AL MEEZAN INVESTMENT MANAGEMENT LIMITED : EVOLUTION OF SHARIAH COMPLAINT MUTUAL FUNDS PDF

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It was a busy Wednesday morning of March 25, 2020. Mohammad Shoaib, CEO of Al Meezan
Investment Management Ltd., was sitting in his office deliberating on the current market
situation. The Pakistan Stock Exchange (KSE-100 Index) had crashed 24,000 points, from a
peak of 53,000 to 2...

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Al Meezan Investment Management Limited: evolution of Sharīʿah-compliant mutual funds Saqib Sharif, Sarwat Ahson and Hina Noor

Introduction It was a busy Wednesday morning of March 25, 2020. Mohammad Shoaib, CEO of Al Meezan Investment Management Ltd., was sitting in his office deliberating on the current market situation. The Pakistan Stock Exchange (KSE-100 Index) had crashed 24,000 points, from a peak of 53,000 to 27,000 index points since the political turmoil of Panama Leaks led to the ouster/disqualification of then Prime Minister, Mian Muhammad Nawaz Sharif, in June 2017 and the seething macroeconomic instability. The general performance of the capital market and simultaneously, Al Meezan Investment Management Ltd.’s funds had plunged in the past three years. The continued political uncertainty, dismal economic indicators, and the impending decision of Financial Action Task Force (FATF) to either hold Pakistan in the grey list or demote it

Saqib Sharif based at the Department of Finance, Institute of Business Administration Karachi, Karachi, Pakistan. Sarwat Ahson is based at CFA Society Pakistan, Karachi, Pakistan. Hina Noor is based at INCEIF, Kuala Lumpur, Malaysia.

to the black list meant more uncertainty in the coming months. On top of it, the emergence of COVID-19 pandemic created further challenges for Pakistan. Shoaib hurriedly called an Investment Committee meeting to discuss alternatives for retention of existing clients and attracting potential investors to maintain number one position. Besides poor stock market performance, Al Meezan, being an Islamic asset management company, had limited investment avenues available compared to its conventional counterparts to enact a contingency plan.

Mohammad Shoaib, while brainstorming product ideas to be discussed in the meeting, had a flashback of the time when Al Meezan Investment Management Limited (Al Meezan) was declared the largest private sector Asset Management and Investment Advisory firm in Pakistan [1], reminiscing the journey of Al Meezan until now [2]. Looking back, the journey was not an easy one. However, in hindsight, Shoaib knew it was worth it. Al Meezan’s position as market leader was not achieved easily. The senior management team of Al Meezan encountered a number of hurdles early on, especially with regard to launch of open-end funds and entering into Sharīʿah-compliant investments [3]. The hurdles, however, led to Al Meezan establishing its reputation as the pioneer of Sharīʿah-compliant investments in Pakistan. As of December 2019, Al Meezan had to its credit five golden milestones: First, it became the largest private sector Asset Management and Investment Advisory firm in Pakistan in April 2017. Later that year, Al Meezan achieved the highest management quality rating i.e. AM1 [4] by JCR-VIS Credit Rating Co. Ltd. (JCR-VIS) [5] in December 2017 (Exhibit 1). Likewise, Al Meezan had grown her Assets under Management (AUM) to the tune of Pak Rupees 100bn by December 2016 [6]. It was for the first time a private sector investment management firm in the country had crossed that mark. Furthermore, Al Meezan, to its credit, was recognized by International Finance Awards as the “The Best Asset Management Company” in Pakistan in 2018. Finally, and to further add to its growing list of

DOI 10.1108/EEMCS-12-2019-0339

VOL. 10 NO. 4 2020, pp. 1-41, © Emerald Publishing Limited, ISSN 2045-0621

Disclaimer. This case is written solely for educational purposes and is not intended to represent successful or unsuccessful managerial decision-making. The authors may have disguised names; financial and other recognisable information to protect confidentiality.

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accolades; Al Meezan was recognized by Global Lipper Fund Awards, awards organized by the esteemed financial services company Thomson Reuters. Al Meezan’s fixed income fund, Meezan Islamic Income Fund, won the award as the Best Fund BOND PKR over a one, two, three, four and five-year period. Later in 2019, Al Meezan won in the following two categories: 1. Best Fund - Meezan Islamic Income Fund (Over 10 Years BOND PKR); and 2. Best Fund - Al Meezan Mutual Fund (Over 10 Years Equity Pakistan). Perhaps the biggest feat that Al Meezan will forever be recognized for was the fact that, till writing of this case, it continues to be the only full-fledged Sharīʿah-compliant asset management company (AMC) in the country with respect to every facet of its operations. All this, along with maintaining a top rank amongst peers, both conventional and Islamic, with respect to AUM, as can be seen in Exhibit 2. Islamic finance differs fundamentally from conventional finance. Islamic finance derives its principles from Shariah, the Islamic religious law which governs the aspects of daily life, based on the teachings of the Quran [7]. While the tenets of conventional and Islamic finance overlap in ensuring accountability and transparency, Islamic finance takes the ethical responsibility a notch further by prohibiting components deemed unlawful (i.e. Haraam). One of the fundamental features of Islamic finance is the prohibition of interest/ usury in all forms, and instead brings about the concept of sharing the profit or loss of investments [8]. Islamic finance prohibits investments in vehicles that derive their income from their involvement in unlawful activities, i.e. gambling, adult entertainment, conventional banking and finance, alcohol, Haraam food items, tobacco and weapons. Shariah law also requires Islamic funds and financial services companies to appoint a Shariah board for oversight and compliance with the principle, conduct Shariah audit annually, and purify income derived from unlawful sources and disburse the income to charity. Al Meezan as a full-fledged Sharīʿah-compliant AMC, hence adheres to the prescribed Shariah principles, and had appointed the honorable Justice (Retd.) Mufti Taqi Usmani as the chairman of its Shariah board [9]. Renowned for the Shariah screening methodology (Exhibit 5) used by the majority of the Islamic finance practitioners globally, he is a pioneer of modern Islamic finance. As a result, Mufti Taqi Usmani’s oversight and the plethora of experience in the field of Islamic finance have inspired confidence in investors to choose Islamic investment solutions and, thus, choose Al Meezan for the reputation it has garnered over the years. Al Meezan offers several investment solutions and investment advisory services, which catered to the specific needs of each of its existing and potential investors, hosting a product suite of 17 mutual funds for various asset classes (categories of funds are provided in Exhibit 3). As of December 2019, Al Meezan amassed a diverse clientele base of over 110,000 investors, including institutions, retail clients and high net worth individual clients. Likewise, by the end of June 2019, Al Meezan’s AUM stood at PKR 91.3bn, with a market/industry share of 17%, as seen in Exhibit 4.

Challenges and success Need for Sharīʿah-compliant financial institutions Islamic Republic of Pakistan, a separate homeland for Muslims, was created after decades of struggle in the name of Islam [10]. The majority (more than 95%) [11] of Pakistan’s population consists of Muslims, most of whom are practicing Muslims that yearn to follow their religious principles. However, as the products offered by financial institutions in Pakistan tend to involve interest/usury (called “Riba” in Arabic), which is considered Haraam (i.e. forbidden) for Muslims, the anecdotal evidence suggests prohibition of

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interest-based transactions as one of the major reasons of lower level of financial inclusion in Pakistan as its inception. On a global scale, during 1990s, some of the Muslim countries, especially the MiddleEastern Gulf Cooperation Council countries, developed banking and financial products that were Riba-free and Sharīʿah-compliant as an alternate mode of financing and investment for Muslims. Sharīʿah-compliant financial products and services gained acceptance, albeit slowly and gradually, and were adopted not only in Islamic States but also countries with Muslim minority population. Likewise, a similar need to develop such kind of products and services was also felt in Pakistan. Meanwhile, an important development that intensified this need was the famed judgment by The Supreme Court of Pakistan against Riba. Pakistan Supreme Court judgment dated December 23, 1999, while hearing various appeals, affirmed that Riba (i.e. interest-based transaction) in all its forms and manifestations is prohibited by the Holy Qur’an and Sunnah (i.e. teachings of Prophet Muhammad (PBUH). This historical judgment prompted a need for setting-up Sharīʿahcompliant financial institutions in the country to extend an alternate model of investment and financing to the households, businesses and government. In line with the apex court’s decision, the government with the help of the State Bank of Pakistan (SBP) (the central bank of Pakistan) and the Securities and Exchange Commission of Pakistan (the securities regulator), began developing a framework for Institutions offering Islamic Financial Services, so that an enabling environment would be provided for the emergence and growth of Islamic financial industry. Moreover, the conventional financial industry in Pakistan also realigned their strategic goals to maintain their growth trajectory.

Beginning of Al Meezan Pak Kuwait Investment Company set up two entities: Al Meezan Investment Management Limited, an AMC that was set up in 1995; and Al Meezan Investment Bank, an Islamic Investment Bank in 1997. Established as a subsidiary of Pakistan Kuwait Investment Company (Private) Ltd, Al Meezan was Pak Kuwait’s action to diversify into public fund management [12]. Back then, Mr Shoaib was the Head of Capital Markets Department in Pak Kuwait Investment Company, managing their proprietary funds. Al Meezan has been among the pioneers of Sharīʿah-compliant fund management in Pakistan; however, Al Meezan was not initially setup as one, despite the establishment of an Islamic Financial Institution in Pakistan proposed. Mr Shoaib reminisced his time working at Pak Kuwait: At the time, Pak Kuwait was performing well and had valuable resources working for them to manage the company’s proprietary portfolio [13]. Pak Kuwait wanted to use this pool of talent at their disposal to manage public funds, so it decided to diversify into investment management. The idea was to launch different mutual funds, and follow the lead of the National Investment Trust (NIT) and Investment Corporation of Pakistan (ICP), which were the role models for Fund Management in Pakistan. NIT was managing the largest single fund at that time, while ICP had a portfolio of various funds.

Al Meezan opened its doors to the investing public in 1995 and successfully received the license to manage closed-end funds as an investment advisor under the name of “Al Meezan Investment Financial Services Limited.” At that time, Pak Kuwait allocated two rooms for Al Meezan within their head office and Al Meezan commenced its operations with a team of less than 10 employees. Soon after, Al Meezan launched its first closed-end fund, Al Meezan Mutual Fund (AMMF) with a paid up capital of PKR 250m. Al Meezan was found on the idea of establishing both closed-end and open-end funds for the benefit of investors, i.e. mobilizing funds from institutions and general public with a view

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to invest and manage to yield attractive returns. However, for the launch of an open-end fund, Pak Kuwait solicited the help of viable partners in both the domestic and international landscape [14]. On the domestic front, Pak Kuwait chose to partner with NIT, the largest asset management firm in the country during the time. While internationally, they joined hands with Jardine Fleming Investment Trust and Advisory Company Limited (JFITAC). Hence, Al Meezan started with three partners: Pak Kuwait Investment Company, NIT and JFITAC having 50:25:25 shareholdings in Al Meezan, respectively, as shown in Exhibit 6.

Difficulties at the embryonic stage On January 1, 1999, Securities and Exchange Commission of Pakistan (SECP) was established under the Securities and Exchange Commission of Pakistan Act 1997 to function as a body corporate by replacing the Corporate Law Authority and became the apex regulator of the securities market in Pakistan. Subsequently, all asset management companies in Pakistan had to now get approval from SECP before launching any type of fund/(s). Meanwhile, in the year 2000, fortunately for the local mutual fund industry, the structure of National Saving Schemes (NSS) in Pakistan were re-examined by the Ministry of Finance under the Government of Pakistan (GoP). As a result, a number of measures were implemented: the rate of return offered on different NSS were reduced, the income from NSS was subject to withholding tax, and certain investment limits were enforced on institutional investors investing in such schemes. This shift in policy regime led to institutional investors rapidly turning away from NSS and sought other lucrative options. The mutual fund industry grasped this opportunity to pitch themselves in front of the financial regulator to mobilize the surplus funds of institutional investors, which proved to be fruitful. Thus, SECP extended more asset management companies’ licenses, however, at that time, SECP differentiated in the two types of licenses it offered, one for managing closed-end funds (Investment Advisor) and other for managing open-end funds. The industry was still emerging, thus no investment management company had open-end funds at that time. Meanwhile, Al Meezan had applied for an open-end fund management license at SECP. Open-end funds were a novel product in the Pakistani market, but Al Meezan had recognized the potential the product held and continues to hold even today. Managing an open-end fund offers several benefits, predominantly the fund manager’s ability issue any number of new shares or can redeem existing shares, unlike a closed-end fund that has a fixed number of shares. The status quo at the time was that if a firm wanted to launch an open-end fund, it needed to partner with a foreign financial services firm, which Al Meezan qualified by partnering with Jardine Fleming. The attainment of the license from SECP was within arm’s reach, only short of a few general regulatory requirements.

Market turbulence and light at the end of the tunnel In May 1998, Pakistan conducted its nuclear tests, and to deter such activity, economic sanctions were imposed on the country. This event significantly derailed the growth of the financial industry in Pakistan. Many foreign firms started fleeing the country out of fear, Jardine Fleming (JFITAC) being one of them. The management of JFITAC, in tandem with their strategic objectives, decided to divest not only from Pakistan but from other emerging markets as well, given the global landscape at the time. Circumstances were unfavourable for Al Meezan; by the time Al Meezan fulfilled all the regulatory requirements to be granted the open-end fund management license, Jardine Fleming decided to exit from Pakistan. In a similar vein a couple of years later, the catastrophic event of September 11, 2001, caused the financial markets to crash globally. The security situation of Pakistan was not favourable to attract any foreign partners. For Al Meezan, the period of 1998–2001 turned out to be turbulent as a fledgling organisation in a nascent market.

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Beginning of new era Al Meezan once again pleaded their case to SECP and proposed that they have the necessary capital; Pak Kuwait was also willing to contribute and they wanted to launch an open-end fund. However, SECP was extremely adamant on the presence of a foreign partner, something that Al Meezan could not possibly manage in those dire circumstances. Shoaib commented on the dilemma: On a superficial level, these circumstances seemed to be an obstruction, but the exit of foreign financial institutions in 2002 turned out to be a blessing in disguise. Societe Generale Bank (Pakistan operations of the French bank) also decided to divest from Pakistan. Acquiring the license for a new commercial bank is a cumbersome process, and more so in those times. Al Meezan Investment Bank – which was an investment bank from 1997 until 2002 – approached the State Bank of Pakistan and proposed to acquire the operations of Societe Generale Bank in Pakistan. Al Meezan Investment Bank got a license from State Bank of Pakistan to form the first full-fledged Islamic bank in the country.

Al Meezan Investment Bank received the license to operate as an Islamic commercial bank in 2002, a positive turn of events in an uncertain business and economic climate. The entity was subsequently renamed “Meezan Bank Limited” and that marked the beginning of a new era for Meezan Bank in 2002, forever earmarked as the first Islamic commercial bank to be launched in Pakistan. When Shaukat Aziz (former Finance Minister of Pakistan) and Dr Ishrat Husain (former Governor of SBP) were presenting the Islamic Banking license to the chief executive officer (CEO) of Meezan Bank Limited, Mr Irfan Siddiqui, Dr Ishrat had remarked: “This license that I am giving you today, it can be the beginning or the end of Islamic banking in Pakistan.” Mr Shoaib recalled: Since it was the first Islamic bank, there were no regulators for Islamic banks at that time in the country. Without an ecosystem of Islamic financial institutions, it was a challenge to run an Islamic asset management company successfully. An Islamic Investment Company at its very core needs access to Islamic assets, Sukuks, [15] and most importantly: Islamic minded investors.

Despite all odds, Al Meezan approached SECP again with the idea that Al Meezan wanted to abandon conventional fund management completely, and instead proposed to transition into Sharīʿah-compliant fund management as the sole focus of its business and operations. This was a new opportunity in Pakistan, the first Islamic commercial bank had just been established and without doubt, there were others to follow suit. Next, there would invariably be an emergence of dedicated investors and market players who would opt for Sharīʿahcompliant investments, driven on the principles of faith-based investing. Al Meezan realized the untapped potential in the new Sharīʿah-compliant financial services market. The global landscape, particularly in Malaysia and the Middle East, was rapidly working toward the development of Islamic finance, which acclimated SECP to the need for Islamic Finance in Pakistan. Al Meezan once again approached the new management of SECP with the plea to grant Al Meezan the coveted license for Sharīʿah-compliant open-end fund management, without the customary need to forcibly partner with a foreign firm. There were not many Islamic mutual funds in the global industry as well, which made it challenging to bring in a foreign partner. Regardless of the hurdles, Al Meezan had already accumulated enough experience of running a closed-end fund in coalition with a foreign partner and acquired all the technical capabilities that were needed. This continuous determination and hard work eventually paid off for Al Meezan when in 2003, SECP finally considered the case without any strings attached and proceeded to grant the license to manage open-end mutual funds. This was the beginning Al Meezan’s journey toward Sharīʿah-compliant fund management. Al Meezan codified a vision: “To make Sharīʿahcompliant Investing a first choice for investors”, which it continues to envision today.

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This vision was in line with Meezan Commercial Bank’s vision (i.e. ...