Islamic Financial Intermediation Beyond Banking – Can a Close Ended Mutual Fund Model Fill the Shoes?
11 Pages Posted: 24 Oct 2015
Date Written: October 22, 2015
This paper attempts to present a comprehensive framework to employ Close Ended Mutual Fund/Investment Company Model for shariah compliant financial Intermediation. Mutual Funds (MF) are an institutionalization of collective investments initiated in the U.S more than century ago. It was in the 1990’s that harbingered an explosive demand of the mutual funds, which witnessed around 16 countries (mostly European) having MF Assets in excess of 20% of their GDP. In the present day world the MF asset penetration highly resonates with the country’s development. Mutual funds can be classified across various dimensions, in terms of their objectives, risk profile, asset classification and their respective formats i.e. close-ended (CEF) and open ended funds (OEF). The major distinction lies in the fact that the CEF is limited by the size and its tradability in the secondary markets. This virtually isolates the investors from the underlying assets, as they are able to buy or sell their investments in the stock exchange, which further implies that pricing of CEF’s is determined by the bull or the bears at the bourses, rather the Nest Asset Value(NAV) (Lee et. all, 1991). This also relieves the fund manager from uncertain outflows owing to redemptions at an unfavourable timing – given the enigmatic propensity of the investors to buy-high and sell-low. This brings in the luxury of parking funds to the long term, growth oriented and less-liquid-yet-rewarding asset classes such as Venture Capitals, REITS, Small Cap stocks etc. (Elton, E., el at, 2013)
The CEFs gets further dose of sophistication on their ability to leverage bank debts, debt instruments issued and zero dividend preferred stocks. On the contrary, the OEFs are relatively unpretentious in their working, with an uncapped size of the issue, redeemable from the issuer at their NAVs, are usually passively managed and mostly invested in liquid assets - thus turning it in to a stable and liquid instrument. The mutuality and profit sharing contours of Mutual Fund model, offers an inherent compatibility, making it suitable as an alternative mode of shariah compliant financial intermediation. In addition to a discussion of market dynamics, and shariah issues (such discount on the NAV), a mathematical model is also framed for an apt articulation and operationalization.
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