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In Islamic financial hubs, such as Malaysia, ETFs have been a crucial presence in boost-
ing the country’s capital market.
An Introduction to Islamic Exchange Trad- ed Funds (ETF) As an investor, business professional or en- trepreneur it is a necessity to become well- acquainted with the relevant Islamic instru- ments that are being made available for use within the Islamic financial sector. Islamic exchange traded funds are open-ended funds which consist of index tracking and is a trust fund that consists of a collection of stocks that can be listed and traded on a stock exchange platform like a single stock. The main objectives of an Islamic ETF are outlined in Figure 1.
One of the key differences between a con- ventional ETF and Islamic ETF is the bench- mark index that the Islamic ETF tracks, as this is unique and complies to the principles of Shariah-financing.
In an Islamic ETF it works by tracking a benchmark index which is comprised wholly of constituent securities all of which are made to be Shariah-compliant whereas a conventional ETF may track any benchmark index regardless of the Shariah status of its constituents.
In addition, an Islamic ETF is directly man- aged under the Shariah principles and guidelines of Islamic finance and follows the principles of the Shariah wholly. Islamic ETF is then regulated and overseen by an ap- pointed Shariah committee or group of Sha- riah regulatory scholars. The Shariah com- mittee or regulatory Islamic financial body then conducts regular reviews and audits on the Islamic ETF to ensure strict compliance
with the Shariah principles and practices at all times. Figure 2 outlines the structure of an Islamic ETF and goes through the proc- esses so you can get a better understand- ing of the structure and dynamics of the concept of Islamic ETFs in comparison to conventional ones which you may be more familiar with.
Who Participates in the Islamic ETF Struc- ture? It may be beneficial to know who can par- ticipate in Islamic ETF structures as some investors are not aware that there are many groups of people who can successfully work together to participate in Islamic exchange traded funds. These participants are out- lined in Figure 3. Exploring the Opportunities for ETFs in 2011 Islamic ETFs are growing in popularity and in 2011 there is growing potential for the sector to receive further investments from investors around the world. This realisation is becoming increasingly widespread as the Islamic finance industry continues to receive unprecedented attention from the global fi- nancial world.
Many investors, both Muslim and non-Mus- lim, have recognised and acknowledged the scope for Islamic financial investments, and in particular they have seen a rise in Islamic ETFs as the perfect alternative to conven- tional ETFs. Islamic ETFs have to adhere to the principles of Shariah law, otherwise they would not be ‘Islamic’, and they would be no difference to their counterpart of a conven- tional ETF.
Figure 1: Main objectives of an Islamic Exchange Traded fund (ETF) To track or replicate the performance of a benchmark index.
Provide investors, in a single transaction, a cost-efficient and convenient way to gain exposure to the basket of securities represented in the index.
Create a unique creation and redemption mechanism supported by a system of participating dealers and liquidity providers.
ETFs are listed and therefore their units can be bought and sold anytime during stock exchange trad- ing hours. Investors buy and sell ETF units through their stockbroker rather than through unit trust agents.
Source: Financial Islam 2012 April Global Islamic Finance 67
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