2011: Year of Shariah Compliant Index Out Performance

January 17, 2012

By Rushdi Siddiqui, Global Head of Islamic Finance, Thomson Reuters

“The proper man understands equity, the small man profits.” Confucius.

The year 2011 was the year for [Malaysia] Shariah compliant index out-performance against all conventional developed and emerging market country indicies and almost all frontier countries.

The Islamic finance industry has not talked up the Islamic equity capital market story, as the Islamic debt capital market poster child, ‘Sukuk,’ has become the alter-ego of Islamic finance. But, does that amount to concentration brand and business risk for a $1 trillion, where Sukuk are, at best, 20% of Islamic finance?

For example, the continued conversation about the ‘controversy’ surrounding Goldman Sach’s $2B Sukuk, structure, proceeds and trading, seems to be a proxy statement about Islamic finance’s welcome mat to market moving institutions.

Equity Conversation

There is an equal and as important conversation that needs to be had on Islamic finance chat-groups and social media, and its about equity. The equity conversation is not only closer to the inclusive and public good objectives of Islamic finance, but, more importantly, its transparent and easier to explain to the ‘man on the street’ and ‘sceptical media’ in the elevator ride time frame.

Lets start the conversation by looking at performance of Shariah compliant indicies and compare them to conventional counter-part indicies for 2011.

Today, we look at Shariah compliant indexes, as it sets up the foundation for the transition to Shariah based indexes. It should be noted there is nothing ‘Islamic’ about Shariah compliant indexes, as most of the underlying companies are not from the Muslim countries. These compliant companies just happen to pass primary business screens (akin to social-ethical indexes) and financial screens (eliminate companies with high debt, high account receivable (translating sales into earnings), and too much non-operating interest income).

May be such screening is the need of the hour for all investors during external shocks or financial tsunamis of sub-prime credit crisis, sovereign debt crisis, so on.

[QUERY: What provides a pulse on the health of Islamic finance? A. Shariah compliant indicies. B. Sukuk Indicies. C. Shariah Based Indexes. D. Ratings of Islamic banks. E. Islamic product offerings. F. Western media coverage. G. Western institutions entry H. Anti-Shariah movement blogs.]

Some observations from the S&P Developed Country indicies for 2011:

1. Shariah compliant indicies out-performed conventional counterpart indicies in 23 of the 25 developed countries, ex Portugal (no Shariah index)

2. Shariah compliant indicies out-performed conventional counterpart indicies all the major countries encountering turmoil in 2011: US (positive return), Greece, Spain (positive return), Ireland (positive return), Italy, etc. There were not enough compliant companies for a Portugal Shariah compliant index.

3. Shariah compliant indicies out-performed conventional counter-part in Germany and France, two countries with large exposure to sovereign debt crisis in Europe

4. Shariah complaint indicies under-performance in resource plays of Australia and Canada, yet out-performed in technology (IT) heavy Shariah compliant Israel Index.

Some observations from the S&P Emerging Market Country indicies for 2011:

1. Shariah compliant emerging market country indicies outperformed conventional counter-part indexes in 14 of the 20 countries.

2. Shariah compliant Muslim country indicies outperformed (Turkey, Malaysia, Egypt) conventional in 3 of the 5 (Morocco and Indonesia) emerging market countries

3. Shariah compliant indicies from the BRIC countries out-performed in three (Russia, India and China) of four (Brazil) countries.

4. Shariah compliant indicies from SAMI countries out-performed in three (Turkey (Ankara), Malaysia, and Saudi (classified as frontier country) of the four (Indonesia) countries.

5. Shariah compliant indicies had positive return in three countries, Thailand, Malaysia and Philippines, whereas conventional had positive return for only one country, Philippines.

Frontier Markets (Courtesy: S&P)

Some observations from the S&P Frontier Country indicies for 2011:

1. Shariah compliant indicies out-performed in 16 of the 26 frontier countries. It should be noted that 11 of the countries, including Kazakhstan, did not have a Shariah compliant country due lack of enough companies for an index. Kazakhstan stands out because it has made statements of wanting to be an Islamic finance hub.

2. Shariah compliant indicies from the Muslim countries outperformed better than conventional country indicies in 7 of the 13, ex Kazakhstan, countries. It should be noted most of the Muslim countries are classified as frontier countries except five countries: Turkey, Malaysia, Morocco, Indonesia and Egypt.

It should be noted the S&P Malaysia Shariah BMI (+3.8%), ahead of S&P Qatar Shariah (+3.5%), was the best performing Shariah compliant index from the 18 Muslim countries covered by S&P. Although, the S&P Malaysia BMI conventional index (at -1.14%) underperformed the Shariah complaint index, it was the second best performing in the Muslim world behind S&P Qatar (+3.34).

The S&P Malaysia Shariah BMI (at +3.8%) outperformed all conventional developed and emerging market S&P country indexes, and only underperformed three conventional country frontier countries: Jamaica (+28%), Panama (+18%), and Namibia (+6%).

Conclusion

One challenging and volatile year (2011) does not establish a performance pattern for Shariah compliant indexes that are ‘light’ on exposure to the conventional financial sector, typically the largest market capitalization weighted in almost all countries. However, it shows that ‘low-debt, non-financial-social/ethical’ way of investing does well when there was an external shock to the financial/capital markets.

The 2011 momentum for Shariah compliant indicies should be the spark for stakeholders of Islamic investing to establish foundation for building out the equity side of Islamic finance. We need to examine:

1. Tex benefits of dividends over interest payments, especially countries wanting to be an Islamic asset management hub. Here the Muslim world, lead by Shariah compliant equities, can provide a lesson for the western capital market’s bias on debt and leveraging.

2. Delivery and payment for clearing and settlement in certain Muslim markets

3. Increasing the free float of Shariah compliant and based companies in Muslim countries, plus increasing foreign ownership percentage stakes

4. Consolidation amongst Islamic banks, Takaful operators, leasing companies, etc., hence, resulting in large cap and liquid companies with large free float (attributes of prominent western complaint companies in Islamic funds)

5. A robust Islamic equity capital market should result in increased IPOs, via private equity exits, family listings, etc.

The ‘proper man understands [the benefits] of equity.’