Sharia's promises turn to asian reality

More than 600 Islamic funds now cater for the 1.4bn Muslims around the world, the majority launched in the last few years. Assets held by fully Sharia-compliant banks or the Islamic arms of conventional banks totalled $822bn last year, according to The Banker’s Top 500 Islamic Financial Institutions survey. The market grew at an annual compound rate of 27.86 per cent between 2006-2009, a striking contrast to conventional asset growth of just 6.8 per cent per anum. While the potential for the Islamic investment market is much hyped, take-up varies considerably by region and reality may lag the marketeers’ dreams. “I’ve been to a number of presentations down here in the Gulf in the last year that would lead you towards a belief that the market is exploding, but I don’t see that yet,” says Tom Connolly, head of asset management for the Middle East at BNY Mellon, who is based in Dubai. While Saudi Arabia, sitting on mountains of oil-generated cash, remains a huge potential market, relatively unscathed by the credit crunch, there are core issues which have put off some industry players. “The concentration of wealth in relatively few hands means these families invest heavily in fixed income, and that is difficult to achieve in a Sharia-compliant way,” says Mr Connolly. Institutional investors in the region are showing little interest in Sharia-compliant investments. “The political pressure is not sufficient to push investors in that direction,” says Mr Connolly. “Most mandates aim to invest around the world, not to restrict the potential universe. For instance, it is hard for Islamic investors to invest in fixed interest or private equity, because of the leverage, and in equities investors may be excluded from buying some of the best managers. “The conventional fixed interest universe is so much bigger,” he adds. “Sharia compliant fixed interest is limited to sukuk [Islamic-style bonds], and is even smaller than the Sharia equity industry. For example in the Dubai credit crisis, if you had been holding sukuk and Sharia compliant investments, you would have been highly undiversified.” Improved reputation The credibility of Sharia investments improved during the financial crisis, as they outperformed traditional investments, largely because they shunned the banking sector. Indonesia and Muslim countries in Central Asia are seen as the next target markets. “The big areas of growth are Malaysia, Pakistan, India and Turkey, and all need further mutual fund development,” says Dan Rudd, head of MENA wholesale at HSBC Global Asset Management. “The mentality is changing and slowly diversifying away from property. In the mutual fund arena, we’re very focused on our Sicav as a platform we’re leveraging off globally. We’re seeing demand from local Islamic banks offering more cautious balanced portfolios, along with aggressive strategies, such as emerging markets.” HSBC’s Islamic-compliant brand, Amanah, includes four equity funds as well as a range of Sharia-compliant strategies domiciled in Saudi Arabia, which the group is looking to expand in the Middle East, Europe and Asia. Mr Rudd believes there would be demand from clients for cautious balanced fund of funds strategies run from Luxembourg and Saudi Arabia. Size advantage The consensus is that big banks with a strong conventional presence have an enormous advantages over independent specialists, particularly if they have developed expertise in socially responsible investment. “I can see niche players trying to build themselves up as an Islamic business manager, but I would say that a sophisticated buyer would look at the conventional capacity, the massive analyst teams and the big systems that a niche player can’t deliver,” suggests BNY Mellon’s Mr Connolly. The cost of scholars, where the supply/demand balance is extreme, can also be difficult for small groups to bear. “Innovation has been led primarily by companies such as Deutsche, RBS, UBS and BNP Paribas,” says Dr Humayon Dar, CEO of BMB Islamic. “When it comes to structuring capability, the big groups have the resources, brainpower and R&D to come up with new ideas, but small and local players may be better in distribution. For example RBS and Merrill Lynch have good products but lack distribution.” Saftar Sarwar, who left Barclays Wealth in February to set up his own wealth management firm, Kingdom Capital Partnership, plans to use the Islamic products of Barclays, Standard Chartered and HSBC. “Barclays, UBS, JPMorgan and other major players are trying to create a platform but they are coming at it from a manufacturing point of view, whereas I see it also as an education process. There is a need to speak to people at their level to bring in customers and a small specialist group can make that work much better than the big banks, while at the same time accessing their know-how,” he says. There are three areas currently resonating says Mr Sarwar. He expects real estate products to do well, as commercial property values recover, and global equities to perform as investors seek greater diversification and income, while there is still lots of interest in commodity space. Activity in private equity has slowed and at least one big fund is expected to be wound up in the Middle East, says Mr Dar. Investors are increasingly interested in so-called frontier countries such as Kazakhstan, Bangladesh, and Cote d’Ivoire, where there is greater choice of Sharia-compliant businesses ripe for expansion. Hedge funds have tried to creep into the Sharia-compliant arena but without much success. “In most cases, the press is negative about hedge funds and this is picked up upon by those who do not like the idea, such as the suspicion of short selling, but there was no positive publicity at the other end when the ban was lifted,” says Mr Dar. “Strict Muslims do not invest in this arena, but it can appeal to the new mass affluent Muslim class for whom investing is a new phenomenon.” This group might not have a view as long as the strategy has been approved by scholars, and this small universe of 360 scholars is slowly becoming more financially sophisticated which is facilitating acceptance of more complicated products. The main difference between Islamic and conventional finance is the prohibition of ‘Riba’ (interest), and fixed interest remains one of the fastest growing and most innovative sectors in Islamic finance. Debate about the forms of sukuk that are allowable has now settled down, following the publication of the Sharia auditing board’s resolutions clarifying its stance. Regulation What the market needs is “the monitoring of the Islamic financial institutions through effective supervision by a regulatory authority under Islamic Sharia, a global policy for pricing Islamic financial products, and a uniform accounting standard all over the world,” says Md. Touhidul Alam Khan, executive vice president at Prime Bank Limited in Bangladesh. He also stresses the importance of establishing appropriate risk and liquidity management techniques and greater clarity around Sharia-based legal and tax restrictions. While product development in the wealth management space has slowed, Prime Rate Capital Management has just launched a new Islamic liquidity fund, the first Sharia compliant overnight liquidity instrument targeting a triple-A rating, says Chris Oulton, CEO. The fund avoids restrictions by investing in commodity Murabaha transactions. Structured products have performed well, and are gaining traction. The launch of Russell-Jadwa Sharia index last June, a joint venture between Russell Investments and Saudi company Jadwa Investment, added another index to a pool including Dow Jones, FTSE, Eurekahedge and MSCI Barra.