),

* are the basis of investable products and

* allow investors to know how their fund, portfolio , stock, etc, did against the benchmarks, be it DJIA, S&P 500, FTSE 100, Russell 2000, TR-IR Islamic Indices.

Pre-1999, Islamic funds were using social-ethical indices and major conventional benchmarks to measure performance against Islamic funds and portfolios. Obviously, it’s a challenge to compare a “pomegranate to an apple”, and the Islamic investor, much like their conventional counterpart, demanded their “own” performance benchmark.


The desire to have their “own” is the beginning of the delinking from the conventional finance. So, today we have thousands of Islamic indices from all six index providers, but only a handful are actually utilised as basis for products. Why?

Today, nearly 95 per cent of the Islamic funds are actively managed funds due to higher management fees, cynically speaking. The more important take-away is that it’s a start point of capital market parti-cipation to start balancing the bias towards a depositor only mentality.

Query: Would an Islamic fund index, that captures the alpha fund managers are trying to achieve, be a ripe offering for Islamic investors? Is this innovation?

Two important questions come to mind to understand progress in Islamic indexing:

* Have Islamic indices achieved the status of high profile indices after 11 years?

* Are companies vying to get into Islamic indices as part of their marketing plan?

Many of the largest companies in a global Islamic index are western/conventional companies.

About 85 per cent of market capi-talisation of a global Islamic index is in the (non-Muslim) G-20 countries, including names like Micro-Soft, Pfizer, ExxonMobil, hence, screening bias results in excessive exposure to three major economic sectors, technology, healthcare and energy. These sectors are not well represented in Organisation of Islamic Countries (OIC) stock exchanges, yet important part of a knowledge-based economy.

Thus, there is delinking from conventional indices, but Islamic indices, have a large bias towards compliant western headquartered companies and economic sectors not available or prominent in Muslim countries, hence, re-lin-king to western/conventional capi-tal markets, as exhibited by high correlation ratios to conventional counterpart indices,92 per cent to 98 per cent!

OIC Exchanges

So, what is the situation in Muslim countries with stock exchanges if we apply the international syariah screening standards of Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)? Typically, the largest economic sector in most Muslim countries is the conventional financial sector, and many companies have small free float and illiquidity issues.

Thus, today’s syariah screening work well in the large and efficient G-10 markets, but not in the Muslim countries. The scholars need to look at the screening situation in OIC countries and, like converting a conventional bank into an Islamic bank, suggest ways and time frames to ‘Islamisise’ non-financial companies in Muslim countries to become compliant.

Additionally, because of automated screening of many of the index providers, many Islamic fi-nancial institutions, like Islamic banks, Takakful, Islamic leasing companies, etc, are sector screened out because classification deems them as “conventional financial” companies! Thus, the present methodology Islamic indices screen out syariah based or syariah by law companies!

(Full Disclosure: on June 27 in Kuala Lumpur, Thomson Reuters and IdealRatings, launched the world first research based Islamic indices following AAOIFI screening standards, TR-IR Islamic Indices, to address many of the concerns raised by fund managers and some scholars associated with automated syariah screening. The concerns go to credibility, especially if there are companies in an Islamic index that are not compliant, as usually associated with revenue streams breaching the 5 per cent threshold!)

High profile?

Thus, today, we have many Western companies in Islamic indices, but are they excited about being in such an index? These companies are neither vying to get into an Islamic index, nor promoting their inclusion in an Islamic index. Additionally, because there are very few Islamic index funds and ETFs, there is very little incentive to get into an Islamic index, as the assets under management for such funds is very small.

Second question is, how are Islamic indices covered in newspapers in Islamic finance hubs, like Malaysia, UAE, etc? The front pages of the business section of NST or GulfNews has previous day performance/closing of conventional indices, bond indices, currency rates, gold and oil prices, but no Islamic index performance! Yet, another reason for companies not to publicise as no publicity in an Islamic index!

Thus, in 11 years of Islamic indices in the public domain, we have:

* Thousands of Islamic indices but very few actually utilised for funds

* Mostly western/conventional screened companies in a global Islamic index, and neither have interest in being in an Islamic index nor promoting their inclusion

* Most of the funds are either in Malaysia or Saudi Arabia with bias towards actively management, and assets under management is small on average

* The print media may have daily stories about Islamic finance, but does not include Islamic indices where conventional indices are located

Surely, syariah-compliant screened companies from the western capital markets cannot be said to give a pulse of Islamic fi-nance as no major link to Islamic finance, except possibly selling their products and services to Muslim world. They may provide, at best, a pulse of fund flows, especially for global Islamic equity funds.

But, two important inter-related questions need to be raised and addressed:

• how to capture the pulse health of Islamic capital markets with equity indices indexes and

• how to build out the Islamic equity capital market to balance the present build out and bias to the Islamic debt capital market?


It must be emphatically stated that today’s syariah-screened indices are permissible and acceptable for all Islamic investors, be they Muslim or non-Muslims, even though there is a bias towards western “conventional” companies. Thus, today’s Islamic equity indices are very much like an Islamic window or subsidiary of a conventional bank holding company, both are scholar approved. But, is that enough?

To those important institutional entities, like pension funds in Muslim countries, that give out mandates for syariah-compliant investing, they need to dangle the “financial carrot” for more precise screening from committed index providers. Pension funds, with Islamic allocations, are the entrusted representative of less-informed Muslim investors, hence, they must be demanding on index providers for not only more thorough scree-ning but also purification.

The last 11 years raised the many issues in Islamic indexing. Now, looking forward, Islamic indexing in next 11 years, 2022, will have high-profile syariah-based indices, carried by many western media, have many passive funds off of it, and provide financial pulse of Islamic finance and Islamic equity capital markets, Inshaallah!

Best Regards
Dr. Zulkifli Hasan

Durham University Summer Congregation 2011. With Reader in Political Economy and Islamic Finance, Dr. Mehmet Asutay

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