Subject material for course Islamic Investment

1. ISLAMIC INVESTMENT
Mahyuddin Khalid
emkay@salam.uitm.edu.my
Islamic Fund Management

2. Topic Outline
 Investment Fund
 Unit Trust
 Classification of Investment Funds
 Type of Funds by Investment Portfolio
 Real Estate Investment Trust (REIT)
 Exchange Traded Funds (ETF)
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3. Investment Fund
AAOIFI define Investment fund as
Funds are investment vehicles
•Which are financially independent of the institutions that establish
them.
Funds take the form of equal participating shares/units
•Which represent the shareholders’/unitholders’ share of the assets,
•Entitled to profits or losses.
The funds are managed on the basis of either
mudharabah or wakalah (agency )contract
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4. Investment Fund
The definition continues by setting out the Shariah ruling
that governs Islamic investment funds:
• Investment funds are permissible by Shariah.
• Because funds are a form of collective investment that continue
throughout their term, the rights and duties of participants are defined
and restricted by the common interest, since they relate to third
parties’ rights.
• Hence, in cases where the fund is managed on the basis of agency the
shareholders/unitholders waive their right to management, redemption
or liquidation except in accordance with the limitations and conditions
set out in the statutes and by-laws.
The term “investment funds” may include unit investment
trust, unit trust, collective investment vehicle (CIS),
mutual funds and other funds.
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5. Unit Trust
Shariah-based unit trust funds give investors the opportunity to invest in a
diversified portfolio of Islamic securities that are managed by professional managers
in accordance with the Shariah.
Unit Trust can be defined as
A pooled investment plan where
the capital contributions of
investors are combined into a
legally formed trust fund
Then invested by professional
fund managers, acting on behalf
of the investors, in a portfolio
of marketable securities
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6. Unit Trust
One important feature of unit trust is
that professional fund managers are
employed to manage the funds.
• They are highly qualified
and experienced in
investments.
• It is done at minimal
cost, minimizing,
liquidity, and capital
appreciation
Investors money will
be pooled together to
be invested in a single
diversified investment
portfolio which
comprise stocks, bonds
and others in
accordance with the
investment objective.
Unit Trust
investment offers a
reasonable amount
of return with
minimal risk.
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7. 7
Key Differences between Islamic and Conventional Funds
Investible
Universe
Purification
Role of
Shariah
Advisor
Fee
structure

8. How a Unit Trust Work?
•An agreement that binds 3 parties (namely, Unit Trust Management Company,
the trustee and the unit trust fund’s investors – also called as unit holders) to
the deed.
•The trust deed will have to be registered with the Securities Commission. A
copy of the trust deed can be bought at the management company.
Trust deed
•A trustee is generally reputable financial institution appointed by a deed of
Trust to look after the interest of the unit holders.
•As the legal owner of the assets of the fund, the trustee is responsible to
ensure that the fund is complying with shariah, fund objectives and common
law.
•According to SC, role of trustee in fund management is:
•Manage funds according to fund deed
•Provide adequate supervision and vigilance to ensure fund operating
company is operating the fund in accordance to the deed, prospectus and
acceptable business practice.
Trustee
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9. How a Unit Trust Work?
• The promoter of the fund to the public and provides investment expertise to manage the
fund and has the primary responsibility of investing the funds according to the
objectives.
• The Management Company also acts as the Registrar of the fund maintaining the records
of the unit holders
Management Company
• The providers of funds through purchase of unit trusts from the management company
would expect to receive benefits from the investment.
• If it is an Open-end Fund, the investors can buy units at anytime, as long as the fund
has not reached its maximum approved size.
• They can also sell the unit trusts back to the management company,.
Investors or Unit holders
• Responsible to safe guarding the interests of the investors who make investments in unit
trusts.
• SEC formulates regulations for the operation of unit trusts and has the necessary power
to ensure the proper conduct of the business.
• It also has the power to license or suspend the licenses of Management Company to
operate unit trusts.
The Securities Commission
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10. Regulatory Approach for Islamic Unit Trust in Malaysia
Securities Commission
(SC) adopts 2 tier
regulation for Islamic unit
trusts
1st tier – Regulation that applies to all
unit trusts
2nd tier – Additional regulation required
for Islamic unit trusts
Additional regulation
required for Islamic unit
trusts:
Appointment of Shariah Committee /
Advisory Board / Adviser
Appointment of 2 Muslim Investment
Committee Member
Appointment of a designated compliance
officer for Islamic unit trusts
Enhanced disclosures in offering
documents
Reports by Shariah Committee / Advisory
Board / Adviser in annual and interim
reports to unitholders.
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11. Regulatory Approach for Islamic Unit Trust in Malaysia
The Securities Commission regulates
the establishment and operations of
unit trusts in Malaysia under:
•Capital Markets And
Services Act 2007
•Securities Commission
Act 1993
•SC Guidelines and other
relevant securities law
This requires, among other things, that the
unit trust fund manager and the trustee
create a deed and register it with the
Securities Commission.
A copy of the deed may be inspected at the
unit trust fund manager's office.
In addition, the Securities
Commission has placed
severe requirements in the
appointment of the unit
trust manager, the
trustee, the unit trust
manager's directors, chief
executive officer,
investment committee and
Committee Members/
Shariah Advisers.
The appointment
of all these parties
must be approved
by the Securities
Commission.
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12. Classification of Investment Fund
Open-Ended Funds Close-Ended Funds
Is a collective investment which can
issue and redeem units at any time.
I.e.: Unit trusts
Feature Is a company (investment company)
structure where the company will
issue shares for subscriptions.
I.e.: share and stock
An investor can purchase units in such
fund directly from the unit trusts
company, or through authorized
agents (individual and bank)
Is another type of collective
investment but with a limited number
of units.
Refers to a fund operated by the fund
manager that makes offers to the
public and invests the proceeds in a
group of assets, in accordance with
the fund’s objectives.
Character It refers to a fund with a fixed
number of units outstanding, and one
which does not redeem units as open-
ended funds.
It behaves more like stock.
Buying and selling through unit trust
company
Trading Buying and selling take place in
secondary market i.e. Stock exchange
Price: Computed on a daily basis by :
(Fund’s Total Asset – Liabilities)/No.
of Units Outstanding.
Price Price: Share determined entirely by
market demand. Often higher or
lower than the NAV per share.
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13. Types of Funds by Investment Portfolio
Equity Funds Fixed Income Funds Money Market Funds Balanced Funds
Islamic/ Shariah Funds Sukuk Funds
Real Estate Investment
Trust Funds
Exchange Traded Funds
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14. Types of Funds by Investment Portfolio
 Equity Fund
 Primarily invest in the stock market.
 High level of risk and are expected to provide a high return in the
long term.
 3 kinds of Equity Funds
 Index Fund
 Invest in companies with higher capital growth potential but associated with
higher risk
 Aggressive Growth Fund
 highly speculative mutual fund that seeks large profits from capital gains
 Invest in small, unseasoned companies with high price/earnings ratios
 High risk investments for very aggressive investors
 International Equity Fund
 Invest primarily in overseas share markets
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15. Types of Funds by Investment Portfolio
 Income funds
 Invest mainly in government securities, corporate bonds and money
market instruments.
 It produces high level of current income- invest in high-grade shares
that pay good dividend.
 Established companies and generally viewed as low-risk.
 Money Market funds
 Operates in similar way to a bank account- the unit price is normally
set at a fixed amount.
 Invest in low risk money market instruments.
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16. Types of Funds by Investment Portfolio
 Balanced funds
 Generates a balanced return of both current income and long-term
capital gains
 Invest in blend of fixed-income securities and common stocks, with 30%
to 40% in fixed income
 Less risky investments for relatively conservative investors looking for
moderate growth
 Islamic Fund
 Fund will invest in shares which complies with Shariah principles.
 The Shariah Principles distinguishes between ‘halal’ and ‘non halal’ type
of business activities.
 The returns received would depend on whether investment objective is
for growth, current income or a combination of growth and current.
 Sukuk Funds
 Funds will be invest in diversified portfolio of sukuk to secure and
distribute annual income to unit holders
 Might include government, corporate, municipal, convertible sukuk etc.
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17. Types of Funds by Investment Portfolio
 REITs Funds
 Special type of close-end fund where it invests mainly in real
property rather than in shares or bonds.
 Provides the investor opportunity to participate in property market
 Because of the nature of the investment, the returns are highly
speculative.
 ETFs
 Exchange Traded Funds (ETF) is linked unit trust fund whose
investment objectives is to achieve the same return as particular
market index
 ETF often have low expense ratio and can be traded throughout
trading day
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18. Types of Funds
TYPES OBJECTIVES STRUCTURE/UNDERLIER
Money Market Funds
To invest in money
market.
Short term debt
instrument, mostly
treasury bills
Income Funds
To provide current
income on a steady
basis.
Government and
corporate debt, stocks
and bonds
Balance Funds
To provide a balance
mixture of safety,
income and capital
appreciation.
Mixture of fixed incomes
and equity
Index Funds
To replicate the
performance of a broad
market index.
Market Index
Investment-Linked
Funds
To provide balanced
income for specific life
insurance or family
takaful plans.
Stock and bonds
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19. Advantages of Unit Trust
Many investors lack sufficient resources to establish an
adequate diversification on their own.
Diversification
Different types of funds are created for different investment
objectives. So investors should have no problem finding funds
that meet their objectives in terms of return and risk
Funds with variety
of objectives
The management company maintains and administers the
records of shareholder’s activity for a given year. This is a
great convenience for the investors.
Record keeping
services.
Fund managers who are knowledgeable about investment and
they have good track records of performance, high integrity,
etc.
Professional
management
Unit trust can be bought and sold easily. Thus they do not
suffer from liquidity risk.
High liquidity
Only a small amount of money is needed to participate in a
portfolio of investment which enjoys the same benefits as in
direct investment which requires large amount capital.
Affordability
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20. Disadvantages of Unit Trust
Load fee
• This is sales charge added to the fund’s NAV
when unit trust is sold. It is as high as
10%.
High annual
expense
• The operating expenses like accounting,
legal, postage, management fees have to
be borne by the investors.
Transaction
costs
• Management companies must also pay
transaction costs to buy and sell securities
even though they trade in large blocks.
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21. Does the Price of Unit Trust fluctuate?
 Unit prices could rise or fall due to value changes of the underlying
securities owned by the Trust Fund.
 The value of equity fluctuates due to changes in the share prices in the
Malaysian Stock Exchange.
 The value of fixed income securities will change due to change in interest
rates in the market.
 Returns on Unit Trust can be determined using the below measurement.
 Holding period = Selling price – Purchased price + dividend
 Return Purchased price
 Return of the fund = new NAV – old NAV
 Based on NAV old NAV
 Market returns = new KLCI – old KLCI
Old KLCI
 Changes of funds return = Return on NAV
 Relative to market return market return
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22. Determination of Price for Unit Trust
 Price for Unit Trust is determined by Net Asset Value (NAV) of the
funds managing the portfolio excluding any liabilities incurred
and the number of units in circulation.
 NAV represents the underlying value of a unit share of stock in a
particular unit trust.
 NAV is found by taking the total market value of all securities
held by the fund, less any liabilities and divided by the number
of units on issue.
 NAV = Value of Assets - liabilities
No. of units outstanding
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23. Real Estate Investment Trusts (REIT)
Definition
•“An investment vehicle that invests or proposes to invest at least 50% of its total assets in
real estate. An investment in real estate may be by way of direct ownership or a
shareholding in a single-purpose company whose principal assets comprise real estate”
•Note: Real estate means physical land and those human-made items which are attached to
the land
Closed-end investment company that invests in mortgages and various
types of real estate investments
Provide high dividends along with capital appreciation potential
Types of REITs
•Property/equity REITs invest in shopping centers, hotels, apartments, office buildings and
other real estate
•Mortgage REITs invest in mortgages
•Hybrid REITS invest in both properties and mortgages
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24. Islamic REIT
Definition
• Islamic REIT is a collective investment scheme in real estate, in
which the tenant(s) operates permissible activities according to the
Shariah”
For real estate investment to be Shariah compliant,
regards should be given to the following:
• Utilization of the real estate must be Shariah compliant, including
tenancies & sub-tenancies
• Financing of the acquisition / development of the real estate
should be Shariah Compliant
• Investment of cash / liquidity must be made in Shariah compliant
instruments
• Insurance scheme for protecting the real estate should also be
Shariah compliant
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25. Islamic REIT vis-à-vis Conventional REIT?
• Not much difference
Fundamentally
• Very similar to Conventional REIT
Objective, administration and structure
• How the incomes of the Islamic REIT are derived and how the fund is being managed,
e.g:
• Type of tenants
• Islamic REIT – tenants in a property acquired must operate in businesses that comply
with Shariah principles
• Conventional REIT – no such requirement
• Proportion of rental
• Islamic REIT – fund must be managed in Shariah compliant manner
• Conventional REIT – no such requirement
Key difference
• Derived from the tenants
Income
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26. Malaysian SC’s Guidelines for Islamic REITs
Non-permissible rental activities
Financial services based on riba (interest)
Gambling/gaming
Manufacture or sale of non-halal products or related products
Conventional insurance
Entertainment activities that are non-permissible according to the Shariah
Manufacture or sale of tobacco-based products or related products
Stockbroking or share trading in Shariah non-compliant securities
Hotels and resorts
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27. Malaysian SC’s Guidelines for Islamic REITs
• If there are “mixed” tenants – the proportion of rentals from the
operation of non-permissible activities to total turnover of the
Islamic REIT in any current financial year must not exceed 20%
Rental from tenant carries out mixed activities.
• Some acceptable approach e.g. utilisation of space occupied, hours
of services or other technics determined by shariah advisor can be
used for calculating ratio of the rental of non-permissible
activities.
Technique of calculating the ratio of rental non-
permissible activities.
• A building where all the tenants operates only non-permissible
activities cannot be included in an Islamic REIT even if the total
rental complies with the 20% ruling
Acquisition of real estate
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28. Malaysian SC’s Guidelines for Islamic REITs
•For new tenant(s) – the Shariah committee / adviser must advise the Islamic REIT
manager against accepting new tenant(s) who operate activities that are fully
non-permissible
Renting out to a new tenant
•The Islamic REIT manager must ensure that all forms of investments, deposits and
financing instruments comply with Shariah principles
Instrument used in investment, deposit and financing
•Takaful schemes must be used to insure the real estate
Takaful Coverage
•The Islamic REIT allowed to take part in forward sales or purchase of currency for
risk management purposes.
•Note: Unless otherwise approved by the trustee and the SC, the total borrowings
of the fund to acquire properties shall not exceed 50% of the total asset value of
the fund at the time the borrowings are incurred
Risk Management
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29. How would a Malaysian Islamic REIT be administered ?
All REITs are governed by multiple levels of stakeholders to
ensure maximum investors’ protection:
• Unit holders
• Manager
• Shariah committee/adviser
• Trustee
• Regulatory authorities
Islamic REITs – must comply with both SC Guidelines on REITs
and SC Guidelines for Islamic REITs
All REITs are established through a Deed of Trust executed by
the trustee who acts on behalf of the unit holders.
The Deed of Trust governs the REITs and the roles of the
trustee and the management company
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30. Structure of an Islamic REIT
Shariah
Committee/
Adviser
Management
Company
Property
Manager
ISLAMIC
REIT
Properties
Trustee
Units subscribed in
IPO and/or acquired
in the open market
Management
fees
Management
services
Property
Management
Services
Direct
Ownership of
Properties
Net
Property
Income
Property
Management
Fees
Unit
holders
Appoint
Trustee
Income
Acts on behalf
of Unit Holder
Oversee
Shari`ah
Compliance
Unit Holders
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31. Exchange Traded Funds (ETF)
Exchange Traded Funds (ETF) can be
defined as
A listed index-tracking fund
Structured as a unit trust scheme
Whose primary objective is to achieve the same return as a
particular market index
By investing all (full replication) or substantially all (strategic
sampling) of its assets
In the constituent securities of the index.
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32. Features of ETF
An ETF is listed
• Its units can be bought and sold anytime during stock exchange
trading hours.
Investors buy and sell ETF units through
stockbrokers rather than unit trust agents.
An ETF is an index tracking fund.
Most ETFs are passively managed index funds
• Managers do not pick stocks based on fundamental analysis.
• Instead, managers track the performance of a benchmark index.
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33. Nature of ETF with Respect to Stocks and Unit Trusts
ETF on the other hand resembles the feature of
a unit trust.
• E.g.; An investor purchases 1 unit of the unit trust. It is as
good as holding the various stocks on the Exchange/Bursa.
• Likewise when an investor purchases 1 unit, it is as if the
investor is holding several top stocks.
In addition, unit trust
involves active management
where the fund managers
pick the stocks that will
generate a higher return
than the market return.
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34. Comparison of Investment Fund
ETFS Stocks Unit Trusts
Nature Units that
represent basket
of stocks
Shares Units that
represent
underlying
basket of stocks
Traded on
Exchange
Yes Yes No
Fund
Information
Market price and
trading activity
data readily
available
Market price and
trading activity
data readily
available
Information
available from
fund manager
and fund’s
appointed agents
Diversification Yes Yes No
Traded through
Broker
Yes Yes No (via Agent)
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35. Advantages of ETF
•Similar to index funds, ETFs provide investors with similar diversification benefits derived from
holding the benchmark index's constituent stocks without having to invest in each of the stocks
directly.
Diversification
•As a passively managed fund, ETF incurs lower management fee and lower transaction costs as
compared to an actively manage fund.Lower expense ratio
•ETF units are bought and sold at the same transaction cost as those charged for trading shares
on the stock exchange. Buying and selling of normal unit trusts are subjected to transaction
costs which are generally higher.
Lower transaction cost
•ETF units can be bought and sold at anytime during trading hours of the stock exchange.Tradability
•ETF prices are disseminated throughout trading hours on the stock exchange. The constituent
stocks of the index which the ETF tracks are normally published on the fund or index
provider's websites.
Transparency
•As for Islamic ETFs, an additional benefit is its conformity to the Shariah principles and
practices, which is important to Muslims. Non-Muslims may also wish to invest in such
funds based on Shariah principles.
Shariah-compliant
investment
35

36. Disadvantages of ETF
ETF are bound to
the ups and downs
of the market
• The performance of the ETF may be directly affected
by the performance of its component stocks/securities
represented in the benchmark index
• ETF fluctuate a lot.
The risk of
tracking error
• The performance of ETF is not representative of the
performance of the benchmark index.
• Moreover, frequent trading of ETFs could be
significantly increase commissions and other costs such
that they may offset any savings from low fees or costs.
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37. Islamic Exchange Traded Funds (I-ETF)
An Islamic ETF and
conventional ETF
share common
characteristics
The main
difference between
a conventional ETF
and Islamic ETF is
The benchmark index
that the Islamic ETF
tracks.
An Islamic ETF only
tracks an Islamic
benchmark index
where the index
constituents comprise
of companies which
are Shariah-compliant.
An Islamic ETF is
also required to
appoint a Shariah
adviser/committee
To provide expertise
and guidance to
ensure its structure,
investment and all
matters related to the
funds’ activities are
comply with Shariah.
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38. The Operation of Islamic ETF
Diagram 1 : Basic Structure of an Islamic ETF
38

39. Summary
In this
chapter
you have
learned
about:
Investment Fund
Unit Trust
Real Estate
Investment Trust
(REIT)
Exchange Traded
Funds (ETF)
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40. Thank you40