Islamic finance

In a dual financial environment, Islamic finance has proven to be a viable channel of financial intermediation. It is also competitive in terms of product and services offerings. As it continues to develop, Islamic finance will present the international business community with an alternative means of raising funds while investors are presented with new asset classes.

Islamic financial institutions have started to emerge in the second half of the twentieth century and become one of the fastest growing segments in the global financial system over the past three decades. Although, Islamic finance institutions are mainly founded in the Middle East and South-east Asia, the interest has extended to Europe and the United States.

How does Islamic economics differ from conventional economics? Conventional economics is built around the idea of utility or satisfaction of individual wants, whereas Islamic economics has a wider perspective of utility in three ways. Firstly, utility encompasses spiritual as well as material values in life. Secondly, the concept of utility is extended temporarily from this life to embrace the hereafter. Thirdly, their well-being requires their concern for the welfare of others. Standard economics is concerned with individual utility maximisation whereas in Islam, well-being is concerned with looking after the welfare of others in the community.

As Islam extols trading, what needs to be done is to determine whether a particular form of trade and exchange is just or unjust. The Quran and Hadith extensively address the prohibitions of usury, gambling, gharar, extravagance, hoarding, fraud, corruption, and encourage benevolent and mutual co-operation between individuals in both market and non-market transactions.

Malaysia has developed a comprehensive Islamic financial system that includes the banking and takaful industries, and the Islamic money and capital markets - a matrix which mutually reinforces the integrity and stability of the Islamic financial system.

Researches by academicians indicate that Islamic funds perform better than conventional funds during bearish economic trend i.e. during the crisis period. However, the performance of conventional funds is better than that of the Islamic funds during bullish trend defined as the pre-crisis period. This means that Islamic funds can be used as a hedging instrument during any financial meltdown or economic slowdown. The findings of the studies made on Islamic versus conventional capital markets, may have very important implications for investors and regulatory agencies of the unit trust industry in Malaysia as well as in other countries.

Unit trust or known as mutual fund in western world is an investment vehicle created by asset management companies specializing in pooling savings from both retail and institutional investors. Individual investors who choose unit trusts as their investment vehicle seeking liquidity, portfolio diversification and investment expertise are increasing. However, based on their risk threshold, liquidity needs and their needs to comply with religious requirement these investors do differ in their preferences.

Over the past decades, Malaysian capital market has been growing at a very rapid pace and this has been supportive of the various complex needs of the country. Capital market functions based on interest, therefore it is not surprising that the operation of capital market does not conform to the principles of Shari'ah (Islamic law as revealed in the Quran and Sunnah). For this reason, it is difficult for Muslim investors representing major part of the total population, to play a part freely in the Malaysian capital market. The increasing demand for alternative investment vehicles, which match the principles of Shari'ah has prompted the Malaysian government to introduce various measures with the aim of boosting the Islamic capital market (ICM). For example, among other measures, with the objective of fulfilling the investment needs of Muslim investors, in 1980 an Islamic bank was established and in 1999 the Kuala Lumpur Shari'ah Index was introduced. Based on the Shari'ah principles, transactions taking place in the capital market should be free from prohibited activities or elements such as usury (riba), gambling (maisir) and ambiguity (gharar). Islamic investing can be defined as investment in financial services and other investment products, which adhere to the principles established by the Shari'ah. According to Shari'ah principles, (1) Investment must be made in ethical sectors. In other words, profits cannot be generated from prohibited activities such as alcohol production, gambling, pornography etc. Moreover, investing in interest (riba)-based financial institutions are not allowed; (2) All wealth creation should result from a partnership between an investor and the user of capital in which rewards and risks are shared. Returns in invested capital should be earned rather than be pre-determined.

In the beginning of 2010, there have been launched two unit trust funds and coincidentally both funds are Islamic-based funds. CIMB-Principal Asset Management got the ball rolling by launching it Islamic global commodities equity fund which was followed by Public Mutual Bhd that introduced the Public Islamic Asia Leaders Equity Fund to tap the growth potential of middle to large capitalized Shari'ah compliant stocks within regional markets.

The resilient performance of local Shari'ah funds throughout the global meltdown could be the reason why both the funds launched so far this year are Islamic-based. As reported by the Securities Commission, the total net asset value (NAV) of Islamic-based funds have been steady around RM16 billion to RM17 billion throughout 2008 while net asset value of its conventional counterpart fell 23.7 percent or to RM134.41 billion. Islamic funds rode the recovery as well when the unit trust industry rebound in 2009.

The total NAV of all local funds began rising from RM137.56 billion in March of 2009 to hit RM193.2 billion in November of 2009 outshining its previous peak of RM170 billion in January 2008. The NAV of conventional funds grew 43.7% to RM169.19 billion, while Shari'ah funds added 25.6% to RM21.34 billion during the same period.

This year, fund houses are set to tap investor optimism in unit trusts by establishing more funds. 28 funds were established last year compared to 54 funds established in 2008 as fund houses held back on poor investor confidence. As of November 2009, 545 unit trust funds were in the market including in it 400 conventional funds and 145 Shari'ah funds.

Total NAV of the unit trust industry equals 19.6% of Bursa Malaysia's market capitalisation. "According to fund houses, a lot of funds are being lined up and more funds will be launched this year. Investor sentiment has improved in the last six months and people are starting to put money back into unit trust," said Dennis Tan, Managing Director of iFAST Capital Sd Bhd, a wealth management portal. As mentioned by him, iFAST has seen pick up in its sales through its web portal and its financial advisors. Besides, he added that they were not back to the top but it was far better than the first half of 2009. On 2010's outlook, he also told that in the first half of this year, investor confidence is there but it might be more challenging in the second half.

The Guidelines on Wholesale Funds were introduced by SC. They give greater flexibility for licensed fund managers for providing innovative products, including those which incorporate alternative investment strategies. The guidelines came into effect on 18 February 2009.

The new guidelines replace the Guidelines on Restricted Investment Schemes and the provisions on wholesale funds in the Guidelines on Unit Trust Funds (UTF Guidelines). It has been rationalized and streamlined to make it easier for fund managers to offer wholesale and retail products. Now, fund managers only need to refer to one set of guidelines for wholesale products.

The guidelines enable fund managers to meet the more complex requirements of sophisticated or professional investors, like high net worth investors and institutional investors. As wholesale funds can only be offered to qualified investors and not the general public, the guidelines do not prescribe any quantitative requirements or restrictions on investments of the fund.

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