Islamic exchange-traded funds (ETFs) continue to make slow but steady market penetration with the recent launch of a gold-based ETF, GoldPlus, launched in Istanbul by Kuveyt Turk Participation Bank, in which Kuwait Finance House has a controlling 62 percent equity state, and the imminent launch by BNP Paribas Investment Partners of its second Islamic ETF, part of its Easy ETF range, which will be listed on Bursa Malaysia.
"We see higher growth prospects in Turkey compared with other countries. According to our estimations, our Turkish operation will take the top position among our global subsidiaries in the long term. This new ETF product will be a model for our other subsidiaries such as KFH Malaysia, Bahrain and Saudi Arabia," explained Mohammed Al-Omar, Chairman of Kuveyt Turk at the Bell Ceremony to launch the trading of the GoldPlus ETF on the Istanbul Stock Exchange (ISE) in the presence of ISE President, Huseyin Erkan, and Kuveyt Turk General Manager, Ufuk Uyan.
At the same time, according to Angelia Chin-Sharpe, executive director, Regional & Islamic Business Development, BNP Paribas Investment Partners in Malaysia, the latest Shariah-compliant ETF fund has been registered in France and the prospectus has been approved by the French securities regulator, the Autorité des Marchés Financiers (AMF). The US dollar denominated Islamic ETF, which is also UCITS III compliant, is targeted at investors globally, although Chin-Sharpe is excited by the interest from institutional investors from the Middle East and Asia. The target fund size is between $50 million and $100 million.
ETFs are open-ended UCITS III funds that track the underlying equity index. According to Dow Jones, an ETF is a special variation of an investment fund in which the fund portfolio is formed of stocks in an index by their proportions in the index and fund shares are traded in the stock exchange. Thus it provides the investors the opportunity to buy and sell the index that the fund represents.
ETFs are well established in the US market, but they are now steadily gaining popularity in Europe and in Asia as well. About 2 percent of all assets under management in Europe are now in ETFs, and 10 percent of the new money in 2009 that have gone into the fund industry has gone into ETFs. That would indicate that ETFs are growing five times faster than other market segments. ETFs have been around much longer than people realize. The first one was listed in the US in 1993 on the S&P 500. These products are responsible for 27 percent of the total turnover in North American markets.
Although Kuveyt Turk stresses that GoldPlus ETF is the first ETF to be launched by a Turkish participation bank in Turkey, Bizim Menkul Degerler A.S. (BMD) Securities in fact issued and managed the Dow Jones Islamic Market (DJIM) Turkiye Exchange-traded Fund way back in 2006 on behalf of the then Family Finans, which subsequently merged with Anadolu Finans to form the Turkiye Finans, in which Saudi Arabia's National Commercial Bank (NCB) has a controlling stake. BMD Securities was also the index maker to the ETF, which tracked the stocks on the DJIM Turkey Index.
DJIM Turkey ETF is the first Islamic ETF to be launched anywhere. Since then i-Value Cap, an investment vehicle of the Malaysian Finance Ministry, launched an Islamic ETF two years ago tracking the DJIM Malaysia Index, followed by one by Daiwa Securities of Japan, which is tracking the FTSE Japan Shariah Index. Indeed, BMD Securities is also managing Kuveyt Turk's GoldPlus ETF. "With GoldPlus Gold Exchange Traded Fund," explained Kuveyt Turk's Ufuk Uyan, "we are targeting to offer both our existing customers and the whole market the opportunity to invest in gold via an exchange. We have opted to issue a gold-based fund in our ETF product by taking advantage of our longstanding experience in the gold market. We seek to further pioneer in the market by offering new and different interest-free investment and treasury instruments and to fill the void currently existing in the market."
These other products include a gold fund directed at institutional investors who want to invest in gold on an interest-free basis; and a pioneering "first-of-its-kind" gold-based participation account which was launched earlier this year and which allows a client to open a gold participation account with a term from one to 12 months and at maturity receive the profit in gold terms.
GoldPlus ETF is an ultra retail product. Each share of the ETF represents 1 gram of gold. The book-building of Kuveyt Türk's offering for its GoldPlus ETF started at the end of July 2010.
Precious metals have historically provided a safe haven, a hedge against inflation and a hedge against currency risk. They have often acted as an event hedge, outperforming during period of financial or geopolitical instability. As precious metals have tended to have a low correlation with most major asset classes they have provided unique diversification benefits that have often improved a portfolio's risk-reward profile.
The global financial crisis boosted gold investments worldwide. Gold has been appreciating significantly in the past year, according to Ufuk Uyan, mainly because the US dollar has been so weak. There are also countries that are shifting to gold, including Russia. As interest rates have gone down significantly due to the crisis, people are seeking new avenues of investment and gold is one of those alternatives.
At the same time, the proposed BNP Paribas Islamic ETF will be the first instant stream listed fund outside Europe and the first to be listed in Asia. The ETF will track greater China shares listed in China and Hong Kong, and will be based on the Dow Jones Islamic Market (DJIM) China/Hong Kong Titans Index, which has 30 constituent components.
Over the last few years, BNP Paribas Investment Partners has built up an expertise in ETFs and combined with its growing experience in Islamic finance, advised i-VCAP, a subsidiary of Valuecap Sdn Bhd, a joint venture between Khazanah Nasional Berhad, the investment vehicle of the Malaysian Finance Ministry, Permodalan Nasional Berhad and Kumpulan Wang Persaran, in the launch of MyETF-DJIM 25, the first Shariah-compliant ETF to be launched in Asia in 2007 and which started trading on Bursa Malaysia in January 2008. The total net asset value of MYETF-DJIM 25 at close on Aug. 17, 2010, was RM670,176,600.
The rationale for choosing a Greater China ETF is that the Chinese economic fundamentals remain string despite the fallout of the global financial crisis. There is little investor concern about the China bubble, although China has its limitations.
In any case, the proposed Islamic ETF will exclude stocks of companies in the financial sector because of the proscription on riba (interest-based) investments, and additionally by choice companies in the real estate sector, which remains a concern to investors.
"There is good exposure to China and Asia without any risk exposure to the financial and real estate sectors. Asia, especially China, has come very strong in this crisis. China has a good story to sell and investors will grow very bullish by having exposure to this market. The stock universe is also weighted toward established large cap companies," explains Chin-Sharpe.
The advantages of ETFs, she maintains, are that they are easy to use and access, which pre-empts the payment of costly management fees, say as in mutual funds or unit trusts. "You can just go to an exchange and buy an ETF. They give you easy access to a particular market or region and are very cheap, about 80 top 100 bps (basis points)," she adds.
However, to boost the uptake and profile of ETFs in the Islamic finance space as in the Asian region per se, would require market and investor education about the product and its characteristics, and how to use it.
The proposed Islamic ETF, for instance, maintains Chin-Sharpe, could be best used by say hedge funds, private banks and other such investors for tactical and technical asset allocation purposes. "If you want exposure to a market where you don't have the resources to research, then this one instrument could be ideal. Other than that you can use it as a technical allocation by weighting other sectors which you are more bullish about without having to buy a whole list of stocks," she explains.
The challenge for the Islamic ETF market going forward, apart of market education and investor awareness, is to overcome the poor reputation these products have in the Islamic finance space. However, the overriding challenge is to find enough market makers for the products. The problem is that especially if one goes for replication some markets may not have the requisite volumes, which in turn makes it less attractive for market makers to get involved.
The benefits ETFs over mutual or unit trusts are implicit. Mutual funds are actively managed, whereas most ETFs are passive which means the tracking error is not wide. In contrast in an active fund, tracking error can be very wide and can affect the net asset value (NAV) of the fund. In an ETF as well, when an investor gets access, and he senses after a short time that something is going to happen, he can exit very quickly, thus limiting exposure to a particular fund or market.