International Mutual Funds,Islamic Perspective

2. INTERNATIONAL MUTUAL FUNDS
ISLAMIC PERSPECTIVE
Presented By Mahwish Tahir
M.Com(Finance),MS(Islamic Banking),JAIBP,AIBP,CIBF
mishicapri84@gmail.com

3. ISLAMIC MUTUAL FUNDS
INTRODUCTION
STRUCTURE OF ISLAMIC MUTUAL FUNDS
ISLAMIC VS CONVENTIONAL MODELS
SCREENING CRITERIA FOR ISLAMIC MUTUAL FUNDS
ISLAMIC MUTUAL FUNDS DURING FINANCIAL CRISES
PROS AND CONS FOR INVESTING IN MUTUAL FUNDS
WHY MUTUAL FUNDS ARE LAGGING-CHALLENGES
outline
RECOMMENDATIONS

4. ISLAMIC FUNDS
 The term "Islamic Investment Fund" means a joint pool wherein the investors
contribute their surplus money for the purpose of its investment to earn halal
profits in strict conformity with the precepts of Islamic Shariah.
 May be categorized as income, money market, fund of funds, equity, balanced or
index tracker.
 All the investments must be Shariah compliant.
 Investment avenues includes Shariah compliant stocks, Sukuks, deposit with
Islamic banks, spread transactions etc
 These funds mainly invest in Riba free securities.
 Islamic funds conduct all their activities according to the Islamic Shariah based on
the guidelines provided by the Shariah Advisory Board appointed for the fund.
 A Shariah Advisory Board comprises of eminent Islamic and financial scholars,
who have considerable experience in the field of Islamic studies.

5. STRUCTURE OF A MUTUAL FUND

6. Funds vital from multiple perspectives
 Ability to meet diverse investment needs
 Potential to enhance growth & corporate governance of capital markets
Inherent structure of a mutual fund built on:
Trust: Fund Manager entrusted with fiduciary responsibility of making investments
in best interest of investors
Profit / loss sharing: value of investment may go up or down - reflective in NAV
Transparent Operations: fees and charges, and performance adequately
disclosed.
No leverage: Fund cannot borrow and invest
Shariah-Compliant Investments – For fund to be classified as Islamic
Islamic mutual funds to comply with additional requirements:
Shariah-compliant investments
Appointment of Shariah Advisor
Some international best practices adopted by industry participants:
Shariah Compliance Audit
Cleansing of “Riba contaminated” portfolio through distribution of haram income to
approved charities
Inclusion of Shariah Advisor report in the Annual Report

7. In Islamic Investment (Equity, Venture Capital, or Trust-type) Funds are so
structured that the Fund’s share owners entrusts the Mudarib (Manager) to act in
their behalf.
Returns on Investments depend on the actual profit or loss generated by the Fund.
The subscribers of the Fund may receive a document certifying their subscription and
entitling them to the pro-rated profits actually accrued to the Fund.
These documents may be called "certificates" "units" "shares"
Instead of a fixed return tied up with their face value, they must carry a pro-rated
profit actually earned by the Fund. Therefore, neither the principal nor a rate of profit
(tied up with the principal) can be guaranteed.
The subscribers must enter into the fund with a clear understanding that the return
on their subscription is tied up with the actual profit earned or loss suffered by the
Fund.
If the Fund earns huge profits, the return in their subscription will increase to that
proportion; and vice versa

8. CHARITY ACCOUNT & DIVIDEND PURIFICATION
Dividend Purification
• It means eliminating prohibited income that is mixed up with the earnings of the
company and the onus is on the owner of the shares.
• Dividend purification exercise are carried on periodic basis in accordance with
Shariah standards.
• Dividend is purified by calculating percentage of non-compliant income to the gross
revenue (Gross sales + Other Income) for each investee company. The resultant rate
is called as Charity rate.
a. Charity rate for each investee company is multiplied with the dividend income
from the respective company to get the amount to be transferred to charity
account.
b. The whole process of income purification is verified by Shariah advisor who
then issues a certificate to be included in the annual accounts of the funds.
Charity Account
• A separate Charity account is maintained for each Islamic Fund.
• All contributions to the charity account are recorded as Liability of the Fund.
• Donations from the charity Account are only made to charitable
organizations/individuals as approved by the Shariah Advisor.

9. TAX STRUCTURE
Income Tax Ordinance, 2001
Income of mutual fund is exempt subject to distribution of 90%
of accounting income reduced by capital gains realized or
unrealized.
Mutual funds are also exempt from withholding tax and capital
gains tax.
Investors also get rebate on income tax on their investment in
mutual funds.
Section 62 of Income Tax Ordinance, 2001, an individual investor
of open end mutual fund (unit trust schemes)can claim tax credit
on investment up to Rs. 1,000,000/- or 20% of individual's
taxable income (whichever is lower), subject to that an
investment is held for a period of two years.

10. Islamic Equity Fund:
Prohibits the Share acquisition of any companies
whose income is derived from Gambling,
Alcoholic beverages, Financial lending for interest,
either with or without risk, derivatives, selling
short or any other method in conflict with Sharia
Islamic Law.
Also borrowing at interest (leverage) is
impermissible. The principal of Sharia does not
allow ‘interest’ to be considered as a part of the
cost of a product or service, it does not add to the
end value and plays no part in the commercial
system.

11. Conventional Equity Funds:
Any and all traded firms, Company or Enterprise,
regardless of activity engaged, qualifies for
investor’s ownership of stocks.
The sole criteria to purchase the stock is the
Company’s ability to prosper and produce high
dividends and opportunity to increase in Capital-
Gain share value.
The taking of interest is considered the cost of
doing business.

12. DIFFERENCE BETWEEN CONVENTIONAL &
ISLAMIC MUTUAL FUNDS
• Presence and careful monitoring by the Shariah Board
It is ensured that all aspects of the Shariah are adhered to
before, during and after an investment is carried out in a
Shariah Compliant manner
• Well defined and Specific Investment Avenues
Investment avenues are limited to those that comply with the
Shariah
• Charity and Purification
Any investment/financing that is deemed to have an element of
Riba becomes liable for Purification and has to be given away
as charity

13. DIFFERENCE BETWEEN CONVENTIONAL &
ISLAMIC MUTUAL FUNDS
• Asset Ownership
The ownership of an asset lies with the party that provides
financing and bears the risk e.g. financing by a bank, and
assumption of all the risk (non recovery, etc) associated with
it.
• Permissible transactions
Transactions have to be conducted according to the Shariah,
e.g. no short sales
• Islamic Investment in only Shariah Compliant Avenues
For Islamic mutual funds and other Islamic Investors,
investment can only be made in those securities (equity, debt,
etc) which comply with well defined screening ratios

14. Screening Criteria # 1:
Business of the Investee Company
The core business of the company should not violate any
principle of Shari'ah. Therefore, it is not permissible to acquire
the shares of the companies providing financial services on
interest like conventional banks, insurance companies, leasing
companies or the companies involved in some other business not
approved by the Shari'ah e.g.
• Companies making or selling liquor
• Pork
• Haram meat
• Gambling
• Operating night clubs

15. Screening Criteria # 2:
Interest Bearing Debt to Total Assets
Interest Bearing Debt < 37% of Total Assets
The Interest Bearing Debt to Total Assets ratio should be less than
37%. To understand the rationale behind this condition, it should
be kept in mind that such companies are mostly based on interest.
Here again, the aforementioned principle applies i.e. if the
shareholder is not personally agreeable to such borrowings, but
has been overruled by the majority, these borrowing transactions
cannot be attributed to him / her. Debt, in this case, is classified as
any interest bearing debt including Bonds, TFCs, Commercial
Paper, Conventional Bank Loans, Finance Lease, Hire Purchase,
issuing preference shares etc.

16. Screening Criteria # 3:
Non-Compliant Investments to Total Assets
Non-Shariah Compliant Investments < 33% of Total Assets
The ratio of Non Compliant Investments to Total Assets should be
less than 33%.
Non-Shari'ah Compliant Investments include investments in
conventional mutual funds, conventional money market
instruments, Commercial Paper, interest bearing bank deposits,
Bonds, PIBs, FIB, T-Bills, CoIs, CoDs, TFCs, DSCs, NSS, derivatives
etc.

17. Screening Criteria # 4:
Non-complaint Income to Total Revenue
1. Non-Compliant Income < 5% of Gross Revenue
The ratio of Non Compliant Income to Total Revenue should be less than
5%. Total Revenue includes Gross Revenue plus any other income earned
by the company.
2. Non Compliant Income includes interest, income from
gambling, gains on derivatives.
Non Compliant Income includes income from gambling, income from
interest based transactions, income from Gharar based transactions i.e.
derivatives, insurance claim reimbursement from a conventional
insurance company, income from casinos, addictive drugs, alcohol,
dividend income from above mentioned businesses or companies which
have been declared Shari'ah Non-Compliant.

18. Screening Criteria # 5:
Illiquid Assets to Total Assets
The ratio of Illiquid Assets to Total Assets should be at
least 20%.
In terms of Shari'ah, illiquid assets are all those assets
that are not cash or cash equivalents.
Therefore, inventory of raw material, work in process,
among all other fixed assets are considered as illiquid
whereas long term investments in interest based
institutions are considered to be liquid in terms of
Shari'ah.

19. Net Liquid Assets per Share
=
(Total Assets - Illiquid Assets - Long Term Liabilities - Current
Liabilities)
Number of Shares Outstanding
Screening Criteria # 6:
Net Liquid Assets/Share vs. Market Price/Share
Market Price per share should be at least equal to or greater than net liquid
assets per share. Net liquid assets per share is calculated by using the
following formula:
Showing of Discomfort:
If the main business of the investee companies is Halal, like automobiles, textiles, manufacturing concerns
etc but they deposit their surplus amounts in an interest bearing account or borrow money on interest, the
share holder must express his / her disapproval against such dealings, preferably by raising his / her voice
against such activities in the annual general meeting of the company and / or by sending a letter to the
management in this regard.
* Net Liquid Assets = TA-ILA-TL

20. Net Asset Value (NAV)
Definition: Total value of the mutual fund’s stocks,
bonds, cash, and other assets minus any liabilities
such as accrued fees, divided by the number of
shares outstanding
Stocks $35,000,000
Bonds $15,000,000
Cash $3,000,000
Total value of assets $53,000,000
Liabilities -$800,000
Net worth $52,200,000
Outstanding shares 15 million
NAV = $52,200,000/15,000,000
= $3.48

21. ‰
ISLAMIC MUTUAL FUNDS DURING FINANCIAL CRISES
As the economic crisis took hold through 2008, these declines continued, but the
Islamic mutual funds began to perform slightly better than their conventional
counterparts.
For example, Standard & Poor's in 2008 observed that in the MENA region, those
funds that had Islamic mandates outperformed conventional funds because their
performance did not decline as rapidly as the performance of conventional funds.
S&P computed a 29% drop for Shari'ah-compliant mutual funds, versus a 34% drop in
the S&P 500 index.
There was also a significant drop in assets under management,with both Shari'ah-
compliant and conventional funds focused on the MENA region suffering a 46% drop in
assets.
Most Islamic Mutual funds avoid investing in the stocks of financial firms, which were
the companies that suffered the most and had the greatest drops in value over the
past year.
If we were investing in a fund that was not exposed to bank and other financial-
institution stocks, we were probably a little happier.

22. ‰
ISLAMIC MUTUAL FUNDS DURING FINANCIAL CRISES
Islamic mutual funds also benefited from avoiding investments in companies that were
highly leveraged. As the credit markets were tightening up and companies needed to
refinance, those companies that had lower levels of financing were not as badly
affected.
Some of the limitations applicable to the Islamic finance industry have stopped Islamic
financial institutions from investing in assets that have later turned out to be toxic.
On a transactional level, Shari'ah-compliant investments have responded in a manner
quite comparable to conventional transactions, largely because the financing for those
transactions is often indirectly funded with conventional funds.
The restrictions applicable to Islamic finance-the requirement that investments and
financings be tied to productive assets and the avoidance of speculative investments-
will no doubt benefit Islamic finance during the current financial crisis and as the
industry develops.
Islamic finance as an industry has held up well to the pressures of the current financial
crisis, but has not been immune to those pressures

23. PROS & CONS Diversification.
Securities from hundreds or even thousands of issuers it reduces the risk of
loss.
 Professional Management.
Expertise to manage and reinvest interest or dividend income, or to
investigate thousands of securities. Access to extensive research, market
information, and skilled securities traders.
 Liquidity.
Mutual fund can be bought and sold on any business day, so investors have
easy access to their money. Many individual securities can also be bought and
sold readily, others aren't widely traded. (CE & IC)
 Life Cycle Planning
Investor can link their investment plans to future individual & family
needs and make changes as the life cycle changes.
 Market Cycle Planning
For investors who understand how to actively manage their portfolio, their
investments can be moved as market conditions change.
 Taxation Benefits
Investment in open end funds also enjoys a Tax-Rebate under section 62 of
the Income Tax Ordinance 2001.

24.  Affordability
A mutual fund invests in a portfolio of assets, i.e. bonds, shares, etc. depending
upon the investment objective of the scheme. An investor can buy in to a
portfolio of equities, which would otherwise be extremely expensive. Each unit
holder thus gets an exposure to such portfolios with an investment as modest as
Rs.5000/-.
 Diversification
We must spread our investment across different securities (stocks, bonds, money
market instruments, real estate, fixed deposits etc.) and different sectors (auto,
textile, information technology etc.).
 Variety
Mutual funds offer a tremendous variety of schemes.
 Professional Management
Qualified investment professionals who seek to maximize returns and minimize
risk monitor investor's money.
 Highly Regulated
Mutual Funds are regulated by Securities & Exchange Commission of Pakistan

25.  Convenience.
Mutual funds offer services that make investing easier. Mail, telephone, or
the Internet. Automatic investments into a fund or automatic transfers from a
fund to your bank account.
 Tax Free Return
The stock dividend from mutual funds are exempt from tax. Cash dividend
taxable
 Transparency
Being under a regulatory framework, mutual funds have to disclose their
holdings, investment pattern and all the information that can be considered
as material, before all investors. SEBI acts as a watchdog and safeguards
investors’ interests
 Liquidity
A distinct advantage of a mutual fund over other investments is that there is
always a market for its unit/ shares. It's easy to get one’s money out of a
mutual fund. Redemptions can be made by filling a form attached with the
account statement of an investor.
 No Guarantees.
Unlike bank deposits, principal and returns are not guaranteed.
Diversification “Penalty." Diversification reduces the risk of loss, it also limits
the potential for making a killing in the market. Diversification does not
protect from a loss caused by an overall decline in financial markets.

26. WHY ISLAMIC MUTUAL FUNDS ARE LAGGING
– CHALLENGES
The very objective of the Shariah is to promote the welfare of the people, which lies in safeguarding
their faith, their life, their intellect, their posterity and their wealth. Whatever ensures the
safeguarding of these five serves public interest and is desirable.
Al-Ghazali
Lack of diversified products range
Understanding of investors’ need
Public awareness at mass level about the industry
Misconception that it is only for Muslims
Un-stability of Stock Markets shake the confidence
level of Investors

27. CHALLENGES
Dearth of liquid debt instruments
Protecting and maintaining the integrity and quality
Ensuring performance
Maintaining momentum to ensure viability
Providing competitive returns
Strong Shariah Compliance
Sound Regulatory Framework

28. Mitigating the Risk involved
Comforting & convincing with bad past investment
experiences
Low saving and Investment oriented society
Information disclosure and transparency
Choosing appropriate distribution network
Right timing to launch funds
Role and Support of Regulators
Misconception that it is only for Muslims

29. RECOMMENDATIONS
Wide-spread investor education and awareness:
Extensive campaign to achieve broad-based
investor participation
Inculcate a culture for savings among public
Media should play a more supportive and
constructive role for awareness and
disseminating information

30. Increased participation through BATS
Team work for the growth of mutual fund
industry
Independent bond pricing agency to value illiquid
debt securities
Improved governance of capital markets for
better price discovery and better disclosures by
listed companies
Strengthening role of participants having an
indirect role in mutual funds

31. Increase investment avenues for shariah-compliant
funds:
Provide impetus for listing more shariah-
compliant companies
Higher number of corporate sukuks and other
shariah-compliant debt securities
 Establishing affiliations with mutual funds
associations in other countries and promote
one-to-one contacts

32. JAZAKALLAH