Thursday 28 Mar 2024
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Malaysia has not enjoyed much success when it comes to exchange-traded funds (ETFs).

The first ETF — the ABF Malaysia Bond Index Fund ETF — was launched in 2005, while the first Islamic ETF — the MyETF Dow Jones Islamic Market Malaysia Titans 25 (MyETF-DJIM25) — was set up in 2008.

It was another six years before the second Islamic ETF was launched. The MyETF MSCI Malaysia Islamic Dividend Fund was listed in March.

i-VCAP Management Sdn Bhd raised RM20 million from this Islamic ETF, with the issue of 20 million units — a modest showing compared with the one launched in 2008, which saw an issue of 840 million units.

There are currently six ETFs on Bursa Malaysia. Another Islamic ETF will be listed on Bursa this year, i-VCAP announced recently.

In an interview with Personal Money, Bursa Malaysia Bhd director of Islamic and Alternative Markets Jamaluddin Nor Mohamad says trading volume is “still very low” for both conventional and Islamic ETFs.

“Despite the many benefits ETFs have to offer, such as instant diversification, cost-effectiveness and transparency, they have yet to gain popularity among Malaysian investors.

“An ETF is the best equivalent to a unit trust. One of the differences is that you go to an agent when you want to invest in unit trusts, but for ETFs, you go to your broker to buy them since they are listed on the stock exchange,” he adds.

According to Bursa’s website, ETFs are open-ended index-tracking funds or trusts. They track indices, commodities or baskets of assets, just like an open-ended investment fund, but are listed and traded in real time on a stock exchange.

Islamic ETFs, meanwhile, adhere to shariah principles and avoid investing in anything related to gambling, alcohol, entertainment, weapons and defence, non-halal food, tobacco and conventional financial services, with the exception of those by Islamic financial institutions.

“For an ETF to be shariah-compliant, it can only invest in financial instruments that are shariah-compliant, such as equities and fixed-income instruments, like sukuk or other Islamic financial instruments approved by the authorities,” says Jamaluddin.

Islamic ETFs have to be managed in accordance with shariah principles and Islamic investment guidelines. Their operations are overseen by a shariah committee or adviser who conducts audits and reviews from time to time.

Before it can qualify as an Islamic ETF, a fund undergoes comprehensive industry and financial ratio screenings. Jamaluddin says how a company invests and its business activities are the main factors when it comes to deciding whether it is shariah-compliant or not.

“The business activities have to be relevant to the real economy, therefore shariah-compliant companies are generally more stable than those that are exposed to a broader range of activities,” he adds.

Jamaluddin thinks the market is evolving towards a greater emphasis on sustainable activities and ethical investing. Islamic ETF investing is moving in the same direction.

“The search for sustainability and ethical investing are the added benefits of investing in Islamic ETFs,” he says.

Limitations

Unlike conventional ETFs, which can track any benchmark index, Islamic ETFs are only allowed to track indices whose constituents are shariah-compliant.

With their smaller investment universe and restrictions on portfolio exposure, there may be some who think Islamic ETFs do not perform as well as their conventional counterparts.

“Restrictions on stock selection do not affect their ability to perform,” says Jamaluddin, adding that there are have been times where shariah-compliant equities outperformed conventional ones.

He also thinks companies involved in activities that are widely considered to be unethical or immoral do not always perform well, depending on market conditions.

“From an index perspective, for the period between July 2013 and June 2014, the FTSE Bursa Malaysia EMAS Shariah Index and FTSE Bursa Malaysia Hijrah Shariah Index outperformed the FBM KLCI,” he notes.


The search for sustainability and ethical investing are the added benefits of investing in Islamic ETFs,” says Jamaluddin.

Less risky?

There are some who think Islamic ETFs are less risky than conventional ones. During the 2008 global financial crisis, Islamic ETFs exhibited lower volatility, owing to their lack of exposure to conventional financial services and highly leveraged companies.

Shahrul Amry Abdul Malek, Bursa Malaysia’s executive vice-president of market development and securities market, says risk depends on the type of ETF. “If we compare an Islamic ETF that tracks small caps with a conventional bond ETF, the latter is usually less volatile. It depends on the composition of the ETF,” he says.

According to a study by Dr Nafis Alam, associate professor of finance and director of the Centre for Islamic Business and Finance Research at Nottingham University Business School,a portfolio of Islamic ETFs shows less variability and, hence, is less risky than their conventional counterparts.

The study also shows that Islamic ETFs significantly outperform the market during a period of general economic downfall. The study covered the period from 2008 to 2011. The sample included 82 conventional ETFs and three Islamic ETFs listed on UK iShares.

Potential

Islamic ETFs offer benefits such as diversification, lower costs, transparency and trading flexibility. Investors can also gain immediate exposure to an asset class, sector or geographical region.

Jamaluddin says an ETF as a good alternative for investors who wish to effectively diversify their investment portfolio as the transaction costs of trading ETFs are lower than those of unit trusts.

“Sometimes, it is not easy for investors to buy 20 or 30 stocks to diversify their portfolio effectively. Through ETFs, they can have a wide exposure, and they need not manage and track these stocks on their own,” he points out.
“The greater transparency is another benefit we wish to highlight,” says Shahrul. “Investors can check Bursa’s website to know exactly what they are investing in. ETFs are required to report their holdings on a daily basis whereas mutual funds only report semi-annually.”

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