Complementing Shariah compliance
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According to Datin Maznah Mahbob, chief executive officer of the funds management division of AmInvestment Bank Group, investors in Islamic funds are generally risk-averse and the challenge for asset managers, therefore, is to enhance the performance of Islamic funds while catering to the investor propensity for risk avoidance – in addition to ensuring compliance with Shariah law.
To enhance their performance while maintaining low risk and volatility levels, conventional funds would use hedge fund methodologies and instruments such as shorting and leveraging which are irreconcilable with Shariah principles, Maznah explains. “Like conventional investors, Islamic investors are looking for investment solutions which offer a higher return than money market funds and which are less volatile than other funds. Because of the nature of these asset classes, there will be a larger role for asset allocation, especially in Islamic fund management.”
Asset allocation education
Maznah agrees that some investor education and communication is needed in terms of asset allocation, but says this can be facilitated for institutional investors by investment consultants and intermediaries and for retail investors by retail distribution platform intermediaries. “Institutional investors are normally advised by investment consultants, so I would imagine that communications might be slightly easier because you are talking about intermediaries who are quite professional. For the retail investors, usually there will be the retail distribution platform intermediary and the wealth management platforms which can be tapped to do the education and communication. Sometimes that can be facilitated by how we package the product for investors, in the form of savings solutions and retirement solutions whereby the asset allocation is only a means to an end,” Maznah adds.
Data culled from Lipper Investment Management indicate that the global Islamic funds market is highly fragmented, comprising a wide variety of funds invested in a number of asset classes, including unit trust funds, exchange traded funds (ETFs), reits (real estate investment trust), property and private equity. (This article focusses on retail Islamic unit trust funds and ETFs, and excludes reits, property, private equity and institutional mandates.) As of July 2010, the Islamic funds (including only unit trust funds and ETFs) have posted an annualized growth rate of 30% per annum from 2005 to 2010. There were a total of 517 Islamic funds as of July 2010, from only 207 funds in 2005. (See chart.)
Assets under management
In terms of assets under management (AUM), Islamic unit trusts and ETFs have expanded to a total of 517 funds with US$34.3 billion AUM as of July 2010 from its previous level of only 207 funds and US$10.4 billion in 2005. Including alternative assets and reits, the total volume of Islamic AUM amounts US$52.3 billion. The two largest markets for Islamic funds are Malaysia and Saudi Arabia which together account for about 60% of the total Islamic retail funds in the global market, in terms of number of funds. But in terms of AUM both countries combined account for 85%, according to the Lipper data.
Malaysia currently has 162 locally domiciled funds, the highest number of funds currently offered in a single country, while Saudi Arabia follows a close second with 144 locally domiciled funds.
The situation is the reverse for the amount of AUM, with Saudi Arabia having a total of US$20.2 billion AUM against US$8.5 billion for Malaysia. Malaysia and Saudi Arabia were the pioneers in the development of Islamic funds. Malaysia was the earliest to develop Islamic funds beginning in 1971 while Saudi Arabia launched its first Islamic fund in 1986. Interestingly, the third largest Islamic funds market – although quite far behind Malaysia and Saudi Arabia – is the US with six funds with a total AUM of US$2.7 billion as of July 2010.
This is still substantial considering that the US is traditionally a non-Islamic market. For Islamic markets alone, Indonesia has 46 funds with US$0.6 billion AUM and Pakistan has 40 funds with US$0.3 billion AUM. Other markets included in the Lipper data are marginal in terms of Islamic assets.
The bulk of Islamic retail funds are invested low risk assets reflecting the traditionally risk-averse nature of Islamic investors.
About 53% (274 funds) of the funds are invested in equities, 16% (84 funds) are invested in mixed asset funds, 15% (75 funds) are invested in money market funds, 13% (67 funds) are invested in bonds, and 17% mainly in capital-protected and structured products. But in terms of NAV (net asset value), money market funds account for half of the total investments with US$17.1 billion.
Looking at their risk profile, investors seem to be truly risk-averse. “It is worth noting,” says Maznah, “that the total AUM of US$34.3 billion does not include the high-risk and other direct investments, so it seems as if there is a polarization of risk among Islamic investors. This means that low-risk investors go into low-yield but highly-liquid money market funds, while high-risk investors invest high-yielding private equity or direct investment funds which have a relatively poor liquidity.”
However, as the low-risk investors mature and begin to tolerate higher risk levels in their portfolios, there will be greater opportunities for investment products which offer higher returns than the low-risk money market funds, while at the same time offering greater liquidity than the high-risk private equity funds or direct investments. “This is reflective too of the conventional (non-Islamic) investment market, in Malaysia and the rest of Asia. As investors mature, you tend to see this polarization. For example, as recently as 15 years ago investors in Malaysia were either in fixed deposits or equities,” Maznah explains. “Even in the conventional markets, it is only in the last 15 years that a lot more funds have been offered in between the low-risk and high-risk space – which means more actively managed bond funds and more hybrid funds to fill the gap in demand between low-risk and high-risk investors. It is probable that we will see the same development vis-à-vis Islamic funds. This could be where the opportunities will arise.”
Promising Islamic equities
A closer examination of the US$17.1 billion in Islamic money market funds reveals that 88% (US$15.1 billion) comes from Saudi Arabia. This is a clear indication that Saudi investors are risk-averse. In terms of equity funds, Malaysian investors are slightly ahead, accounting for 35% (US$5.0 billion) of the total of US$14.1 billion in NAV while Saudi investors account for 32% (US$4.5 billion). It is interesting to note that the US accounts for 19% (US$2.7 billion) of the total Islamic equity funds. “This illustrates the great fragmentation of the Islamic funds market. In Malaysia the bulk is in equities and money markets, but globally it looks like all the money is in money markets because of Saudi Arabia. There is potential in the equity and the mixed asset space in the rest of the world, in addition to sukuk,”
Maznah remarks. “For sukuk, I think demand definitely exceeds supply.
Sukuk has its own challenges in terms of supply so the size and development of this asset class has been limited by that challenge.
For Islamic equities there is no supply problem and there is strong demand. Considering the opportunities for innovation and solutions that equity provides, it is possible to imagine this as an area on which a lot of people will be focussing.”