Religion Investment Intersection - Shariah Stock Indices

Religion has been the basis of a lot of things in the past. It has also come upon influencing trade and business. Islamic Banking is a very well known idea in the business world. It is all about doing the business of banking in such a way that it complies with the provisions of Shariah ( a code of conduct which rules most aspects of a Muslim individual's life include marraige, business, charity etc). Since the last two decades a lot of reading and experimenting has happened in the area of Islamic Banking.

Islamic Investing is a fairly recent innovation. This is all about investing in companies whose operations and products are Shariah compliant. Major fund-houses and index-service providers have exploited this idea and set up hedge-funds, mutual funds, ETFs which are Shariah compliant. In India BSE along with Taqwaa Advisory and Shariah Investment Solutions (TASIS) have come-up with BSE Shariah 50, presently the only thematic index at BSE. NSE has introduced two similar indices namely S&P CNX 500 Shariah and S&P CNX Nifty Shariah.



BSE-TASIS Shariah 50 consists of stocks of 50 most liquid companies which are Shariah compliant drawn from the broad-based BSE 500. Key highlight of this index is that it has a 8% cap of scrip weights. Thus the portfolio will remain fairly diversified. Major sectors included are Oil&Gas, IT, FMCG, Capital Goods etc. As on 20 May 2011 the 1-year return of Shariah 50 is 14.48% while that BSE 500 is 7.72%.

TASIS, which is a Shariah advisory firm, plays the role of screening the stock for Shariah compliance. The fact sheet posted on BSE site doesn't clearly spell out the process that TASIS would follow to identify the stocks and decide the continuance of existing constituents of the index. The document states all constituents will be subject to screening at monthly intervals. Any constituents failing to meet the requirements will be dropped at once. But the reconstitution of the index will happen only at quarterly frequency.

International Experience:

Shariah compliant indices are already in existence in the international arena. FTSE, Dow Jones, Credit Suisse all have similar indices. It is interesting to know how such indices are constructed. FTSE follows the following 'ground' rules to construct their Shariah Global Equity Index. Companies involved in the following activities are rejected outright by default.

• Conventional Finance (non-Islamic Banking, Finance, Insurance etc)
• Alcohol
• Pork-related and non-Halal food production, processing and packaging
• Entertainment (Casino, Theatre, Films)
• Tobacco
• Weapons, arms and Defence Productions

NSE's Shariah Indices exclude companies involved in Advertising & Media (excluding Newspapers) and Trading in Gold & Silver also. Further the companies that pass the activity test should also pass the financial ratio test.

• Debt is less than 33% of total assets 
• Cash and Interest bearing items are less than 33% of total assets 
• Accounts receivable and cash are less than 50% of total assets 
• Total interest and non compliant activities income should not exceed 5% of total revenue

Most of the international-level Shariah compliant indices seem to have similar screening tests. May be BSE-TASIS should provide the details of the screening that they perform for this index (while S&P CNX Indices have clearly spelled documents). Further there are some gaps in BSE's offering. 

• Most of the international Indexing companies invariably maintain a second-line of constituents to fill the gap of any constituent leaving the index. Given the facts that screening happens at monthly frequency and index reconstitution happens at quarterly intervals. 
• Also how will some corporate actions like mergers, de-mergers, acquisition, carve-outs etc will be treated remain to be discussed. 

May be this is a bit too early for BSE to think of these issues for its thematic index.

Most interesting aspect of this offering from BSE is that Shariah 50 is projected as a Socially Responsible Investment (SRI). May be BSE should take out some time and explain how investing in Banks and Insurance Companies will constitute socially irresponsible behaviour. 

Though it is not very clear how big the market for Islamic Investing is. Given the fact that major exchanges have shown keen interest in these products suggests that the market could be big and deep enough. Now learning age-old religious codes can be a lucrative business proposition.