The first Islamic indexes were developed and launched by Dow Jones in 1999 to measure the performance of a global universe of investable equities; undergoing two levels of screening consistent with Dow Jones Indexes’ methodology.
Soon after, other index providers including Standard & Poor’s, FTSE and MSCI began offering Islamic indexes alongside their conventional offerings. Indexes in the Islamic or conventional space generally tend to focus on equities and bonds.
Islamic indexes tracking physical commodities were non-existent however, until the FTSE Physical Industrial Metals Index Series launched this May with the collaboration of FTSE Group and Dubai International Financial Center Investments (DIFCI), through its wholly owned subsidiary Global Commodity Finance, and Merit Commodity Partners. It is touted as the world’s first investible Shariah compliant physical industrial metals index series.
Simon Glower, an executive director of Merit Commodity Partners, believes a physical commodities index will allow investors – retail or institutional – to hedge their risk by diversifying their portfolio investments. “In addition to exposure and hedging, [the index] provides a straightforward opportunity for traditional portfolio management to add investments in these indexes into a conservative portfolio which normally consists of equities and bonds, allowing [the completion of] the asset allocation portfolio,” he says.
He feels that in the last two years, the metal markets have exhibited a high correlation with regards to other financial markets. Nonetheless, as the world is so focused on demand and economic growth, commodity markets have not escaped the same pullback. “Depending on one’s view, the metal markets in the short term can be characterized by quite a massive reduction in speculative long positions and stock drawdowns, so they probably represent today a very good value proposition. However if they continue to decline, they could become a more interesting asset class to look at from an investment perspective because their long-term fundamentals remain so favorable: on the assumption that economic growth will recover in a year to three years,” he explains.
Following reports of a slowdown in its demand for commodities, China – as one of the biggest global commodity purchasers – saw its official Purchasing and Manufacturing Index (PMI), which gathers information from the country’s biggest manufacturers, register at 50.4 for October: below the market forecast of 51.6 and even lower than September`s reading of 51.2. This has triggered alarm bells among analysts, many of whom are of the view that China is heading for a downturn.
However, Glower remains unperturbed. Despite the perceived slowdown, he points out that the Chinese economy is still growing at about 9% and is still highly resource-dependent due to its population growth, urbanization and high standards of living. Demand for commodities, he continues, will remain and can be identified for at least the next 20 years.
Glower is of the view that the physical metals indexes series will appeal to all sectors of the Islamic finance industry, by providing a low-cost and simplified method of managing one’s exposure. It will also allow smaller-scale investors access to what was previously a difficult market to enter, he explains, because it has up till now primarily involved “trading futures accounts… which may or may not be suitable to hedge the risk one has identified, which then requires constantly active management that can be costly, with margin calls and other issues”.
He identifies Shariah compliant exchange traded funds (ETFs) as one of the asset classes that has the most growth potential as a result of the launch of these physical commodity indexes. This has already been witnessed in the conventional space, where retail investors can now easily add ETF positions to their investment portfolios: which have typically been focused around precious metals such as gold and silver.
In spite of the prolonged economic uncertainty stemming from the embattled Eurozone and a bruised US economy, Glower is optimistic that commodities will not suffer any further downside following the recent corrections over the past six months. “There is much greater risk for an upside appreciation now than there would be for any further significant downside corrections, which are largely behind us,” he concludes. — RW