180 AN INTRODUCTION TO ISLAMIC FINANCE
the availability of new fi nancial information, changes in capital struc-
ture, and the daily change in market capitalization — the major decision -
maker for Shari’ah fi nancial ratios. This means that the compliance sta-
tus needs to be monitored on a frequent basis so that:
i) fund managers respond quickly to compliance changes
ii) Shari’ah boards are notifi ed and consulted regarding status changes
iii) the necessary purifi cation exercise is carried out with respect to
status changes.^3
■ (^) This means that Islamic funds require a higher degree of compliance
and monitoring and support from good information and technology
systems to ensure compliance.
■ (^) The shallow stock markets in many OIC countries do not offer oppor-
tunities for meaningful portfolio construction after applying the screen-
ing criteria. Several of the listed stocks have weak fi nancials and do
not have depth in the market. In market capitalization terms, Malaysia
has the largest segment of Shari’ah - compliant stocks, followed by the
Karachi Stock Exchange (KSE), Turkey and Bahrain. The low propor-
tion of Shari’ah - compatible markets is due to the high debt - to - equity
ratio of a majority of the listed companies, which disqualifi es them for
inclusion in the equity funds.
■ (^) The screening criteria are not very stable, as changing market condi-
tions can change a company’s fi nancial ratios in such a way that it may
or may not pass the fi lter set by the fund manager from one period to
another. For example, depending upon the market price, a stock can be
in and out of the fund during a relatively short period of time as a result
of fl uctuating debt - to-equity ratios. This can have an adverse effect on
the diversifi cation of the portfolio and may lead to additional transac-
tion costs each time a portfolio is re - balanced.
■ (^) As a result of the screening and fi ltering process, the resultant universe
of stock may not be large enough to offer good opportunities for port-
folio diversifi cation. Efforts should be made to expand the universe of
Shari’ah - compliant stocks.
■ (^) On a more serious note, the main emphasis of fund managers has been
on the screening mechanism, but little attention has been paid to certain
market practices such as short - selling and margin account maintenance,
which are not compatible with the Shari’ah. Practices followed by each
fund manager should be clearly spelled out and should be cleared by
Shari’ah scholars.
Commodity Funds
Commodity funds are also popular among Islamic investors, whose contri-
butions are used in purchasing commodities for resale. The profi ts generated
by the sales represent the fund’s income of the fund, which is distributed
pro rata among the subscribers. Commodity funds are subject to certain
conditions such as (i) short sales are not allowed; (ii) forward sales are
allowed only in the case of salam and istisna’; and (iii) dealing in certain