ZAINORA HAYARI ZP 01456

SUZANA ITHNAIN ZP 01432

ISLAMIC UNIT TRUSTS

&

ISLAMIC EXCHANGE-TRADED FUND

(ETF)

Purification

Types of Funds

Islamic Unit Trusts

An OverviewIssue

Investment Strategies of

Funds

ISLAMIC FUNDS:

ISLAMIC UNIT TRUSTS

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AN OVERVIEW

Islamic Unit Trust Funds, more commonly referred to asShariah funds are a group of specialized collectiveinvestment funds which offer investors the opportunity toinvest in a diversified portfolio of securities that aremanaged and selected by professional portfoliomanagers in accordance to Shariah principles.

Beginning mid 1990s, the fund management sector hasbecome an attractive industry where investmentopportunities have increased choices available forinvestors.

The term “Islamic Investment Fund” means a joint poolwherein the investors contribute their money for thepurpose of investment to earn halal profits in strictconformity with the precepts of Islamic Shariah.

What is a difference between an Islamic and Non-

Islamic Unit Trust Fund?

A Shariah Fund offers similar benefits to any

other fund with the same investment objective;

the only difference is that it only invests in

companies that are in compliance with the

Shariah principles as outlined by the Shariah

Advisory Council (SAC) of the Malaysian

Securities Commission.

Like all the other non-Islamic Funds in Malaysia,

Shariah Funds are regulated by the Securities

Commission and placed under the same stringent

regulatory criteria.

2 TYPES OF INVESTMENT FUND

Open-Ended Funds Close-Ended Funds

Is a collective investment which can

issue and redeem units at any time.

Ie: Unit trusts

Is a company (investment company)

structure where the company will issue

shares for subscriptions.

Ie: the mutual funds in the US, In

Malaysia is ICapital.Biz.

An investor can purchase units in such

fund directly from the unit trusts

company, or through authorised agents

(individual and bank)

Is another type of collective investment

but with a limited number of units.

Refers to a fund operated by the fund

manager that makes offers to the public

and invests the proceeds in a group of

assets, in accordance with the fund’s

objectives.

It refers to a fund with a fixed number of

units outstanding, and one which does

not redeem units as open-ended funds.

It behaves more like stock.

Price: Computed on a daily basis by :

(Fund’s Total Aset – Liabilities)/No.of

Units Outstanding.

Price: Share determined entirely by

market demand. Often higher or lower

than the NAV per share.

TYPES OF FUND

There are 3 Varieties of Unit Trusts.

1. Equity Funds(deals in stocks)

2. Fixed income funds (deals in bonds)

3. Money market funds.

All units trusts are variations of these 3 asset

classes.

TYPES OBJECTIVES STRUCTURE/UNDERLIER

Money Market Funds To invest in money market. Short term debt instrument,

mostly treasury bills

Income Funds To provide current income

on a steady basis.

Government and corporate

debt, stocks and bonds.

Balance Funds To provide a balance

mixture of safety, income

and capital appreciation.

Mixture of fixed incomes and

equity.

Index Funds To replicate the

performance of a broad

market index.

Market Index.

Investment-Linked

Funds

To provide balanced

income for specific life

insurance or family takaful

plans.

Stock and bonds.

ISLAMIC UNIT TRUSTS

INTRODUCTION

1992 – 1ST Islamic Unit Trusts, namely Tabung

Ittikal Arab-Malaysian was launched.

This unit trust is managed by Arab-Malaysian Unit

Trust Bhd.

Then, there has been encouraging growth in the

Islamic unit trust industry.

Establishing Islamic Unit Trusts

Requires an Islamic fund Manager (must be holder of the

CMSL).

An Islamic fund Manager must carry on Islamic fund

management business only and must be stated in its

Memorandum and Articles of Association.

Major requirements for establishing Islamic fund

management is that the fund manager must appoint an

independent Shariah adviser (individual/a

corporation/Islamic Bank).

The Shariah Adviser :-

either a resident/non-resident (approved & registered by the

regulator

roles and duties quite similar to Shariah Board/Shariah

Advisory Committee of an Islamic Bank.

Must provide and advise Shariah expertise and guidance on

all aspects and matters of the Islamic fund management

business.

Must certify that the business has been managed and

administered according to Shariah principles.

VALUATION & PRICING OF UNITS

A fund manager should take all reasonable steps andexercise due diligence to ensure that the fund and thefund’s units are correctly valued and price.

To determine the fund’s NAV per unit, a fair andaccurate valuation of all assets and liabilities of thefund should be conducted.

Valuations should be based on a process which isconsistently applied and leads to objective andindependently verifiable valuations.

Investment Strategies of Funds

Investment Strategies of Funds

• Applicable techniques

1- Fundamental Analysis

2- Technical Analysis3- Asset Allocation4- Absolute Return

5- Arbitrage6- Style Investing

Active Management

• The fund does not seek toour perform any investmentbenchmark, but rather aimsto replicate or track thereturn performance of aninvestment benchmark.

• Eg; CIMB-Principal’s KLCI-Linked fund endeavours toprovide its unit holders areturn similar to theperformance of the KLCI.

• Less frequent and lessrecurrent fund managementactivities.

Passive Management

Purification of Earnings of Fund

The fund must have a Shariah Board.

The Shariah Board shall ensure that the returns

of the fund are purified from non-Shariah

compliant gains before the distribution of profits to

investors.

Purification = the cleansing of an investment

portfolio of impure elements.

Purifications may be done by deducting from the

returns on the investment those earnings

emanating from the unacceptable source.

t1. Speculation

- Has mistakenly been equated with gambling

- Involves a great deal of computation which in the

highly developed computation techniques of today can

hardly be a game of chance

- The issue:

i.Accounts period

ii.Buying securities in margin

iii.Taxation

iv.Commission

v.Service charge

ISSUES in ISLAMIC UNIT TRUSTS

1.1 Account periods

-The length of this period can give the speculator a

great chance to operate:

“ he can buy shares even if he does not have any

cash: hope that towards the end of the period the

price of the share will go up so he can sell the shares

which he previously bought at the beginning of the

period and make a profit after paying the commission

and other costs”

- In order to curb speculation, it is tempting to suggest

that the Settlement day be the day of transaction.

Solution:

-In Shariah rules- “selling what he does not own” is

not permissible

-The transaction can be regarded as comparable to

the Salam (credit sale contract) transaction.

2. The diversity provided by an islamic Unit

Trust is perhaps its most attractive

feature, which on the flip side can also

provide room for uncertainty.

- Is the fact that an investor buys into a basket of

underlying

equities.

- In some cases, there are stocks which do not

comply with the

binding Islamic requirements

Solution:-Have three options;

1. In i-VCAP’s case, the index is based on 25 stockcomponents: therefore, if one is not approved bythe SCM, we can rebalance the remaining 24stocks so that it will proportionately take on thepercentage on the non-approved stock

1. To look for an approved stock with similarcharacteristics and correlation as the one which isnot approved, and include that into the portfolio asa replacement stock.

1. Maintain that portion of the non-approved counterin cash.

3. Global InvestmentsAbility to gather information to analyse global companies orissues to determine whether it is Shariah-compliant.

Justification:

- In classifying these securities as approved securities, theSAC has applied a standard criterion in focusing on the coreactivities of the companies listed on the Bursa Malaysia.

- companies with activities involving both permissible andnon-permissible elements must have good public perceptionor image and that the core activities of the company areimportant and considered maslahah (‘benefit’ in general) tothe Muslim ummah (nation) and the country, and the non-permissible element is very small and involves matters suchas ‘umumbalwa (common plight and difficult to avoid) ‘uruf(custom) and the rights of the non-Muslim community whichare accepted by Islam.

4. Selling Unit Trust products Outside

Malaysia

Legal and Regulatory issues

Acceptance by Middle-East investors of Malaysian unit

trust products.

i. Differing Shariah opinions and rulings

ii. Differing accounting standards

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Islamic Exchange Traded Fund (I-ETF)

Understanding the nature of

ETF

Advantages & Disadvantages of ETF

What is an ETF?

The Operation of Islamic ETF

ETF Structure

ISLAMIC EXCHANGE-

TRADED FUND(ETS)

What is an ETF?A listed index-tracking fund, structured as a unit

trust scheme whose primary objective is to

achieve the same return as a particular market

index by investing all (full replication) or

substantially all (strategic sampling) of its assets

in the constituent securities of the index.

In a simple meaning, ETF are actually unit trusts

that are listed on stock exchanges, which means

that the investors could trade them like stocks.

Understanding the Nature of ETF with

Respect to Stocks and Unit Trusts

ETF on the other hand resembles the feature of a

unit trust.

Eg; An investor purchases 1 unit of the unit trust.

It is as good as holding the various stocks on the

Exchange/Bursa.

Likewise when an investor purchases 1 unit, it is

as if the investor is holding several top stocks.

In addition, unit trust involves active management

where the fund managers pick the stocks that will

generate a higher return than the market return.

In Malaysia,

ETFs can be

differentiated

from shares

and unit trust

fund as in the

diagram box.

Advantages of ETF

Disadvantages of ETF1.

ETF are

bound to the

ups and

downs of the

market.

ETF STRUCTURE

The ETF structure as operated in the Malaysian market is illustrated

below :

Islamic Exchange Traded Funds (I-

ETF)

An Islamic ETF and conventional ETF sharecommon characteristics. The main differencebetween a conventional ETF and Islamic ETF isthe benchmark index that the Islamic ETF tracks.An Islamic ETF only tracks an Islamic benchmarkindex where the index constituents comprise ofcompanies which are Shariah-compliant.

An Islamic ETF is also required to appoint aShariah adviser/committee to provide expertiseand guidance to ensure its structure, investmentand all matters related to the funds’ activities arecomply with Shariah.

The Operation of Islamic ETF

Diagram 1 : Basic Structure of an Islamic

ETF

Diagram 2 : Concept and Regulation of

Islamic ETF in Malaysia

What are the risks?

Among the risks that investors should carefully consider before

investing in ETF are:

1) Market risk- ETF prices are exposed to the economic,political, currency, legal and other risks related to the indexthat the ETF tracks.

2) Tracking error- Although the main objective of an ETF is totrack the performance of its benchmark index, the ETF’sperformance may deviate from the performance of thebenchmark index.

3) Lack of manager’s discretion- In this passive managementstrategy, the manager does not try to outperform thebenchmark index.

4) Liquidity risk- The listing of an ETF does not guarantee thatthere will be an active trading market for it. There is nocertain basis for predicting the sizes or actual prices at whichthe ETF units will trade.

1. Purification or earningShariah scholars have different views about whether the“purification” is necesary where the profits are made throughdividens, capital gains, assets or liabilities.

Justification:

- As per the current Shariah guidelines, purification is carriedout on any interest income earned and paid to theshareholder through dividends only.

- The existing mechanism only purifies the dividend incomeportion of the shareholder and that too on a partial basis.

- A dividend purification rate is calculated for each companyand applied to the dividend income earned from thatcompany.

Issue in Islamic Exchange Traded Fund

2. Liquidity

Large majority of Islamic funds is not listed in any stock

Exchange

While it's important to look at how ETF shares are

trading, the fund's underlying holdings are really the

heart of the liquidity issue

One problem is that market makers—those who help

maintain orderly trading in ETFs—get rebates from

exchanges that are calculated on a per-share basis.

Thus, they may not have much incentive to maintain

relatively narrow gaps between bid and ask prices in

funds with very low trading volume.

Liquidity may be lower based on liquidity of compliant

sectors

Issue in Islamic Exchange Traded Fund

3. Technical Issues

ETF requires intense technical infrastructure and

regulations for exchange, custodian or settlement

bank, manager and market maker

Regulations and technical systems are usually

established for conventional ETFs

Infrastructure may be incompatible with Islamic ETFs

for some instances and may require adjustments

Issue in Islamic Exchange Traded Fund

4. Compliance Limitations

Short-selling of Islamic ETF may conflict with Islamic

principles

Asset-lending may be limited according to some

schools

Futures & options are also controversial, so it is hard

to establish Islamic commodity ETFs (ETCs) based on

futures contracts

Issue in Islamic Exchange Traded Fund

5. Asset Allocation Issues

Since asset classes are limited, equity and bond

ETFs will be major types

Compliant bonds are best for allocation purposes if

their market is liquid

Gold and FX are compliant as long as they are traded

in spot market

Conventional hedging strategies using futures &

options on ETF may not be available

Issue in Islamic Exchange Traded Fund

Solution

Tawarruq

- is the mode through which Islamic Banks are

facilitating the supply of cash to their clients. The

method consists on buying an asset and immediately

selling it to a client, either directly or indirectly, on a

deferred payment basis.

- The client then sells the same asset to a third party

for immediate delivery and payment, the end result

being that the client receives a cash amount and has

a deferred payment obligation for the marked-up price

to the Islamic Bank.