Tuesday, January 20, 2009

Islamic Investment Opportunities in India

By M H Ahssan



Globally, Islamic finance is estimated to be worth about $350 billion, growing at 20% annually. With this growth, the need for Shariah compliant financial products has also increased. The product offerings are similar to normal banking products; however the main difference is that the funds collected are not for the purpose of accumulating/ paying interest or invested in any negative businesses that harm morality of the society. The basic principle of Islamic banking is the prohibition of interest.



India with a 15% Muslim population, the highest in a non-Islamic country and third highest in the world is slowly becoming forefront of Islamic banking initiatives. It has benefited the Indian economy by attracting investments from the cash rich Middle Eastern economies on the lookout for new investment destinations. After 9/11, most of these countries started pulling out their investments from the US and Europe because of the fear of freezing of assets. Another reason could be the slowdown in the economies of western countries. A growing Indian economy has created huge interests among Islamic nations. Five Indian companies, Reliance Industries, Infosys Technologies, Wipro, Tata Motors and Satyam Computer Services figure in the Standard & Poor’s BRIC Shariah Index.



Shariah Law

Shariah is Islamic canonical law, which observant Muslims adhere to in their daily lives. Shariah has certain strictures regarding finance and commercial activities permitted for Muslims. It prescribes a set of criteria which needs to be satisfied before a Muslim investor or institution can invest in the equity of a given company. From the view point of Shariah law, businesses such as those dealing in pork, alcohol, gambling, conventional financial services, media or advertising, tobacco, pornography, music etc are non-permissible for investment. Furthermore, companies have to be screened so that they satisfy certain accounting ratio restrictions.



Shariah Compliant Investment Avenues

Out of 6,000 BSE listed companies, approximately 4,200 are Shariah compliant. The market capitalization of these stocks accounts for approximately 61% of the total market capitalization of companies listed on BSE. This figure is higher even when compared with a number of predominantly Islamic countries such as Malaysia, Pakistan and Bahrain. The growth in the market capitalization of these stocks was more impressive than that of the non-Shariah compliant stocks.



The software, drugs and pharmaceuticals and automobile ancillaries sector were the largest sectors among the Shariah compliant stocks. They constitute about 36% of the total Shariah compliant stocks on NSE. Further on examining the BSE 500 the market capitalization of the 321 Shariah compliant companies hovered between 48% and 50% of the total BSE 500 market capitalization.



Stock Market

Under Islamic banking, the conditions for investing in shares are:

1. The company’s activities should not include liquor, pork, hotel, casino, gambling, cinema, music, interest bearing financial institutions, conventional insurance companies, etc.

2. It is not permissible to acquire the shares of the companies providing financial services on interest, like conventional banks, insurance companies, or the companies involved in some other business not approved by the Shariah, such as companies manufacturing, selling or offering liquors, pork haram (prohibited) meat, or involved in gambling, night club activities, pornography, gold trading, advertising and media (with the exception of newspapers)

3. If the main business of the companies is halal (lawful), like automobiles, textiles etc, but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the shareholder disapprove such dealings.

4. If income from interest-bearing accounts is included in the income of the company, the proportion of such income in the dividend paid to the shareholder must be given to charity, and must not be retained by investor.

5. The shares of a company are negotiable only if the company owns some illiquid assets. If all the assets of a company are in liquid form, i.e. in the form of money, they cannot be purchased or sold except on par value, because in this case the share represents money only and the money cannot be traded in except at par.

6. For companies whose main activity is not un-Islamic but a part of their income is not purely Islamic or a minor part of it comes from un-Islamic activities are prohibited, for example hotel, sugar, entertainment etc.



Once companies are chosen from the above criteria, further screening is done on the basis of following financial ratios:

1. Exclude companies if Total Debt divided by Trailing 12-Month Average Market Capitalization is greater than or equal to 33%.

2. Exclude companies if the sum of Cash and Interest Bearing Securities divided by Trailing 12-Month Average Market Capitalization is greater than or equal to 33%.

3. Exclude companies if Accounts Receivables divided by Total Assets is greater than or equal to 45%.

4. Exclude companies if they have any interest bearing income more than 10% in any condition.



For profits made through capital gains, the accepted rule is that if requirements of the ‘halal’ shares are observed, then most of the assets of the company are ‘halal’, and a very small proportion of its assets may have been created by the income of interest, so the whole price of the share therefore, may be taken as the price of the ‘halal’ assets only.



Mutual Funds

Another opportunity is mutual fund which is based on 100% equity. These funds are invested in different sectors like IT, automobile telecommunication, cement and a few present in interest based financial institutes, almost 10 to 15 %. So investor has to purify that amount from the profits. And also there are many sectoral funds which invest only in a particular sector like automobile, Oil & Gas, etc.



Here are some of the most common types of the Shariah compliant funds and their basic investment profile, which an investor must know before leaving his/her hard-earned money at their disposal.



Equity Funds: As the name suggests, equity funds invest the money pooled in from the investors into stocks. Equity MFs are further classified into sub-categories depending upon the asset classes such as large-cap, mid-cap and small-cap, sectors or themes. Equity funds carry a bigger risk profile than the bond funds.



Sector Funds: Sector funds invest in the stocks of one particular sector and these funds are generally conceptualized after some sector catches fancy of the market or when there is any significant buzz for some major growth in a particular sector. For example, the infrastructure sector is the current favourite in the MF circle, while a few other sectors with exposure to the country’s infrastructure growth are also finding favour. However, sector funds do not offer the much-desired diversification to the MF investors and often these funds enter the market after most of the growth has already materialized in that particular sector. However, there are certain defensive sectors like FMCG and pharmaceuticals, which consistently witness some modest growth with limited volatility.



Index Funds: The index funds primarily invest in the constituent stocks of a particular market index, such as Sensex and Nifty, and most often track the movements of those indices. While during a bull run, index funds can give impressive returns, the losses are also sharp during the bearish phases of the market. However, the index funds are known to given good returns in the long term, as their portfolio generally consist of stocks with proven track record. Here however you have to consider purification as quite a few banking stocks are there in the current index.



Growth Funds: These funds invest in growth stocks, or the stocks of those companies that are likely to see a sharp rise in their sales and profits. These funds seek to cash in upon the rise in the share prices of these companies, driven by their bulging sales and profit books.



Real Estate

The real estate sector is attracting investment from Middle East, as fund raising has got difficult in this sector. India has so far seen investments of over $500 Million for middle-east investors in real estate sector. Investing in real estate is relatively better than stocks or mutual funds where risk and uncertainty are very high.



Conclusion

India as compared to many other developing countries has been a star performer in recent years, both in terms of returns and attracting funds from overseas. Economic reforms, successful services industry, growing manufacturing activity, high corporate profitability, buoyant equity markets, robust merchandise exports and imports and lead indicators of service sector activity all point to a brightening of prospects for the Indian economy in the future. Consequently, the return from the equity market has also been very handsome.



As we mentioned earlier, around 50% of Indian stocks are believed to be Shariah complaint, but very few companies realize the potential, which is primarily due to non-availability of data on Shariah based investment appetite among local Muslims. Investors, local as well as global, will find Indian stock market a better place to invest, and sectors like IT, pharmaceuticals, automobile, energy, cement, steel and mining to choose from. Islamic financial institutions that are looking for investment opportunities beyond the Arabian Gulf can find Indian stock market a very good place to put their funds.

No comments: