EMERGENCE OF ISLAMIC INVESTMENT: Issues and Practices Ausaf Ahmad Presentation at IBF-NET COURSE ON ISLAMIC FINANCE At The Hotel Palm Grove Chennai October.

EMERGENCE OF ISLAMIC INVESTMENT:

Issues and Practices

Ausaf Ahmad

Presentation at IBF-NET COURSE ON ISLAMIC FINANCE

At The Hotel Palm Grove

ChennaiOctober 04 2008

In the name of Allah, The Most beneficent, The Most Merciful.

What is Ethical Investment?

• To many, expressions like ethical Investment may sound a contradiction in terms.

• Could there be an “Ethical Investment”?

• The answer is not easy. Many intricate issues of Economics and Ethics are involved.

The Relationship Between Economics and Ethics

Economics and Ethics both govern human behavior and provide guiding principles.

Modern Economics is ‘amoral’ in nature.

Economic man and invisible hands.

Positivism i.e. value neutrality and universalism.

Efficacy and efficiency of market (No Market Failure)

Pareto Optimality and Normative Goals

• Market solution is optimal i.e. interaction of utility maximizing consumer and profit maximizing producers shall produce an optimal market solution.

• Definition of Pareto optimality: A solution is Pareto Optimal if it could not be improved without making some one worse off.

• No mention of equity. It is held that Pareto Optimality shall be able to handle all cases of market failures, social evils, like pollution, pornography etc.

• The Actual Experience negates these claims

Which is a Good Investment?

• Economic View: The Investment which is brings in Profit is a “good” investment.

• Dictionary Meaning of Ethics:Moral principles, Value system, Value

orientation (the principles of “right” and “wrong”, “good and “bad” as accepted by an individual or a social group.

• Ethical Question: Is it really a good Investment?

Social Consequences of Investment

• Should Self interest be the only motivating factor for an investment?

• Should I care for only my profit? What if my investment leads to:

Increased AlcoholismDrug AbuseSpread of PornographyEnvironmental and social degradation such as

Crime and violence.

• Should I remain insensitive to social needs and damage to the society and environment that my investment must have done it.

• Shouldn’t I channel my investment differently.?

A Million Dollar Question

• If I motivate someone to commit a heinous crime such as a murder, Shall I be held responsible for my action?

According to LawAccording to Morality

• If there is no direct or indirect evidence against me, I may not be prosecuted by law, but I cannot be absolved of my responsibility by morality.

• ‘ The biggest court is one’s own conscience• The same provides justification for Ethical

Investment

The Desire of Investors

• The ethical investors wish to make their contribution, through their investment, to a clean, pollution free environment, ecological balance and towards a more humane and livable society.

• These desires have reflected in emergence of green investment, Environment friendly investment, Islamic Investment, Dharma investment etc.

Green Investment

• Pollution free cars: It is estimated that by 2030, plug in cars would make up 50% of all cars sold, and by 2010, China will spend over $236 billion each year on Green investment.

• Pundits claim that ethical investments has doubled in the past seven years.

Sources of Investment Morality

• Secular Morality Human rights Disarmament Social commitments Environmental Impact Opposition to Oppressive Regimes Animal welfare

• Religious Morality• Ave Maria Catholic Values (Excludes

investment in Health and Technology)

• Islamic Investment (Prohibition of Riba, Pork, processed meat, liquor, pornography etc.)

Performance of Religious Funds(Grading by Morning Star Managers, 2006 data)

Fund Prohibition Grade

Amanah Mutual Fund Trust

Banks, Alcohol, porno, gambling A

Ave Maria Catholic Values

Abortion, Planned Parenthood, Porno, partner benefit

C

MMA Praxis Core Stock

(Mennonites)

Defense, alcohol, gambling, Tobacco, Nuclear

D

New Covenant Growth

(Presbyterian)

Alcohol, gambling, Tobacco, Firearms etc.

C

Timothy Conservative (Evangelical)

Abortion, Alocohol, porno, Tobacco, gambling,

D

Socially Responsible Investment

• Based on Environment, Social and Governance (ESG) considerations.

• “Triple Bottom line”: Monetary returns, Social benefits, Environmental sustainability.

• A company showing good ‘triple bottom line’ is considered to be a ‘socially responsible company’.

Islamic Investment

• An Investment is considered Islamic if it is made in accordance with the Islamic principles.

• Shari’ah Compatible Investment• The companies are screened on the

basis of some index to determine their Shari’ah compatibility. According to Nisar, 61% Indian companies are Shari’ah Compatible.

Ethical Indices for Screening

• Screening is carried out on the basis of financial ratios, business performance and corporate governance.

Financial Filter= Total Debt/ Trailing 12 months average market capitalization >33% Company is ruled out.

Financial Screening

• FF2= Cash + interest bearing Securities/ 12 months average Capitalization>33% Rule out

• FF3= Accounts Receivable / 12 months average capitalization >33% Rule out

• In order to qualify for investment a company has to pass all three tests.

Moral Filters

• The Companies producing prohibited items like pork, alcoholic drinks etc. are ruled out.

Ethical Indices

• Dow Jones Islamic Market Index• Standard and Poor Large Cap World

Shari’ah• S &P Small Cap World Shari;ah• S &P UK Shari’ah• SBI Resurgent India Opportunity Fund• UTI Off Shore Shari’ah Compliant Fund• Dow Jones Dharma index• Parsoli Islamic Index (PIE)• East Wind India Islamic Index

Parsoli Islamic Equity Index (PIE)

• Shari’ah Compliance

• Liquidity : Actively traded stocks

• Comprehensive coverage across the industry [More than 5000 Indian companies included].

• Consistent Methodology

Business Screener

Mixed Business Screener

Financial Screener

TTMAMC*

Trailing 12-Month Average Market Capitalization

TMAMVE**

12 Months Average Market value of equity

Financial Screener (Contd.)

CRITICAL EVALUATION

• Various Indices differ from each other in coverage and comprehensiveness in Business Screener

• The norms in financial screener appear to be arbitrary. The arbitrary nature of these indices must be recognized.

CONCLUSION

In conclusion, we may say:

Islamic and other Ethical Investments are in the market to stay. These trends are expected to be strengthened more and more, with time.

THANK YOU VERY MUCH