HSBC Holdings Plc, the second-largest underwriter of Islamic bonds, plans to start its first Shariah-compliant exchange traded funds (ETFs) in the Persian Gulf, a region that is struggling to lure international investors.

ETFs may help local markets attract some of the $49.4 billion that EPFR Global says poured into emerging market stock funds this year. Restrictions on foreign participation in Gulf markets range from bans to caps on ownership. Investors have sidestepped most countries in the Middle East and North Africa during the recent surge in capital inflows to emerging markets because of debt restructurings, the International Monetary Fund said in a report released Wednesday.

ETFs are index-based investment products that allow investors to buy or sell shares of entire portfolios of stock in a single security. The funds are unique in that they combine the opportunities of indexing with the advantages of stock trading.

The ETFs will give overseas investors greater access to the region's markets, Razi Fakih, deputy chief executive officer of HSBC's Islamic unit in Dubai, said in a telephone interview Thursday. National Bank of Abu Dhabi PJSC started the Gulf's first non-Shariah compliant ETF in March, followed by Falcom Financial Services' Islamic fund in Saudi Arabia that month.

"We are at an advanced stage of launching Islamic ETFs in the fourth quarter," Fakih said. "ETFs will make up as much as 10 percent of the Islamic fund industry in the coming five years."

HSBC is seeking investment from wealthy individuals and institutions for the ETFs, said Fakih. "Wealth generation in the GCC (Gulf Cooperation Council) has been significant over the past few years, and there is significant surplus funds looking for quality investment opportunity."

The Dow Jones Islamic Market World Index, which tracks shares that meet Shariah guidelines and has a market capitalization of $12 trillion, climbed 13 percent in the past 12 months, while the Dow Jones Global Index gained 10 percent during the same period.

Prior to the start of Saudi Arabia's Falcom ETF, non-resident foreigners were only permitted to trade through share-swap transactions in the Middle East's largest exchange by market value. The United Arab Emirates restricts non-GCC investors from owning more than 49 percent of listed companies. The six-member GCC is made up of Saudi Arabia, Kuwait, Qatar, Oman, Bahrain and the UAE (United Arab Emirates).

"I can see some potential for a product that offers investibility to foreign investors," Bryce Fegley, chief investment officer of Saturna Sdn, the Malaysian unit of Saturna Capital LLC, the biggest Shariah-compliant equity fund in the US, wrote in an emailed response to questions. "I wonder whether there would be sufficient diversification in such an ETF to make it attractive."

"I don't think the appetite is there for ETFs or equities in general from within the region," John Sfakianakis, chief economist at Riyadh-based Banque Saudi Fransi, said in a telephone interview on Tuesday. The markets are "still in the process of deleveraging and recovering from a difficult and challenging two years," he said.

Shariah forbids gambling, payment of interest and alcohol, so fund managers have to select investments deemed halal, or permissible.

Bloomberg News

(HK Edition 10/08/2010 page3)