FINANCE

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KembaraXtra–Islamic Finance–Islamic Capital Market – Islamic Assets Under Management

-Meaning of fund management in Islamic finance:
-When a group of investors pool resources to collectively purchase stocks or other assets,the activity requires professional management
-This activity is known as fund management
-A professional fund manager is appointed to manage investments on behalf of investors


-Why collective investment is used:
-Individual investors may lack sufficient capital or expertise to invest independently
-Collective investment enables access to diversified portfolios and professional decision-making


-Institutions providing fund management:
-Both commercial banks and investment banks offer fund management services
-In practice,investment banks dominate this service more than commercial banks
-Because Islamic finance is asset-based,fund management suits Islamic financial institutions (IFIs) better than traditional lending

-Global presence of Islamic funds (2018):
-Approximately 323 Islamic funds offered Shari’ah-compliant products
-Funds operated across Saudi Arabia,Bahrain,Kuwait,Qatar,Pakistan,Malaysia,Singapore,Germany,the US,the UK,and Ireland
-Funds covered low-risk/moderate-return,balanced,and high-risk/high-return categories
-Most were equity and mutual funds,with some in real estate,hybrid funds,and Takaful

Modes of Managing Islamic Funds

-Mudarabah basis:
-The fund manager acts as mudarib
-The manager earns a share of realised profits based on a pre-agreed ratio
-No fixed salary is guaranteed


-Agency (Wakalah) basis:
-The fund manager acts as an agent
-The manager receives a fixed fee or a percentage of the fund’s Net Asset Value (NAV)


Classification of Islamic Investment Funds by Usage

-Equity funds:
-Invest in shares of Shari’ah-compliant joint-stock companies
-Returns earned through capital gains and halal dividends
-Distributed to investors on a pro rata basis


-Ijarah funds:
-Used to purchase assets for leasing
-Lease income is shared among fund subscribers
-Ijarah Sukuk can be traded in the secondary market
-New buyers assume all rights and obligations of the seller


-Commodity funds:
-Used to purchase commodities for resale
-Profits from resale are distributed among investors


-Murabahah funds:
-Closed-ended funds
-Not tradable in the secondary market
-Reason:Islamic banks do not hold sufficient tangible assets in Murabahah structures


-Mixed funds:
-Invest in a combination of equities,commodities,and leasing assets
-Trading allowed only if 51% or more of assets are tangible

Role of Shari’ah-Compliant Products

-Serve purposes of equity and debt securitisation
-Also used in Shari’ah-compliant derivative-like structures
-Banking,brokering,investment,and Shari’ah advisory services follow Islamic principles

Equity Financing in Islamic Finance

-Equity financing is central to Islamic finance
-Achieved through Uqud Al-Isytirak (partnership contracts)
-Includes:
-Mudarabah – profit-sharing
-Musharaka – profit and loss sharing

Debt Financing in Islamic Finance

-Conventional interest-based debt is prohibited
-Islamic debt financing must be linked to real assets
-Achieved through Uqud Al-Mu’awadat (exchange contracts)

-Common Islamic debt instruments include:
-Murabahah – cost-plus sale
-Ijarah – leasing
-Bai‘ al-Salam – advance purchase
-Istisna – purchase order/manufacturing contract

-Types of Ijarah recognised under Shari’ah:
-Operating lease
-Finance lease

Key Takeaway

-Islamic assets under management emphasise asset-backed financing,ethical investment,risk-sharing,and professional fund management,forming a core pillar of the Islamic capital market


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KembaraXtra–Islamic Finance–Islamic Capital Market – Equity Funds

-Equity funds are a major category of Islamic investment funds that focus on investing in shares of Shari’ah-compliant joint-stock companies
-These funds pool money from multiple investors and invest collectively in approved equities
-All investments must pass Shari’ah screening,including business activity screening and financial ratio screening


-Nature of investment:
-Equity funds invest directly in ownership instruments rather than debt
-Investors become indirect owners of companies through the fund
-Returns depend on the performance of underlying companies,not guaranteed income


-Sources of return:
-Returns are generated through capital gains,when share prices increase
-Halal dividends,if distributed by the company and purified if required
-Profits are distributed to investors on a pro rata basis according to units held


-Risk profile:
-Equity funds generally carry higher risk compared to Sukuk or money market funds
-However,they offer higher long-term return potential
-Risk arises from market volatility,business performance,and economic conditions


-Shari’ah compliance features:
-Exclude companies involved in prohibited activities such as alcohol,gambling,interest-based finance,and non-halal products
-Limit exposure to interest-based debt and income through financial ratio screening
-Any incidental non-compliant income must undergo purification


-Management structure:
-Equity funds are managed either on a Mudarabah basis (profit-sharing) or Wakalah basis (fee-based agency)
-Fund managers make investment decisions under Shari’ah supervisory oversight


-Liquidity:
-Units of Islamic equity funds are generally redeemable at NAV
-Provides higher liquidity compared to direct ownership of individual shares
-However,liquidity is typically lower than conventional equity funds due to market depth


-Role in Islamic finance:
-Equity funds promote risk-sharing,a core Islamic finance principle
-Encourage investment in real economic activities
-Support long-term capital formation and ethical wealth creation


-Key takeaway:
-Islamic equity funds offer investors a Shari’ah-compliant pathway to participate in stock markets while adhering to ethical standards and risk-sharing principles


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KembaraXtra–Islamic Finance–Islamic Capital Market – Ijarah Funds and NAV

-Meaning of an Ijarah fund:
-An Ijarah fund is a Shari’ah-compliant investment fund that pools money from investors to purchase tangible assets such as buildings,aircraft,vehicles,or machinery
-These assets are then leased to users under Ijarah (leasing) contracts
-Investors collectively own the leased assets through the fund


-Source of return:
-Returns are generated from lease (rental) income paid by lessees
-The rental income is distributed among investors on a pro rata basis
-Returns are performance-based and depend on asset utilisation and lease payments


-Risk-sharing aspect:
-Investors bear risks related to asset ownership,such as asset damage,vacancy,or depreciation
-This aligns with Shari’ah principles of ownership and risk-sharing


-Does an Ijarah fund involve NAV?
-Yes,Ijarah funds also use Net Asset Value (NAV)
-Although the assets are leased and income-generating,the fund is still a collective investment vehicle
-Investors buy and redeem fund units directly with the fund,not through market trading


-Why NAV is necessary for Ijarah funds:
-NAV reflects the current market value of leased assets plus accrued rental income
-Liabilities such as management fees,maintenance costs,and financing obligations are deducted
-NAV provides a fair valuation for investors entering or exiting the fund


-NAV calculation in an Ijarah fund:
-NAV = (Market value of leased assets + accrued rental income − liabilities) ÷ total units


-Liquidity of Ijarah funds:
-Units are generally redeemable at NAV,subject to fund terms
-Ijarah funds are usually less liquid than equity funds due to the nature of physical assets


-Shari’ah perspective:
-Using NAV ensures transparency,fairness,and justice among investors
-It prevents speculation and aligns pricing with real asset value


-Key takeaway:
-Ijarah funds involve NAV because they are mutual-fund-type structures investing in leased assets,and NAV ensures fair pricing based on real asset ownership and rental income


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KembaraXtra–Islamic Finance–Islamic Capital Market – Commodity Funds and NAV

-Meaning of a commodity fund:
-A commodity fund is a Shari’ah-compliant investment fund that pools money from investors to purchase halal commodities
-Common commodities include metals,agricultural products,and other tradable goods approved under Shari’ah
-The fund engages in buying,holding,and reselling commodities to generate profit


-Shari’ah compliance conditions:
-Commodities must be halal and clearly identifiable
-The fund must involve actual ownership and possession of commodities
-Speculative trading and purely paper-based commodity transactions are prohibited
-Transactions must avoid riba,gharar,and maisir


-Source of return:
-Returns are generated from the resale of commodities at a higher price
-Profit arises from trade,not from interest or price speculation
-Profits are distributed to investors on a pro rata basis


-Risk-sharing aspect:
-Investors bear price risk related to commodity market fluctuations
-They also bear risks related to storage,transportation,and market demand
-This aligns with Islamic principles of ownership and risk-sharing


-Does a commodity fund involve NAV?
-Yes,commodity funds also use Net Asset Value (NAV)
-The fund operates as a collective investment vehicle,where units are bought and redeemed with the fund


-Why NAV is necessary for commodity funds:
-NAV reflects the current market value of commodities held by the fund
-Any cash balances and accrued trading profits are included
-Liabilities such as storage costs,logistics expenses,and management fees are deducted
-NAV ensures fair entry and exit pricing for investors


-NAV calculation in a commodity fund:
-NAV = (Market value of commodities + cash − liabilities) ÷ total units


-Liquidity considerations:
-Commodity funds are generally less liquid than equity funds
-Liquidity depends on how easily the commodities can be sold in the market


-Shari’ah perspective:
-The use of NAV ensures transparency,justice,and avoidance of speculative pricing
-It ties investor value directly to real,owned commodities


-Key takeaway:
-Islamic commodity funds generate halal profits through real trade in commodities,and NAV is essential to fairly value investor units based on actual asset ownership


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KembaraXtra-Islamic Finance-Islamic Capital Market -NAV vs Share Price

NAV (Net Asset Value)
• Refers to the price per unit of a mutual fund
• Calculated as: (Total assets − Total liabilities) ÷ Total units outstanding
• Represents the true underlying value of the fund per unit
• Calculated once per day, usually at the end of the trading day
• Used for buying and redeeming mutual fund units
• Does not fluctuate during the trading day
• Investors transact directly with the fund manager
• Mutual fund units are not traded on stock exchanges


Share Price
• Refers to the market price of a company’s share
• Determined by demand and supply in the stock market
• Reflects investors’ expectations, news, sentiment, and performance
• Changes continuously during market hours
• Used for buying and selling shares in the secondary market
• Fluctuates intraday
• Investors transact with other investors via stock exchanges
• Shares are listed and traded on stock exchanges


Key Difference (Quick Recall)
• NAV = fund value per unit (once a day)
• Share price = market-driven price (all day)

NAV is the per-unit value of a mutual fund calculated daily based on assets and liabilities, while share price is the market-determined price of a company’s stock that fluctuates throughout the trading day.


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KembaraXtra-Islamic Finance-Islamic Capital Market-Exchanges Trading Islamic Capital Market Instruments

Jakarta Stock Exchange

• Acts as a holding company
• Lists more than 500 companies
• Trades:
– Sukuk
– Shari’ah-compliant equities
– Conventional financial products

Bursa Malaysia (MYX)

• Kuala Lumpur–based stock exchange
• Lists almost 1,000 companies
• Trades:
– Islamic securities
– Conventional capital market products

Labuan International Financial Exchange (LFX)

• Offshore exchange based in Malaysia
• Launched in 2000
• Operates 24/7
• Trades:
– Sukuk
– Islamic funds

London Stock Exchange (LSE)

• One of the largest stock exchanges in the world
• Owns the Alternative Investment Market (AIM)
• AIM includes Shari’ah-compliant firms
• Trades:
– Sukuk
– Equity funds
– Islamic exchange-traded funds (ETFs)

Luxembourg Stock Exchange

• First European exchange to transact Sukuk
• Sukuk represent:
– ownership of tangible assets
– projects
– businesses
– services
– joint ventures
• Trades:
– Sukuk
– Shari’ah-compliant funds

Nasdaq Dubai

• Serves:
– Western investors
– Middle Eastern investors
– European investors
– East Asian investors
• A leading Sukuk exchange in the Middle East
• Trades:
– Shari’ah-compliant stocks
– Islamic mutual funds
– Islamic ETFs
– Islamic real estate investment trusts (REITs)

Tadawul (Saudi Arabian Stock Exchange)


• Located in Riyadh
• Lists companies operating in:
– oil and gas
– food
– agriculture
– banking
– other financial sectors
• Trades:
– Stocks
– Islamic ETFs (IETFs)
– Mutual funds
– Sukuk


Understanding Shari’ah Screening

Meaning

• Shari’ah screening is the process of ensuring investments comply with Islamic law
• It applies to:
– stocks
– mutual funds
– ETFs
– Sukuk

Impact on Islamic Capital Market Growth

• Increased interest in Islamic capital market products has led to:
– growth in market capitalisation of Shari’ah-compliant stocks
– increase in Net Asset Value (NAV) of Shari’ah-compliant mutual funds

Key Driver of Growth

• High level of market confidence among:
– investors
– market participants
• Confidence is strengthened by:
– active Shari’ah governance
– participation of Shari’ah boards and scholars
– transparency and compliance assurance


Why Shari’ah Screening Matters

• Ensures investments are:
– free from riba (interest)
– free from maisir (gambling)
– free from gharar (excessive uncertainty)
• Builds trust and credibility in the Islamic capital market
• Encourages both Muslim and non-Muslim investors

One-Line Exam Summary

Shari’ah screening ensures that Islamic capital market instruments comply with Islamic principles, and strong Shari’ah governance has increased investor confidence, leading to higher market capitalisation and NAV growth.


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KembaraXtra–Islamic Finance–Islamic Capital Market – Flow of Funds in the Islamic Capital Market


1. Financial Architecture in an Economy

  • There are two major types of financial systems:
    • Bank-based system
      • Banks are the main source of external finance.
      • In Islamic finance, this role is played by Islamic Financial Institutions (IFIs).
    • Market-based system
      • Firms raise funds directly from the public through capital markets.
      • Financing is done by issuing equity and Shari’ah-compliant debt instruments (e.g. Sukuk)
  • The Islamic capital market (ICM) follows a market-based system but strictly complies with Shari’ah principles.


2. Replacement of Interest with Profit Sharing

  • The Islamic capital market prohibits interest (riba).
  • Instead of fixed interest:
    • Returns are generated through profit-sharing arrangements.
    • Investors earn returns only if the underlying business performs well.

  • There is no guaranteed or pre-fixed increment on investments.

3. Savings Surplus Units (SSUs)

  • Savings Surplus Units (SSUs) are individuals or entities whose:
    • Income > Expenditure

  • Characteristics of SSUs:
    • They accumulate surplus wealth.
    • They are obligated to pay Zakah if their wealth exceeds Nisab.

  • Why SSUs must invest:
    • Idle wealth reduces due to Zakah.
    • To avoid wealth erosion and earn halal returns, SSUs invest in:
      • Real economic activities
      • Shari’ah-compliant capital market instruments (shares, Sukuk, funds

4. Savings Deficit Units (SDUs)

  • Savings Deficit Units (SDUs) are consumers or firms whose:
    • Expenditure > Income

  • Mathematical representation:
    • For consumers:
      • (t −)
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KembaraXtra–Islamic Finance–Islamic Capital Market – Liquidity Issues in the Islamic Capital Market

-Liquidity meaning:Ability to convert Islamic investments into cash quickly without significant loss in value

-Why liquidity matters:Investors need confidence to meet current and future financial obligations

-Unique liquidity challenge in ICM:Islamic investors face liquidity constraints not commonly faced in conventional markets due to the developing nature of the Islamic capital market

-Slower growth of Islamic products:Fewer Islamic financial instruments exist compared to conventional markets, limiting the availability of highly liquid assets

-Cause 1:Smaller market share:Islamic investments form a relatively small portion of global capital markets, leading to fewer participants, lower trading volume, and reduced liquidity, making resale of Islamic stocks or Sukuk slower

-Cause 2:Shari’ah compliance requirements:Mandatory business activity and financial ratio screening, along with differing scholarly opinions, slows product approval, listing, and development, affecting market liquidity

-Cause 3:Limited market access and infrastructure:Islamic capital market infrastructure is unevenly developed globally, restricting cross-border access and reducing investors’ ability to convert assets into cash quickly;for example, UK investors may struggle to access US-based Islamic assets

-Overall impact on investors:Higher liquidity risk,longer investment holding periods,and possible price discounts when selling assets
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-Key takeaway:Liquidity remains a major structural challenge in the Islamic capital market,and strengthening market depth,access,and infrastructure is essential for long-term growth


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KembaraXtra–Islamic Finance–Islamic Capital Market – Regulatory and Legal Frameworks of the Islamic Capital Market

-The Islamic capital market is regulated by government authorities in line with standards set by Islamic Financial Services Board (IFSB) and Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)

-Because the Islamic capital market is still at an early stage of development, its regulatory and legal frameworks are also continuously evolving

-In most countries,the conventional capital market authority supervises both conventional and Islamic capital markets

-Despite this,Islamic capital markets also rely on Shari’ah Supervisory Boards (SSBs),which are specifically responsible for Shari’ah-related matters

-All Islamic Financial Institutions (IFIs) must be carefully regulated and monitored to protect investors’ funds from intermediary failures,ensure fair redistribution,and prevent financial crimes

-Regulatory objectives are achieved through:regulation of securities,regulation of financial institutions,and strong corporate governance at the highest level

-The unique structure of IFIs,which combines financial and Shari’ah principles,makes standard-setting and regulation more complex

-This uniqueness explains why divergent opinions exist on how Islamic financial institutions should be supervised and regulated

-Despite these challenges,significant progress has been made toward global harmonisation of Islamic financial regulation

-Key international Islamic financial infrastructure institutions working toward harmonisation include:Islamic Financial Services Board,Accounting and Auditing Organization for Islamic Financial Institutions,Liquidity Management Centre,International Islamic Financial Market,International Islamic Liquidity Management Corporation,andInternational Islamic Rating Agency

-A strong legal framework is essential to protect the Islamic capital market from misuse arising from system ambiguities

-Legal protection prevents unfair exploitation and strengthens investor confidence

-There is a strong relationship between legal protection of financiers and economic development

-Effective enforcement of legal rules positively influences the size,depth,and growth of the Islamic capital market
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-Key takeaway:strong legal enforcement and harmonised regulation are critical for the long-term growth,credibility,and stability of the Islamic capital market


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KembaraXtra–Islamic Finance–Islamic Capital Market – Challenges Faced by the Islamic Capital Market

-Islamic financial businesses operate under distinct Shari’ah-based rules, which differ fundamentally from traditional business operations
-One major challenge is that the Islamic capital market is often required to comply with regulatory frameworks originally designed for conventional financial systems
-These conventional regulations are based on different objectives and philosophies, such as interest-based financing, which do not align with Islamic principles
-As a result, Islamic capital market institutions may face regulatory mismatch and operational constraints
-The Islamic capital market is relatively young and still evolving, whereas the conventional capital market has existed and developed over several centuries
-Both markets currently operate within the same financial and economic environment, creating competitive and structural challenges for Islamic finance
-The long-established dominance of the traditional capital market makes it difficult for the Islamic capital market to expand rapidly and gain equal footing
-Key takeaway:The Islamic capital market faces challenges due to regulatory incompatibility and its relatively early stage of development compared to the long-established conventional capital market


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