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29 June 2012

OIC Islamic Index – The Malaysia Story?

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By Rushdi Siddiqui

There were two important announcements last week concerning Islamic equity index:

1. Malaysia’s Securities Commission ‘…announced the adoption of a revised screening methodology to determine the Shariah-compliant status of listed companies …’

2. S&P Indicies ‘…announced the launch of the S&P/OIC COMCEC 50 Shariah Index (Shariah 50), which is designed to measure the performance of 50 leading Shariah-compliant companies from the [19] member states of the Organization of Islamic Cooperation (OIC).

Methodology

The Shariah 50 index is not pure market capitalization weighted, because of the unique situation in the emerging markets. For example, to reduce bias (and ensuing volatility) associated with larger country markets and larger companies in an index, the country weights are capped at 20%, and single stocks are capped at 10% at each quarterly rebalancing.

Furthermore, to have ‘democratic’ approach of inclusion, the number of stocks per country are capped at eight (8) and there must be one (1) stock from each country must be included. The end result of placing ‘caps’ is a sharp reduction in the weight of larger countries and companies, and a corresponding increase in weightings of other countries and companies.

Impact

Its difficult to compare an apple to an orange, but one index could have a greater impact on directing portfolio fund flows to Malaysia.

The Shariah 50 tells an interesting Malaysia story:

1. It has the most Malaysian companies in the top 10, as three of the top 10 companies are Sime Derby, IOI Corp and Maxis, and total number of seven Malaysian companies out of 50. The four other Malaysian companies are Petronas Chemical Group, Digi.com, KL Kepong, and Petronas Gas.

2. The top 10 companies have 42% market capitalization weighting, and the three Malaysian companies account for 11% of the weighting of 42%. Put differently, the three Malaysian companies hold 26% market capital weighting of the top 10 companies.

3. Malaysia has a total market capitalization weighting of 20% of the index, and is lead-tied with a G-20 country, Saudi Arabia, and ahead of Indonesia (G-20), Turkey (G-20), Qatar, Kuwait, etc.

It should be noted the higher profile of Malaysia is attributed to the above-mentioned ‘capping’ rules for a more balanced and marketable index as basis for funds.

What could the Shariah 50 index mean for Malaysia?

First, it shows objectively, without cheerleading, Malaysia leadership on Shariah compliant companies from the Muslim world using a global index providers Shariah screening methodology. It is a generally well accepted hypothesis that more money is managed off of indexes from index providers than indexes from stock exchanges, i.e. S&P 500, FTSE 100, Russell 2000, MSCI EAFE, DJIA, etc.

Second, although Malaysia is not (today) a G-20 country, large Malaysian compliant companies are categorized with G-20 Muslim country companies from Saudi Arabia, Turkey and Indonesia. It could be interpreted as market capitalization development is ahead of gross domestic product (GDP) development.

Third, it paves a path for other Muslim countries, especially those categorized as frontiers with stock exchanges, to look at the Malaysia (a non-petroleum country) on compliant company champions as part of capital market development. For example, Pie-Chart A, below, shows the eight economic market sector breakdown for the Shariah 50 (from the 19 OIC stock exchanges), and should provide possible guidance (industrial policy?) on sector development.

Fourth, active/enhanced (index) fund managers, Exchange Traded Funds, and structured notes are more likely to include the top 10 companies because of their liquidity and market capitalization weighting. Graph A, below, shows performance attribution to the S&P Global BMI Shariah and S&P Global BMI (conventional index). It shows (1) high correlation to the global conventional index and (2) market performance for the time period of January 2009 to May 2012.

Walk the Talk

To move beyond the academic chalk (now, it would be electronic) board, the OIC, as the locomotive for the Muslim world, needs to aggressively solicit seed money from the Islamic Development Bank (IDB) and leading Muslim countries like Malaysia, Indonesia, Turkey, and Saudi Arabia for a fund or, better yet, an Exchange Traded Fund (ETF) off of the index. This is not the public sector leading, but, rather, sparking or supporting a private sector led initiative.

Bottom-line, to keep more Muslim money in Muslim countries, the equity capital markets need to catch up to the banking sector and debt capital markets. The S&P/OIC COMCEC 50 Shariah Index may just be about (1) inward and intra-OIC investing, (2) capital market development, (3) financial inclusion, and (4) attracting foreign portfolio investment looking for emerging market opportunities.

[Rushdi Siddiqui is Global Head Of Islamic Finance and OIC Countries, Thomson Reuters. he can be contacted at rushdi.siddiqui@thomsonreuters.com]

(Courtesy: AlifArabia)

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