ISLAMIC STOCK MARKET INDICES

 

A Dow Jones experience

By: Sh. Yousaf Haroon
Sep 06, 1999

Health is the most precious blessing Almighty has bestowed upon us. There are times in our life when we lose our healthy condition and fall sick. Let ask ourselves: do we ever feel temperature? Sure, most of us. To measure the temperature what we use is a device called thermometer. Using this device we are able to know the fluctuation in our temperature and if it is above normal, we have high fever and we are sick.

Similarly, in the world of financial management, financial markets never maintain robust trend all the time. They are prone to cyclical fluctuations. The financial markets have their peaks and valleys, sometimes they are bullish; sometimes bearish. As one should have an update report of one's health, there is a similar need to closely and precisely monitor the trends and conditions the financial markets undergo. To measure the 'temperature' i.e., fluctuations of these financial markets, the financial instrument or thermometer we use, for checking the performance of our stock markets, are " The Stock Market Indices" .

Once we talk about the 'the stock market indices' firstly it is pivotal to understand what is a stock market. Secondly, to comprehend what is its nature and scope. Whenever one thinks of starting a business, the first thing that comes into consideration is the capital to finance it. As business firms need tremendous amounts of capital to finance their operations to grow, to expand, they must invest capital in amounts that are beyond their capacity to save in any reasonable period of time. The financial markets permit businesses to raise the needed funds by selling securities (pieces of paper evidencing a claim on some issuer) in securities markets. By selling securities the companies enable themselves to tide over the liquidity crunch which, otherwise, is not possible for them to arrange by their own resources. The stock exchange is a place which gives the opportunity trade such securities. So, by definition, the stock exchange is an organized security market, either regional or national in scope, where all buyers and sellers of securities can meet at a central location to transact purchases and sales. New York Stock Exchange (NYSC), London Stock Exchange, Hong Kong Stock Exchange, Tokyo Stock Exchange and Frankfurt Stock Exchange are some most reknowned stock exchanges in the world.

Today, the most common question the finance managers, business executives, market analysts, fund managers, and we ask daily is," How has the stock market performed today?" To answer this question, we need a composite report on market performance, which is what stock market averages and indices are designed to provide. The indices tell us either today the market is bullish or bearish, providing us the information of the general sentiment or condition of the business. On the basis of these indices the investors make their decisions to invest or to disinvest from the stocks. If the stock market shows bullish signs, the index goes up, meaning that the overall business environment is healthy for investment and if the stock market crashes, it shows that the overall business environment is not healthy for investment. In short these market indices are the reflection of the mood of business.

Usually the stock market indices comprise of a bundle of top securities by performance, representing as an intelligent indicator of the general sentiment of the business prevailing within the stock markets. Usually this bundle consists of securities which have highest profitability ratio. Today these indices are considered to be the most important vehicle for investment. Prudent investors all over the world observe the performance of relative stock market indices to safeguard their investments in the securities and square positions in conformity with the performance of their securities and that of the stock market in general. Over the years, the stock markets around the world have rapidly developed.

The stock markets are considered a national indicator of the country's economy. Better or worse, the economic conditions directly reflect the volatility of the daily market confidence where the stock indices are the best measure of confidence. The stock market indices can now be bifurcated into a number of categories with respect to region, country, industry, even religion. This has given investors the variety of investment options to plug'n pull their investments according to their choice and personal preference to optimise the chances of returns on investments and hedge the risks.

The most renowned country market indices are New York S&P 500, London FT 100, Hong Kong Hang Seng, Singapore ST Indl. and Tokyo Nikki. Likewise for Pakistan, KSE 100 is the most popular stock market index.

Need for Islamic stock market indices

In recent years Islamic financial instruments are much in demand. Islamic Banking or Interest Free Banking, Murabah or Cost-plus Financing, Mudaraba or Trust Financing, Musharaka or Partnership Financing, Islamic Insurance, Ijara or Islamic Leasing and Islamic Fund Management are no more mere concepts today but a reality. The number of companies practicing Islamic finance is increasing day by day globally. In view of the tremendous potential of growth and profit enjoyed and offered by these companies there was a genuine vacuum to be filled for Islamic Stock Market Indices.

These Islamic indices offer the best of both worlds. The excellence of Islamic ideology coupled with brilliance of traditional financial management, gives the choice to invest where the propensity of the investor really resides.

Realizing the potential Dow Jones has created a new equity benchmark index for people who wish to invest according to Islamic investment guidelines. The Dow Jones Islamic Market Index - DJIM, for short - tracks Shari'ah Law compliant stocks from around the world, providing Islamic investors with a truly global perspective.

Reference to our topic now lets see what Dow Jones offers to Islamic investors and to those who want to invest in Islamic stocks and securities:

Dow Jones industrial average

The best-known average in the United States is the Dow Jones Industrial Average (DJIA). It is the oldest market measure, originating in 1896 and modified over the years. The DIJA is computed from leading industrial stocks whose composition changes slowly over time reflect changes in the economy. This average is said to be composed of blue chip stocks, meaning large, well-established and well-known companies. Dow Jones Company also computes and the Journal publishes, a transportation average and a public utility average.

Dow-Jones family of market indices

Dow Jones Indexes licenses Dow Jones market indexes for investment products. The family of indexes includes the Dow Jones Industrial, Transportation and Utility Averages, as well as the Dow Jones Global Indexes (the "World" index family), Dow Jones STOXX Indexes, Dow Jones U.S. Small-Cap Index, Dow Jones Islamic Market Index, Dow Jones REIT Indexes and the Dow Jones-AIG Commodity Index. Dow Jones Global Indexes are capitalization-weighted and cover about 3,000 stocks in 33 countries and 122 industry groups. Dow Jones STOXX, a subset of the global index family, is comprised of two benchmark pan-European indexes, two blue chip indexes and 19 industry sectors. The Dow Jones U.S. Small-Cap Index includes liquid components with balanced sector representation. The Dow Jones Islamic Market Index is Shari'ah Law compliant with full global representation. The Dow Jones REIT Indexes include 129 issues: 118 Equity, 4 Hybrid and 7 Mortgage. The Dow Jones-AIG Commodity Index is composed of 20 commodities and is based on the prices of liquid futures contracts.

Categories of Islamic indices

Dow Jones Indexes has created two additional Islamic compliant equity indexes: Dow Jones Islamic US (DJIM-US) and Dow Jones Islamic Global Technology (DJIM-Global Technology). The DJIM-US and DJIM-Global Technology are sub-indexes of the benchmark Dow Jones Islamic Market Index (DJIM), which was successfully launched on Feb. 9, 1999 in Manama, Bahrain.

As stated by A. Rushdi Siddiqui, Director of the Islamic Index Group at Dow Jones Indexes, "Our goal is to offer the Islamic investment community additional regional and sector indexes that provide them the same kind of choices presently available to non-Islamic investors". Like the DJIM, the DJIM-US and DJIM-Global Technology have been tested against established equity indexes for correlation, volatility, tracking error, turnover, performance, etc., for the last three years.

The DJIM-US includes about 230 US companies and the DJIM-Global Technology contains about 70 companies.

Features

Dow Jones Islamic Market Index is constructed from the 2,700 stocks in the Dow Jones Global Indexes family, which means they all are accessible to investors and are well traded. The DJGI methodology removes issues that are not suitable for global investing. Dow Jones Islamic Market Index includes the most liquid securities meeting the Shari'ah investment criteria in the market, and reflects the industry breakdown of the global market.

Dow Jones Islamic Market Index is capitalization-weighted. It is calculated in real-time and disseminated to major market-data vendors. Dow Jones Islamic Market Index is based at December 31, 1995. The base value is set at 1000. Dow Jones Islamic Market Index is reviewed quarterly, with component changes implemented on the third Friday of March, June, September and December. This frequency assures that the index reflects the latest trends and developments in the global stock market.

Islamic filters

The criterion is simple. Certain businesses are incompatible with Shari'ah Laws. Thus, stocks of companies whose primary business is in areas not suitable for Islamic investment purposes are excluded from the Dow Jones Islamic Market Index.

Excluded products include:

o Alcohol

o Pork related products

o Conventional financial services (banking, insurance, etc.)

o Entertainment (hotels, casinos/gambling, cinema, pornography, music, etc.)

(Shari'ah scholars also do not advise investments in companies that produce tobacco and/or defence/weapons.)

These incompatible lines of business, represented by 18 of the 122 industry groups within Dow Jones Global Indexes, are removed from the "universe" of stocks considered for the Dow Jones Islamic Market Index. Other companies classified in other industry groups also may be excluded if they are deemed to have a material ownership in or revenues from prohibited business activities.

After removing companies with unacceptable primary business activities, the remaining universe is tested by three financial-ratio "filters." The purpose is to remove companies with unacceptable financial ratios. The filters are:

1. Exclude companies if Total Debt divided by Total Assets is equal to or greater than 33%. (Note: Total debt = Short-Term Debt + Current Portion of Long-Term Debt + Long-Term Debt)

2. Exclude companies if Accounts Receivables divided by Total Assets is equal to or greater than 47%. (Note: Accounts Receivables = Current receivables + Long-Term Receivables)

3. Exclude companies if Non-Operating Interest Income divided by Operating Income is equal to or greater than 9%

Companies that pass these screens are included in the Dow Jones Islamic Market Index investable universe, from which index components are selected.

SELECTION PARAMETERES

Description Filters

Non-permissible Industries Yes

Screen

Debt/Assets < 33%

Debt/Equity N/A

Loan + Cash/Assets N/A

 

Short-Term Liquidity Screen

 

Accounts Receivable/Assets < 47%

Accounts Receivable/Market N/A

Value

 

Interest Income Screen:

 

Non-Operating Interest < 9%

Income/Operating Income

Interest Income/Total Revenue N/A

3-year Average Interest N/A

Income/Total Income

 

Component Statistics (as of December 1998)

$Mktcap('000)

DJIM Index financial ratio:

P/E 29.08

P/B 4.10

Dividend Yield 1.41

DJIM Index selection parameter average:

Debt/Assets 17 .26%

Accounts Receivables/Assets 14.14%

Non-Operating Interest Income/Operating Income 2.53%

 

Advisory board

To ensure that all the companies selected for the Dow Jones Islamic Market Index are acceptable under Shari'ah law, a Shari'ah Supervisory Board of Islamic scholars have been advising Dow Jones Indexes. The members of the board are Justice Muhammad Taqi Usmani of Pakistan; Dr. Abdul Sattar Abu-Ghuddah of Syria; Dr. Mohamed Elgari of Saudi Arabia; Shaykh Nizam Yaquby of Bahrain; and Shaykh Yusuf Talal DeLorenzo of the U.S.

Conclusion:

With the emergence of information super highway, the world of financial markets have seen a paradigm shift. Using Internet you can invest in any stock market in the world and can buy and sell securities of any company, which means, a investor can create a truly global portfolio. Online brokerage houses like Merrill Lynch, Charles Schwab, JP Morgan and others can help you maintaining a truly global portfolio.

As in case of Pakistan, I would like to stress upon a need to create a Islamic index which we may call PIMI (Pakistan Islamic Market Index). PIMI should be based upon Islamic principals representing a portfolio of Pakistani securities. The local investment companies like (ICP) Investment Corporation of Pakistan, KASB, Jehangir Siddiqui, VIS and InvestCapital etc. should either join hands and develop this index or initiate Islamic indices of their own, which can cater the needs of global investors and can give local market the much needed innovation. Diversification is the key to global portfolio management!