Equity Investment Risk
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This document discusses risk management in Islamic finance, specifically equity investment risk. It defines equity investment risk according to the Islamic Financial Service Board as the risk of participating in a business partnership where the provider of finance shares in business risks. Equity investments in Islamic finance are typically done through mudarabah and musharakah contracts which are profit/loss sharing in nature and can result in total loss of capital. The document outlines some of the key risks of equity investment including partner risk, lack of reliable partner information, credit risk, industry risk, and risks specific to mudarabah and musharakah contracts. It concludes by suggesting some ways to mitigate equity investment risk such as diversification, long-term investing, expert advice,
Equity Investment Risk
- 2. Equity Investment Risk Content Features of Equity Investments Equity Type of Shariah Contract Ways To Mitigate Equity Risk Learning Outcome • To explain definition and feature of Islamic Equity Investment • To state risk in Islamic Equity Investment Risk and their contract. • To explain ways to reduce Islamic Equity Risk in contract 2
- 3. Definition Islamic Financial Service Board (IFSB) identifies Equity Investment Risk as: the risk arising from entering into a partnership of undertaking or participating in general business activity as described, in the contract and in which the provider of finance shares the business risk E.g. Partnership-based investment are mudarabah and musharakah contract. 3
- 4. Features of Equity Investments The nature of equity investments requires enhanced monitoring measures to reduce informational asymmetric. Both mudarabah and musharakah are profit/loss sharing contract and are subject to loss of capital despite proper monitoring Equity investment may not generate a steady income 4
- 5. Quality of Partner Considerations as to the quality of the partner, underlying business activities and ongoing operational matters. By nature, this type of equity investment is exposed to a confluence of risks associated with Mudharib or Mushārakah partner, business activity and operations. Factor of Environment Factors relating to the legal and regulatory environment affect equity investment performance, and need to be considered in the risk evaluation. These factors include policies pertaining to tariffs, quotas, taxation or subsidies and any sudden policy changes affecting the quality and viability of an investment. 5
- 6. BNM classifies the following as equity positions: Ordinary shares; voting or nonvoting (common or preferred) Convertible Securities Commitments to buy or sell equity securities Equity Derivatives Off-balance sheet items i.e. swaps and options Underwriting of equities Lack of Reliable Information Equity Market are exposed to the risks attaching to a lack of truthful information on which to base their investment evaluation, such as an inadequate financial control system. These risk can do by Mudharib and Musyarakah Partners. 6
- 7. Credit Risk One example of credit risk exposure arises from the Mudhārib’s obligation to pay the agreed share of profit to the IIFS as Rabb al- māl when such payment falls due. Failure to meet this obligation constitutes a case of misconduct and negligence in the part of the Mudhārib. Industry Risk All industries have some kind of cyclical growth. Shareholders get rewarded most during the expansion stage. However, once the industry reaches maturity stage, the rewards of investment are limited and can go decline. 7
- 8. Equity Type of Shariah Contract Mudharabah Mudharib Performance of Sales Misreporting of profit Rabul Mal Financial problem to continue investing Responsibilities to destruct of the company property 8
- 9. Musyarakah Musyarakah Performance of partners in Sales Credit Risk Financial problem in Musyarakah partner Musyarakah Partners misreporting of profits 9
- 10. Ways To Mitigate Equity Risk Diversification Invest over a long time Take advice from an expert Choosing a right company 10
- 11. Mahyuddin Khalid End of Chapter 11