Chapter 5 Islamic Equities Market

ISLAMIC INVESTMENT

Mahyuddin Khalidemkay@

salam.uitm

.edu.my

Islamic Equities Market

Topic Outline

Islamic Equities Market Types of Securities Common Stock Preferred Stock Shareholders Reward

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Introduction

Securities are financial assets

Traded in the capital markets

Since the fluctuations in securities prices can be very volatile it is very attractive investment

People with surplus funds

To buy and sell them

Hoping to get dividends and/or

capital gains within a short

time

Issuers of securities

Use their securities to raise

funds

For future expansion of their

business

Governments

Issue securities to raise funds

For development projects.


Going by the Shariah, equity financing would be the preferred financing/investing technique. • Equity financing has no fixity of return.• Returns that are tied to the earnings of the underlying

business. • A risk-profile not detached from that of the business. Thus, equity financing is very much profit and loss sharing with all the business risks thrown in. Investment in a stock resembles the provision of Mudarabah financing.

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However, not all stocks listed in an exchange may be acceptable from a Shariah viewpoint.

The need for a shariah evaluation of stocks and the identification of shariah compliant stock has led to the development of :

• Shariah filters• Shariah indices• Shariah compliant REIT (Real Estate Investments Trust) and ETFs

(Exchange Traded Funds)• Entire industry of Islamic Mutual Funds

All these have meant that there is an Islamic Equities Market operating in parallel with the conventional equity market.

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Components of Islamic Equities Market

Stock/ shares

Islamic Mutual Funds

Islamic ETFs (Exchange Trade

Funds)

Islamic REITs (Real Estate Investment

Trusts)

Others like Islamic Private Equity Funds,

Islamic Structured

Products etc.

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STOCK EXCHANGES

SHARIAH COMPLIANT STOCKS

INVESTORS

ISLAMIC PRIVATEEQUITY

ISLAMIC REITS

ISLAMICETFs

ISLAMIC MUTUAL FUNDS

Types of Securities

There are 2 main types of securities namely:

Equity instruments

Debt instruments

The third type which

is increasingl

y becoming popular is:The hybrids. Hybrids are those that have the

characteristics of both equity

and debt.

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Types of Securities

The most common equity

instrument is the common stock

As long as the stockholder has

the shares he has a residual claim on

the firm.

The most common debt

instrument is the bond/sukuk

Generally bonds would provide holders a fixed annual or semi-annual interest

payments (coupon payments) and full

repayment of principal at maturity.

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Common Stock

Characteristics of Common

stock

• Right to residual value of the firm• Right to the portions of dividends if

announced• Right to vote in the AGM.

Common Stock

Dividend

• Cash: Treated as investment income and taxable

• Stock: Dividend in form of additional stock issued in proportion of stock owned

• Property: Dividend in form of product and services

Equity instruments represent ownership in the company.

Common stock is

• A public listed company is jointly owned by its shareholders.• Since the corporation is a separate legal entity the shareholder is responsible for any losses up to his total investment.

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Types of Common Stock

Types of Common stock associated with the underlying company

Blue chip

Strong, stable and mature, with a long history of consecutive quarterly dividends; May also be a suitable investment for an investor with an income objective.

Growth

Strong potential for improving profits. The company's earnings are growing faster than the overall economy, and thus the stock has a strong potential for outperforming the market.

Emerging growth industry

Young firm in new industry with good growth prospects, but also high-risk.

Income

Mature company with high dividend yield and few prospects for growth or diversification. These are typically utility companies; however, they may also be blue chip companies.

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Types of Common Stock

Types of Common stock associated with the characteristics of the industry

Cyclical stocks

Move with the broader market - and often with greater volatility -

so they outpace the market during an expansion but whipsaw back

during a contraction. Automotive stocks are one

example.

Counter-cyclical or defensive stocks

Do better in bear markets, when investors are looking for safe places - that are not affected

greatly by economic currents - to park their money.

Companies in the food, health care and defence industries are all

examples.

Speculative or special situation stocks

Those for whatever reason, an investor believes will rise quickly

in market price.

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Common Stock Investment Strategies

Buy and Hold

Conservative

approach and value-oriented

Goal : current income

and capital gain

Current income

Safety and stability of

income

Goal: supplement for other

income

Quality long-term

growthTotal

Return Approach

i.e. emphasize

capital gain and

high income

Goal: Capital

gain

Aggressive stock

management

Aggresively trade in and out stock;

timing is the key element

Goal: Capital

gain

Speculation and

short term trading

Known as Day

Trading, capital gain in

short time period

Goal: Capital

gain

Advantages of Investing in Common Stock

Advantages of investing in Common stock• High current income• Higher rate of return• Low unit cost • Less risky due to its

position during liquidation

Disadvantages of investing in Common stock• Return is limited and fixed

in amount• Capital gain potential is

small• Yield give-up relative to

bond• Yield not kept up with

inflation

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Preferred Stock

Preferred Stock

A share that does not give a right to the shareholders to vote at its general meeting or any right to participate in any distribution of the company that has stated the amount, whether through dividends, redemption,dissolution or otherwise.

Characteristics of Preferred stock

Limited voting right

in the event of merger, liquidation or issuance

of bond

Call provision

stock repurchase by company

Conversion feature

to common stock

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Types of Preferred Stock

• Continuous claim to dividend• Dividend paid before common stockholders

Cumulative Preferred

• Doesn’t confer steady claim to dividend• Would not be paid any missed dividend

Non-cumulative Preferred

• Receive extra dividend over nominal onesParticipating Preferred

• Option to convert to common stock Convertible Preferred

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Advantages of Investing in Preferred Stock

Advantages of investing in Preferred stock• Can be bought or sold

easily• Legal liabilities are

restricted• 2 ways to gain

benefits

Disadvantages of investing in Preferred stock• Volatility of price• Could lose substantial

value in short period• Lack of control

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Underlying Shariah Contract of Stocks

Issuance of shares by companies is based on principles that relate to

contract of Musharakah.

Musharakah is contract which

involves two or more parties in a project or business where each

of the parties contribute to the

capital and actively involves the

management of the project or business

Thus, the investor who hold the shares of a company actually participate in the terms of up and downsides of the company.

They will share company’s fortune in the form of higher dividend and higher value of the share, and if the com suffer losses, the shareholder may not received div and experience in declinations of share values.

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Shariah Ruling on Common Stock

In general• It is permissible if the

main business of the company is in compliant with Shariah rulings

OIC Fiqh Academy • It is permissible to

purchase, hold or sell its shares even if the company was to undertake prohibited activities such as borrowing money and/or invest its money on the basis of interest, the company can still be invested provided they fulfil certain criteria.

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Shariah Ruling on Preferred Stock

OIC Fiqh Academy

• Not permissible

SAC of Malaysian Securities

Commission• Only Non-

cumulative preference shares are permissible

• Based on tanazul concept

• Where the right to profit of the common stockholder is given willingly to a preferred stockholders.

Convertible Preferred Stock

• No formal fatwa given although most Shariah scholars are concerned about element of gharar

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Shareholder Rewards

Cash dividends

No objections from Shariah perspectives

Bonus issue or

stock dividend

Shares in lieu of cash

No objections from Shariah

Rights issues

Current shareholders given special

right topurchase new

shares at below market

price

Acceptable to Shariah

Shareholder

benefits or perksRewards given to shareholder in kind ratherthan cash, for e.g., free food

or food coupon,

hotel stays etc.

Acceptable to Shariah

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Summary

In this chapter

you have learned about:


Types of Securities

Shareholders Reward

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Education

Chapter 5 Islamic Equities Market