FTSE forecasts growth for Islamic equity

Arab News - FTSE, one of the world's largest equity index providers, is projecting a huge growth in Islamic equity products over the next few years including sophisticated value-added off the index products such as exchange traded funds (ETFs). And the index provider sees most of the demand and market growth coming from the GCC countries, especially Saudi Arabia, and southeast Asia, especially Malaysia.

"From what we have heard, we expect the Islamic equity investment market growing at a much faster rate than the overall sector as a whole, because it is coming from a lower base," confirmed Donald Keith, Deputy Chief Executive of FTSE. "The Islamic finance sector per se, we are told, is growing at an annual rate of 15 percent to 20 percent. Islamic investors are increasingly looking to invest along the same lines as conventional ones.

They want to access the same kind of opportunities and the same sort of markets. What we are trying to do is to mirror our global equity index series to cover both developed and emerging markets. We want to use that as the base and build up from there," he added.

Only a few weeks ago, FTSE launched a 96 series of Shariah-compliant indices, which now rivals the Dow Jones Islamic Market (DJIM) indexes, its main rival in this space, in breadth and asset classes. MSCI and S&P are the other two global index providers servicing the Islamic funds space.

"If you look at the economies and the amount of wealth in the Middle East and southeast Asia it is growing very rapidly. The overall Islamic equity market currently is very small, but what you are seeing is the global index providers recognizing and reflecting what their clients are asking them for and we are positioning ourselves in that space and make sure we can offer our clients that range of investment tools," explained Keith.

FTSE, in fact, launched its first few Islamic indexes in 1999, more-or-less at the same time DJIM was launched. But the indexes never got off the ground. So what caused a change in strategy with the recent launch of the family of 96 Shariah-compliant indexes? "I don't know whether the market was developed in 1999," explained Keith, "it probably gave us some expertise and a good insight to some of the facets of Islamic equities. But it didn't really take off.

Last time we were basically trying to replicate the global indexes and make them Shariah-compliant. This time there has been a massive growth in interest in Islamic finance, banking and products.

The rationale for a much broader suite of indices is that spectacular growth in the market. The investor and user base has also expanded exponentially and there is a much broader requirement from clients. We are increasingly getting client demand for Islamic index products primarily at this stage from Europe, Middle East and Asia. We are also starting to see some demand coming from North America as well."

Keith is not overly concerned that the Islamic investment funds space is getting over-indexed, because he believes the market is big enough to accommodate all four major index providers. The FTSE calculates over a 100,000 indices every day. This is only commercially sustainable because of client demand and their views on asset allocation and fund structures.

The total funds under management in the Islamic finance sector is estimated at $1 trillion, but only about an estimated $20bn is in the equity and investment funds sector. This is very modest compared with the conventional equity sector which has a market capitalization size of almost $2 trillion.

The FTSE is taking a long-term view of the Islamic investment fund sector and believes it will continue to grow. It has even had discussions with potential clients about the launching of Shariah-compliant real estate indices.

Keith rejects any notion that the FTSE Islamic indices are merely a Shariah stock screening process. "If that is we were offering then we would not be sufficiently interested in the sector from a commercial point of view. If we mirror our conventional indices we have both the broad benchmark equity indices used by the big pension funds and institutional investors worldwide for fund management and risk attribution.

In time we will see those uses come into play actively in the Islamic index area. Fund managers and product creators will look to do the same for Islamic sector. There are certain notable exceptions here given some of the proscriptions, but broadly speaking this is the aim," stressed Keith.

Unlike DJIM which has its own in-house Shariah Board, FTSE outsources its Shariah advisory and screening to a specialized Shariah Advisory firm, Yasaar Limited, which has offices in the UK, Dubai and Pakistan. FTSE says its business is modeled on partnerships with stock exchanges, other associations and commercial entities. It is more confident with working with partners because it does not have the in-house expertise on Shariah screening and compliance. "We are an index provider - design, calculate, manage disseminate, that is our speciality.

We are not specialist in Shariah and any aspects of Islamic investment. To try to create this expertise in-house there is a number of shortcomings. It would be relatively narrow base and interpretation; by doing it this way we get far greater breadth of expertise; access to people who really know what they are doing. But, we have to be confident that our partner is good, professional and experienced," added Keith.

FTSE has a comprehensive financial screening ratios for its equity universe stocks. They include debt not greater than 33 percent of total assets; cash and interest-bearing items not more than 33 percent of total assets; accounts receivables and cash not more than 50 percent of total assets; non-compliant income other than interest is less than 5 percent of total revenue; total interest income is less than 5 percent of total revenue; and appropriate purification of dividends at 5 percent.

The FTSE ratios use debt to total assets as opposed to debt to market capitalization. This is because the latter will experience greater volatility on a daily basis particularly in today's uncertain markets. As such, the debt to total assets is also seen as a more stable and representative ratio.

Keith believes that the FTSE indices, which follow a rules-based methodology as opposed to a principles-based one, will play a part in developing a greater disclosure and transparency culture in these markets. He believes that product creation and innovation and market education is vital for the growth of the sector, which is potentially huge.

The drivers of the Islamic equity and investment fund markets, according to FTSE, include:

* the increased global awareness and demand for Shariah-compliant investment tools from a new generation of Muslims, both in Middle East but also globally;

* the need for structured products to absorb liquidity in regional markets; the increasing product availability;

* Shariah-compliant stocks are under pressure to perform as well as their non-Shariah counterparts

* a trend toward converting to Islamic investment and launching specialist funds

* a trend toward access to Shariah compliant products investing outside the Muslim world; and

* the fact that Shariah screening effects on debt on interest can lower trading costs.