ISSN: 2224-5618
Volume 2, Issue 2 (Sep, 2012), Poster No. 08 , Pages No. 51-60
Analysis of KMI-30 Islamic Market Index of Pakistan: Enter or Exit Decisions of Shariah Advisory Board
a
Presented at: Venue: Date(s):
Haider S. A. Za, Ashraf R. Ua , Ramzan Mb COMSATS Institute of Information Technology Vehari, Pakistan b Lahore University of Management Sciences, Lahore, Pakistan.
1st National Conference on ASR 2012 COMSATS Vehari, Pakistan 27-02-2012
Abstract Rising demand of Islamic banking in Pakistan has insisted the main regulators of the market to develop market index where buying and selling of Islamic shares can be conducted. Although Pakistan is lacking such proper market yet however Karachi Stock Exchange and Al-Meezan Investment Bank [1] has taken initiative to introduce Islamic Market Index in the name of Karachi stock exchange Meezan Index (KMI-30). The main objective of this study is to evaluate the criteria used by KMI-30, for selecting a company to include in the KMI 30 index and to analyze that whether the selected companies fulfil the prescribed criteria or not. KMI-30 index criteria consist of six measures/tests during the screening process. While studying the perception of investors regarding Islamic Index, some of the investors found focusing on analysis of 30 companies which are listed in KMI-30, therefore, analysis have been made in order to point out that what investors can perceive if they themselves analyze the companies as the financial data is available easily and selection criteria as well. The technique of Ratio Analysis has been used as the criteria of KMI-30 consist of some ratios. The paper finds out that although some companies don’t fulfil the criteria even though they are included in KMI-30 index. This study conducted on November 2011 and the data of 30 companies derived from the annual reports of 2010.It is recommended to revise the Selection Criteria in line with other global Islamic Market Indices so that standardization of Islamic Indices may be ensured and management must be sticky in following the selection criteria. Keywords: Shariah; KMI; Pakistan.
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Introduction Returns from Conventional Indices, as measured by various researchers, have been slightly better than Islamic Market Indices due to Non-Hilal activities like Gambling, Gharar and Arbitrage opportunities which are not permitted in Islam. However, Islamic indices are moderately more unwavering as compare to conventional ones as they have a little lower instability and in a better position to adapt themselves with the market variations and changes [2]. Islamic Market Index is a dire need of Pakistani market where growth of Islamic Banking is obvious and investors are interested in earning Hilal. Such index would help local as well as foreign investors, who don’t want to earn interest, to invest in Shariah Compliant Stocks. The endeavours of KSE and Al-Meezan Investment are stupendous in developing an initial market index. This index, if wins the positive perception of investors, will have greater growth rate as compare to other stock exchanges and also positive impact on macro factors of the economy of Pakistan. The success of index depends upon the perception of investors. If the purpose of Islamic index is to induce the investors who are religiously rigid, this index must possess the characteristics which are Shariah compliant. Further the criteria set up for screening the companies to include in the index must be pure Islamic. This study will help out the management of the index to review the selection criteria and process in order to win the positive perception of investors. This study will help the academic researchers by showing them a different pose of index. KSE Meezan Index (KMI-30) [3] consists of 30 companies which meet the criteria of KMI Shariah. The index was launched on KSE in September 2008 with the base period June 30, 2008. KMI measures the performance of Shariah compliant equity investments. It may also help in the strategic asset allocation process. Its construction may increase investor confidence and augment their contribution. Currently, the three indices being maintained at the Karachi Stock Exchange are KSE-100 Index, KSE All-Share Index, and KSE-30 Index. First two Indices are based on market capitalization and KMI-30 is based on free-float capitalization. The level of index reveals the free float market value of selected Shariah complaint shares in contrast with the base period. Rebalancing of KMI-30 is conducted after six months. Shariah compliance of stocks is done with the help and guidance of well qualified and renowned Shariah scholars. (KMI Brochure 2010) [4]. Al Meezan Investment Management Limited (Al Meezan) being largest Shariah compliant asset management company in Pakistan initiated to provide its Shariah expertise, guidelines and expertise for launching and continuation process of the Index. Stock Screening is also done by Al-Meezan whereas KSE provides maintenance and dissemination support for the index [1].
Shariah Screening Criteria of KMI – 30 Screening criteria of KMI-30 consists of six key tests which are as under:[3] I.
Business of the Investee Company
First criterion states that the core business of the company must be Hilal and in accordance with doctrines of Shariah. Thus, investment in stocks of any company which deals in conventional banking, arms manufacturing, pornography, conventional insurance, alcoholic drinks, tobacco, pork production, or related activities is not allowed. II.
Debt to Total Assets
Second test states that Debt (interest bearing) to Asset ratio should be less than 40%. Zero coupon bonds and preference shares are also element of debt. III.
Non-compliant Investments to Total Assets
Third test states that the ratio of non compliant investments to total assets should be less than 33%. Investment in any non-compliant security is included for the calculation of this ratio. IV.
Non-complaint Income to Total revenue – Purification of Non-compliant income
Fourth test states that the ratio of non-compliant income to total revenue should be less than 5%. Total revenue includes Gross revenue plus any other income earned by the company. This amount is cleansed out as charity as a pro rata ratio of dividends issued by the company. V.
Illiquid Assets to Total Assets 52
Fifth test requires that the ratio of illiquid assets to total assets should be at least 20%. Illiquid asset, here, is defined as any asset that Shariah allows to be traded at value other than the par. Illiquid Assets are tangible assets that are not liquid. It focuses on that the company should invest in the tangible assets. VI.
Net Liquid Assets to Share Price
Sixth test states that the market price per share should be greater than the net liquid assets per share calculated as: (Total Assets – Illiquid Assets – Total Liabilities) divided by number of shares.
KMI – 30 Index Compositions KMI-30 comprises of 30 Shariah Compliant Companies. Shariah compliance of the stocks is ensured through Stock Screening process conducted by Al-Meezan Investment Management Limited and counter checked by Capital Advisory division of its PDSC Department [4]. Following are the list of companies that has been taken from KSE Meezan Index (KMI-30) as on 6th April 2012.
S-NO. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
NAME OF COMPANY Atlas Battery Ltd. Attock PetroleumXD Attock Refinery Ltd Clariant Pak XD D.G.K.Cement Fauji Fert Bin Fauji Fertilizer GlaxoSmithKlineXDXB Habib Sugar Hub Power Co.XD ICI Pakistan Indus Motor Company Lotte PakPTAXD Lucky Cement Mari Gas Company
S-NO. 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
NAME OF COMPANY Millat Tractors National Refinery Nishat Mills Limited Oil & Gas DeveSPOT P.S.O. P.T.C.L.A Packages Limited Pak OilfieldsXD Pak Petroleum Pak Refinery Sitara Peroxide Sui North Gas Thal Limited Tri-Pack Films XD UniLever Pak LtdXD
Literature Review As the KMI-30 is a new index, very little literature is available in Pakistan and abroad regarding its 53
performance and functionality. However, apt literature is available regarding other Islamic Market Indices such as Dow Jones, FTSE Global and Kuwait Islamic Index. Therefore the results of this paper can be an addition to literature. Hanif (2011) [5] documented the perception of investors about Shariah compliant equities, to draw attention to the market response about KSE-Meezan Index (KMI-30) where he collected the data from Finance professionals through survey in order to know their perception regarding index. He did not include small traders/investors in his sample. Through survey research he tried to know perception of large organizations which can invest in short as well as long term projects. Small traders must also be aware to act in accordance of Shariah, Quran and Sunnah of Hazrat Muhammad (PBUH). Ahmed and Haron (2002) [6] accepted that though the Islamic financial system was introduced in Malaysia in Eighties but companies are still less familiar to it. They argued that if IFIs offered low costs of products, there would be better chance of Islamic financial system. Abdullah and Dusuki (2006) [7] acknowledged after taking customer survey that there is a need to educate about Islamic financing. So this is fact in case of Pakistan as well where most of the investors don’t have knowledge of Islamic Index in Pakistan. Investment in equity is a modern economic activity which did not exist during the Prophet Muhammad’s (peace be upon him) period. Moreover, it is not stated specifically in Al-Quran or the Sunnah. The guidelines used by Islamic Indices at present are based on consensus (ijtihad ) of Islamic scholars from various disciplines (such as Islamic finance, law, and economy) who are members of the Shari’ah Supervisory Board for each respective index. In such cases, the differences between indices on the rules used are termed as differences in views, which is permitted in Islam. (Rahman & Yahya, 2010) [8]. Different Islamic Market Indices use different criteria for screening the stocks; majorly two or three unanimous principles. The difference may be due to economic conditions of that country that how companies are financed in that particular company. But the rising trend of Islamic products has insisted the countries to establish Islamic Market Indices. Salman A. Shaikh (2010) [9] in his paper “Analysis of Stock Screening Principles in Islamic Mutual Funds Industry” argued that the sixth principle of KMI that the market price per share should be greater than net liquid assets per share restricts investments in the stock of liquid companies. Excess liquidity may be favourable from creditors’ view point but shareholders don’t feel happy. Shareholders focus on less liquidity and investment of funds in operations fully. There should be a trade-off between profitability and liquidity. He concluded that cash equivalents and marketable securities usually yield a return that is negative in reality in most developing countries. Sadeghi .M (2008) [10] in his research paper titled “Financial Performance of Shariah-Compliant Investment: Evidence from Malaysian Stock Market” In April 17, 1999, argued that the Investors Set the Shariah Compliance Index (SI) as a benchmark when they want Shariah Compliant Investment. SI is helpful for them towards making better informed decisions. He checked the effect of the Shariah-compliant Index (SI) by Bursa Malaysia on the performance and liquidity of included stocks. His findings showed that there was positive impact of SI on financial performance of those included stocks.
Material & Methods We analyzed 30 companies of KMI 30 index and according to the data [11] that was taken from the Annual Reports of 2010-11 [12-41] of these companies; we presented the different ratios of these companies and matched the ratios with Shariah compliance. While studying the perception of investors regarding Islamic Index, some of the investors found focusing on analysis of 30 companies which are listed in KMI-30, therefore, analysis have been made in order to point out that what investors can perceive if they themselves analyze the companies as the financial data is available easily and selection criteria as well. Point wise analysis is as under:
Results & Discussion 54
I.
Business of the Investee Company
KMI 30 index consists of 30 companies from 12 industries in Pakistan. 1st criterion was checked by visiting the business of selected companies and it was found that all the 30 companies fulfil the 1st criteria of Hilal business (Business according to the Islamic rules). Not a single company involved in prohibited business. II.
Interest Bearing Debt Ratio
According to our analysis 10 companies have zero percent debt which shows that most of the companies do not have behaviour of using debt for their business operations but on the other hand three companies have more than 40% (prescribed) debt ratio.
Ratios
Interest Bearing Debt Ratio 49.00% 48.00% 47.00% 46.00% 45.00% 44.00% 43.00% 42.00%
47.76%
47.41%
44.47% Interest Bearing Debt Ratio
FCCL
Lucky Cement Sitara Peroxide
Non-Shariah CompliantLimited Investments
50.00% Figure 1.1 45.00%
47.53%
Companies
40.00%
Ratios
35.00% 30.00%
24.81%
25.00%
18.28%
20.00%
Non-Shariah Compliant Investments
15.00% 10.00% 5.00% 0.00% Nishat Mills Limited
Pakistan Oilfields Limited
Fauji Fertilizer Co
Companies
III.
Non-Shariah Compliant Investments
According to the Shariah compliance only 33% non-Shariah compliant investment is allowed and one company (Nishat Mills Ltd) in KMI 30 index has more than 33 % non-Shariah compliant investment.
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IV.
Non-Compliant Income
Figure 1.3 shows the non-compliant income that has been earned through conventional banking or other sources. PTCL has largest percentage in earning non-compliant income.
Ratios
Non-Compliant Income 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00%
14.19%
7.13%
6.96%
Pakistan Oilfields Limited Figure 1.3
V.
PTCL
Non-Compliant Income
Fauji Fertilizer Co
Companies
Illiquid Assets to Total Assets Ratios
Figure 1.4 shows the seven companies which have less than 20% illiquid assets of the total assets. Pakistan State Oil (PSO) has lowest 3.16% from all these 30 companies.
Illiquid Assets/Total Assets Ratio
Companies
Toyota Indus Motor Co PSO
12.33% 3.16%
Pakistan Refinery Limited National Refinery Limited Millat Tractors Limited
17.45% 5.71% 6.88%
BankIslami Attock Petroleum Limited 0.00%
14.47%
Illiquid Assets/Total Assets Ratio
5.66% 10.00%
20.00%
Ratios
VI.
Net Liquid Assets to Share Price
The market price per share should be greater than the net liquid assets per share calculated as: (Total Assets – Illiquid Assets – Total Liabilities) divided by number of shares. There are four following companies which have greater net liquid assets per share than their market price. Figure 1.5 shows the companies which have greater net liquid assets per share. 56
Figure 1.4
Rupees
Net Liquid Assets to Share Price 1600 1400 1200 1000 800 600 400 200 0
1460.87
Net Liquid Assets/Share
379.94 67.64 Ghani Glass Mills Limited
Figure 1.5
194.96
173.83
82.02
Lucky Cement
Pakistan Petroleum Limited
56.45 10.75
Share Price
PTCL
Companies
KMI-30 index criteria use six measures during the screening process. As for the level of debt standard, the results show that three companies listed under the KMI 30 index are highly geared (Debt ratio is greater than standard limit which is 40%). These companies depend heavily on debt to finance their capital. Only one company posses Non-compliant Investments to Total Assets which is over the limit (33%). Seven companies have less than 20% illiquid assets to their total assets which is also lower than the standard criteria of KMI 30. Three companies posses more than 5% of their income from Non-Compliant Income (Bank Interest, Income from gambling, nightclubs, prostitution, casino, tobacco, alcohol, dividend income from above mentioned businesses). Four companies have more Net Liquid Assets Price than its market price that is also against the Shariah rules of KMI 30 index. The final results indicate that if we match these companies with the Shariah Screening Criteria only 14 companies out of 30 listed under the KMI-30 index meet the Shariah Screening Criteria.
Conclusions First the Hilal business criteria states that every company should be in that business which is valid according to the Islamic parameters, but on the other hand in criteria No.3 non-complaint investment ratio allows every company to have less than 33% non-complaint investment. These both points are contradictory because if a company has up to 32% non-complaint investment of total assets than how can we say that particular company is doing Hilal business. Therefore there must be harmony among the criteria. The Second stock screening criteria is Interest Bearing Debt to Asset ratio that should be less than 40%. If we talk about Islamic point of view about Interest (Riba) we can’t use even a one percent interest in our business. If a country faces lack of capital problems that doesn’t mean Islam has allowed Interest (Riba) to that country. We cannot relax the rules and orders of Islam keeping in view particular economic conditions. Non-Compliant Investment is allowed up to 33% and non-complaint investment include investments in conventional mutual funds, conventional money market instruments, Bonds, PIBs, Term Finance Certificate, Defence Saving Certificate, Treasury Bills (T-Bills), all Interest based placements and interest based loans and advances etc. This test must be modified so that Islamization of investments can be ensured. The forth criterion of stock screening is non-complaint income which is allowed 5%. According to Shariah rules of KMI-30 the non-compliant income includes Bank Interest, Income from gambling, nightclubs, prostitution, casino, tobacco, alcohol, dividend income from above mentioned businesses, and dividend income from Shariah non-Compliant Companies etc. If we allow the companies to generate their income through above mentioned businesses then can we say that income from such businesses is Hilal and according to the Islamic rules? Different Islamic Indices use different types of Shariah compliance and different types of stock screening criteria [42-46]. The customers have less confidence if these Shariah rules are contradictory from each other. We recommend that all Islamic Indices in the world should make a generic Shariah Stock Screening Standards just like in all over the world the International Financial Reporting Standards (IFRSs) are the same. If we make generic Islamic Shariah Stock Screening Standards that would increase the popularity of Islamic Indices in the 57
world and customer will have full confidence in Islamic indices.
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Abbreviations PIBs: Pakistan Investment Bonds KMI: Karachi Meezan Index Correspondence Contact Details Email address of corresponding author:
[email protected]
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