chapter 2 shariah stock screening

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ISLAMIC INVESTMENT

Mahyuddin Khalidemkay@

salam.uitm

.edu.my

Shariah Stock Screening

Topic Outline

Screening Methodology for Shariah-Compliant Stocks Shariah Screening of Stocks in Malaysia Fiqh Justification For Shariah Benchmarks

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Shariah Screening of Stocks in Malaysia

Currently there is no international Shariah standard for stock screening

Different funds or fund managers utilise differentstandards based on their Shariah council

In Malaysia we have the list issued by SecuritiesCommission, Dow Jones-RHB Islamic Malaysia Index and FBM Shariah Index

At the international level we have the Dow Jones Islamic Market Indexes, FTSE Global Islamic Index Series and S&P Islamic Index Series

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Security Commission is responsible for determining the Shariah compliant stocks and the Shariah Index through its very own Shariah Advisory Council (SAC)

In classifying these securities, the SAC received input and support from the SC.

The SC obtained information on the companies through, among others, annual reports and enquiries made to the companies.

The SAC, through the SC, will continue to review the Shariah status of securities listed on Bursa Malaysia, on an annual basis, based on the latest available annual audited financialstatements of the companies.

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Securities Commission of Malaysia applied additional criteria to companies which are involved in mixed business i.e. companies whose business activities comprise both Shariah

permissible and non-permissible elements. The analysis is done at the holding company, subsidiary

company and associate company levels. The additional criteria include: Core activities of the company are activities not against the

Shariah principles as mentioned earlier Haram element is small compared to core activities, i.e.,

compared against benchmark Public image/perception of company is good Core activities of the company are important and of public

interest (maslahah) to the Muslim ummah and the country Proportion of haram element is small and in matters such as

umum balwa (common plight), ‘uruf (customs) and the rights ofthe non-Muslim community which are accepted by Islam

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While the above criteria are all subjective, in order to translate these subjective criteria into actionable filters, the SAC adopts a two-tier quantitative approach.

The objective is to compute the percentage contribution of non permissible activities to the company’s total asset. These being;1. Business Activity Benchmark:

Evaluation in terms of company activities, products and industry2. Financial Ratio Benchmark:

Computation of a set of financial ratios and compare them against specified benchmarks

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Business Activity Benchmark

The business activity benchmark is essentially used on a case-by-case method.

This is applicable for situations where the core activity of the company has importance and maslahah (benefit in general) to the ummah but includes a small element that may be haram.

The non permissible activity could also be driven by custom or involve the rights of non-Muslims.

In analyzing such companies on a case-by-case basis, the SAC allows for threshold levels anywhere between 5% and 20%.

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Business Activity Benchmark

Previous Revised (Current)5% BENCHMARK 5% BENCHMARK• Conventional Banking• Conventional Insurance• Gambling• Liquor and liquor related activities• Pork and pork related activities• Non halal food activities• Shariah non compliant entertainment

• Conventional Banking• Conventional Insurance• Gambling• Liquor and liquor related activities• Pork and pork related activities• Non halal food activities• Shariah non compliant entertainment• Interest Income from conventional accounts

andinstrument

• Tobacco and tobacco related10% BENCHMARK• Interest Income from conventional accounts

and instrument• Tobacco and tobacco related20% BENCHMARK 20% BENCHMARK• Rental received from shariah non compliant

activities• Rental received from shariah non compliant

activities• Hotel & Resorts operations• Share Trading• Stockbroking Business

25% BENCHMARK• Hotel & Resorts operations• Share Trading• Stockbroking Business

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Financial Ratio Benchmark

Next, a set of measures called financial filters is also used to refine the selection.

The filters use a number of financial ratios and comparethem against their respective benchmarks to weed out non-Shariah compliant stocks

In general these ratios can be categorised as: Cash over Total Assets

Cash will include cash placed in conventional accounts and instrument

Debt over Total Assets Debt will only include interest bearing debt

The financial ratio benchmark must be lower than 33% Both ratios intended to measure riba and riba based-

element within a company balance sheet

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Comparison of Stock Screening Techniques

Since the SAC criteria is Malaysia specific, using a stringent filter will result in a smaller group of eligible stocks and therefore a much narrower investible spectrum for Muslim investors in Malaysia.

One might ask, what is wrong with having a smaller but ‘purer’ group of investible stocks?

There are several problems with this: From a portfolio theory viewpoint, a smaller investible group of

stocks restricts diversification and limits the benefits of diversification.

One cannot form efficient portfolios or superior risk-return portfolios if the group of investible stocks is restricted.

By implication one cannot be on the ‘optimal’ efficient frontier or get close to such a frontier.

As with everything else in economics, there is a trade off. The cost may be less efficient portfolios.

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Shariah compliant securities which are subsequently considered Shariah non-compliant: If the price of the securities is more than its cost: must sell

immediately. If not the proceeds should go to charity If the price is lower than cost: then wait until the price is

equal to cost and then sell. If dividends are declared during the holding period the dividend may be accepted

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How Does The Revised Methodology AffectShariah Compliant Status Of Listed Companies?

Companies with mixed activities which are currently assessed under the 10% or 25% benchmarks may be affected because their activities are now assessed under the 5% or 20% benchmarks.

Example:

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Company A Shariah non-compliant activity

Previous methodology[10% benchmark]

New Revised methodology[5% benchmark]

• Cigarettes (tobacco)• Listed on Main Market,

Bursa Malaysia• Business activities:

Property development,trading of building, materials and manufacture anddistribution

• Tobacco’s revenue / Group revenue

= 9%

• Status : Shariah-compliant

• Status: Shariah non-compliant

How Does The Revised Methodology AffectShariah Compliant Status Of Listed Companies?

Companies with high level of conventional debt may be affected as currently there is no screening based on the total conventional debt of the company.

Example:

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Company B Level of Conventional Debt

Previous methodology New Revised methodology[33% benchmark]

• Cigarettes (tobacco)• Listed on Main Market,

Bursa Malaysia• Business activities:

Property development,trading of buildingmaterials andconstruction works

• Total conventional debt / Group total asset

= 36%

• Not applicable • Status: Shariah non-compliant

Treatment Shariah Non-Compliant Securities

These refer to securities which were earlier classified as Shariah-compliant but due to certain factors such as changes in the companies’ business operations and financial positions, are subsequently reclassified as Shariah non-compliant.

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Price On Announcement Date Price After Announcement Date

Price>Original investmentcost

Price<Original investmentcost

Price>Original investmentcost

Price<Original investmentcost

• Dispose securities• Any capital gain,

dividend arepermissible to keep

• Permissible to hold securities until price is same with investment cost

• dividend can be use to improve the disposal Process

• Dispose securities• Profit(different from

investment cost and closing price is permissible to keep)

• Profit(different from dispose price and closing price is donate to charity

• Permissible to keep the securities until the price same with originalinvestment cost

• dividend can be use to improve the disposalprocess

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Fiqh Justification For Shariah Benchmarks

Status of mixed business companies: No historical precedent Cited Ibnu Subki in Al-Ashbah wa al-Naza’ir, “to rule as

prohibited something that is a mix of the permissible and the prohibited is ihtiyat (precautionary measure) and it is not necessarily prohibited”.

SAC of SC took into accounts other Fiqh principles to support their case:

Maslahah, ‘Umum balwa, ‘Urf khas min asalib iqtisodiyah, Fasaduz zaman Huquq ghair Muslimin

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In addition they also cited Ibnu Qayyim who wrote in his book “Bada’ie al-Fawa’id” about the nature of prohibited property which is of 2 kinds: Prohibited because of its zat (nature),

e.g., pork, liquor. Hence mixing of meat slaughtered by Muslim and Non Ahli Kitab is prohibited.

Prohibited due to other reasons such as the means orway it is earned or acquired. e.g. money in itself is okay but the manner it is acquired such as by

robbery is not acceptable. Shares of companies are by nature acceptable but shares of mixed business companiesmay not be acceptable.

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50% rule Utilize the fatwa concerning silk mixed with common thread.

This is based on the hadith of the Prophet saw: “The Prophet saw took a piece of silk and placed it on his right. He

took some gold and placed it on his left. Then he said: “Both these things are prohibited unto men among my followers, but permissible for the women”

If it is pure silk then it is prohibited for men to wear the silk cloth but if the cloth is mixed with 50% or less silk and the remaining common -thread then it is permissible

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One Third/ 33% rule Utilize the analogy of hibah (gift) where a person can

bequeath a maximum of one third of his property as gift to an unrelated person

Benchmark based on Ghabn Fahish (extraordinary margin or profit or gain)

Describes gain through cheating and manipulation (tanajush)

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Ghabn fahish accompanied with tanajush is not permissible

Hanafi mazhab ruled that the upper limits forghabn fahish are as follows: 5% for ordinary goods 10% for animals used for riding and 20% for fixed assets

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Summary

In this chapter

you have learned about:

Screening Methodology for

Shariah-Compliant

StocksShariah

Screening of Stocks in Malaysia


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21 Thank you

chapter 2 shariah stock screening

Education