Jan 5, 2011|
Shariah 50 index: The whys and the hows.
BSE launched its Shariah Index this week. But what is the Shariah index? The Shariah index is an index made up of 50 of the Shariah compliant companies out of the BSE 500. But what does Shariah mean? Shariah is Islamic law that governs the day-to-day life in Islam. This holds relevance for investing in companies as well. As per criteria set by BSE and TASIS (Taqwaa Advisory and Shariah Investment Solutions (P) Ltd.), a company can be considered Shariah compliant only if it meets the following conditions:
- Companies which are engaged (to any extent) in business which is prohibited in Shariah i.e. relating to liquor, pork, tobacco, hotel, casino, gambling, vulgar entertainment, interest based financial institutions (banks, insurance companies, stock broking etc), are not considered as Shariah compliant.
Companies found eligible after business screening are further screened on financial ratios to ensure that (on financial matters too) they remain within the tolerance limit fixed by shariah scholars. It is to be noted here that BSE-TASIS Shariah screening norms are much more stringent than those found elsewhere. The following financial screening criteria are used to screen the companies which qualify on the business screening parameters:
- The total interest bearing debt of the company at any point in time should remain below 25% of the company's assets.
- Earning of the company from interest income and interest bearing assets should not exceed 3% of the company's total revenue.
Companies which meet all the above conditions are considered Shariah compliant and be eligible for inclusion on the BSE-TASIS Shariah 50 Index.
The index will utilise stock capping with stock weights capped at 8%. In case a script exceeds the maximum stock weight, its weight will be rebalanced. This is so that diversification for the index is maintained. Furthermore, investors will be informed using relevant channels the total interest income earned by a company on the index for a particular period. This would be relevant for those who want to purge their income. Moreover, companies are reviewed monthly to see if they continue to be Shariah compliant. In case they are not then they are removed from the index. However, new companies to replace the excluded companies are added only once a quarter.
The BSE TASIS Shariah 50 index has been set up jointly by BSE and TASIS. TASIS is a finance and investment organisation which provides guidance and support to individuals and corporate on the Islamic finance industry in India.
The need for a Shariah index
Muslims constitute 13.4% of India's total population. In absolute terms the Muslim population in India is second largest in the world. Many studies and reports have shown that Muslim participation in the financial system of the country in minimal. Sanchar Committee Report in 2006 has reported that almost 50% of the community's population is excluded from the organised financial sector. Another study has shown that remittances coming from the Middle East to the Indian state of Kerala amounts to approximately Rs 120 bn (USD 2.4 billion) annually. A majority of this money is either lying idle in bank accounts (more popularly known as 786 accounts) or is invested in real estate and jewellery. These findings indicate the community's indifference towards the financial system for religious reasons. The creation of this index will help financial inclusion of the Muslim population in India and also attract investment flows from international funds that must adhere to Shariah norms.
BSE and TASIS have conducted a back-test of the index from 1/1/2008. The relative performance of the BSE TASIS Shariah 50 index relative to the BSE-Sensex AND BSE 500 is shown in the table below.
||BSE TASIS Shariah 50
|YTD(Jan-Dec 22, 2010)
|1 year (23-Dec-09 to 22-Dec-10)
|2 years (23-Dec-08 to 22-Dec-10)
|Since start date (Since 01-Jan-08)
As per this table, the BSE TASIS Shariah index has outperformed both the SENSEX and the BSE 500 over all time periods. This demonstrates that the stocks which have been selected using the Shariah conditions are fundamentally sound.
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