RIBA FREE INVESTMENT OPPORTUNITIES

High cost of funds still a key issue but should be resolved with the flotation of Musharika-based term finance certificates

By SHABBIR H. KAZMI
July 28 - Aug 03, 2003

Many investors are keen in earning Riba free income on their investment. They also want to be exposed to lower risk as well as to earn modest return on their investment. There are few opportunities available in the financial system operating in the country to secure modest return and even fewer options to earn Riba free income in the prevailing business environment. Modaraba sector offers both, the opportunities to earn modest return on investment as well as Riba free income.

There are 36 members of Modaraba Association of Pakistan (MAP). The value of certificates issued of these modarabas exceeds Rs 7,688 million. While sponsors of most of the listed companies own at least 51% shares, modaraba management companies normally control only 20% of total issued capital and remaining 80% shares are held by others, mostly by the individual investors. As the market float is large, the probability of a few persons or any group acquiring the ability to manoeuvre their prices is low. Therefore, the prices of modaraba certificates are less volatile and are mostly driven by the demand and supply.

There are two apprehensions of investors regarding investing in modarabas certificates: 1) the certificates of a large number of modarabas are quoted below par value and 2) the daily trading is confined to only a few modarabas. This perception forces many investors to stay away from investing in modaraba certificates, despite the fact that some of them offer very attractive dividend yields. The dividend yield often looks incredibly high mainly due to the quoted prices of the certificates.

There are a number of factors responsible for quoted prices being lower than par value, the most important being lack of interest of foreign fund managers in investing in modaraba certificates. The other factors are the large market float and inability of speculators to manoeuvre quoted price. It is noteworthy that prices of shares of a number of listed companies are kept high artificially despite low or hardly any trading. This is possible only because the sponsors mostly hold shares of these companies. They occasionally make a few transactions of very small lots to show that trading do take place in the shares of these companies. However, if any one wishes to buy the shares of these companies it is almost impossible. Similarly, if any one wishes to sell these shares at the quoted prices there is hardly any buyer.

As regards low daily trading volume, there can be many possible rationalizations. However, two factors seems to be dominant: - 1) investors of high yielding certificates are generally not willing to sell their holding unless inevitable and 2) prices being quoted below par value do not attract many investors. However, it is interesting to note that even if very low dividend is paid the dividend yield comes very high. For example four modarabas, namely First UDL, Guardian, First Mehran and Trust modarabas declared only 5% dividend. However, the yield was 10%, 13.33%, 25.64% and 16.13% respectively. The yield is much higher than the yield available on the much-preferred products offered by National Savings Scheme. Therefore, it may be correct to say that dividend yield on a number of modarabas is very attractive. On top of every thing, the income is Riba free.

With a number of leasing companies floating term finance certificates (TFCs) and other financial institutions entering into leasing business, the fears are that the modarabas may gradually loose their share in leasing business. On the face value, this apprehension may seem to carry some weight. However, it is only a temporary phenomenon. Most of the modarabas are now in a position to float TFCs based on Islamic injunctions. This will help them in mobilizing additional funds at competitive rates to expand their existing business.

Besides this, some modarabas are ready to sign Income Note agreement with International Finance Corporation (IFC). Similar agreements were signed by some modarabas with the IFC in the past. The cost of funds under this arrangement is generally lower than the cost of funds mobilized through any other arrangement. With the conclusion of new agreements and availability of low cost funds modarabas will be able to underwrite leases at competitive rates and to further improve their profitability.

According to some analysts, modarabas should increase their paid-up certificate value to facilitate investors, interested in earning Riba free income. Issue of right and/or bonus certificates can increase the paid-up value of certificates. A number of modarabas have accumulated large amounts under statutory reserves, they are required to retain a specified percentage of their annual income and Bonus certificates can be issued against the statutory reserve.

TOP 5 MODARABAS
(Equity in million rupees)

Fayzan Manufacturing 908
BRR International 707
First Grindlays 695
First Habib Bank 523
First Habib 423
Source: Modaraba Year Book 2002