Islamic asset management is a fledgling industry compared to its conventional counterpart, despite having undergone a major period of growth and development over the past decade. It is now at a stage where product innovation is crucial for the future development of the sector, helping it to mature to the point where investors see it as a viable alternative investment solution.
Many Islamic funds are competitive when compared to conventional funds and have investment strategies that are comparable to those of ethical funds. Since the beginning of the year, a number of products have been brought to market and have enabled private investors to choose from different competitive Shariah funds.
Despite the first Islamic fund being launched in the 1970s and with total assets under management for the industry being estimated at over $1.1 trillion at year end-2009, it is still less than the assets under management of the world’s single largest asset management company. Forecasters for companies such as Cerulli predict that Shariah-compliant assets will reach $5.0 trillion by 2015, which should fuel the growth of the Islamic asset management sector.
Key differences between Islamic and conventional funds
Traditional and Islamic funds have the same objectives, but the ways they operate differ. In compliance with Shariah law, the main principles of Islamic finance are the avoidance of activities such as gambling, excessive speculation or leverage, and risk and reward sharing. The charging and receiving of interest is forbidden, with investors receiving a profit share instead.
Islamic asset managers offer a range of investments and innovative products that compete with the offerings of many conventional institutions. The types of products developed are based on a specific sector or a dedicated investment strategy and the funds are designed to achieve comparable yields, but the underlying structures are different as well as the principles they are based on. Shariah-compliant funds are founded on principles that are in contrast to those of many conventional funds. There are prohibitions against:
Riba (unfair gain), this is possibly the most commonly known prohibition and although often translated as interest or usury, the concept of riba includes any unfair gain or exploitation. Returns on money invested should be as a result of the performance of a tangible investment.
Maisir (speculation) transactions which rely on or involve speculative behaviour are prohibited by Shariah. However, Shariah does not prohibit ordinary commercial risk taking, it is only excessive risk that is unacceptable. Islamic financial institutions are not permitted to trade futures, short sell or use derivatives.
Gharar (uncertainty). Transactions which do not contain full disclosure from the parties involved are considered void transactions by Shariah. The prohibition of gharar ensures that contracts do not include any uncertain terms or conditions.
Constructing a portfolio
Islamic asset management is no different from conventional asset management when it comes to constructing a portfolio in a post-crisis environment where private investors have become more concerned with wealth preservation, downside protection and efficient diversification. The key factors for investing in a fund rely heavily on its track record, performance and manager profile. In addition, investors are increasingly seeking innovative products that can generate strong returns, but creating new products that meet these requirements within the Shariah space is a complex exercise.
To date, the bulk of Islamic investment products have been equity products that use one of the core Islamic indices as investment parameters ensuring that all investments are compliant. Fixed income products within Islamic finance are more difficult to create than equity products as they require in-depth knowledge of the Sukuk market and the principles of Islamic finance.
Since Bank of London and The Middle East (BLME) launched its asset management business in 2009, we have seen increasing demand from private investors for fixed income products. Consequently, BLME has launched a number of products to address this need. These include a High Yield Fund and a US Dollar Income Fund which has been rated in the top decile of a peer group of over 800 by Lipper Hindsight, Reuters fund ranking service and is ranked as investment grade by Moody’s.
Islamic high yield funds mainly invest in Sukuk, Shariah compliant bonds, which many conventional funds do not hold. This is an increasingly appealing and growing sector with new issuance reaching a six-year high in July 2011, returning to pre-2007 levels of issuance. According to the Zawya’s Sukuk Quarterly Bulletin, Sukuk issuance rose by 18 per cent in Q2 2011 compared to Q2 2010 levels, and conventional companies such as GE Capital and Nomura have also begun issuing Sukuk in order to access capital from Islamic countries.
The demand for Sukuk remains strong, in particular given the limited nature of supply and funds provide a good vehicle for investors to access this market, as well as other assets such as ijara, an Islamic leasing agreement, and property.
Addressing the specific demand in the property sector, BLME has also developed and launched the Light Industrial Building Fund - a Shariah-compliant fund that offers high income returns from this sector. It is aimed at investors who wish to expand their property investments in a growing sector and allows for geographical spread and diverse tenants. The fund also offers excellent potential and value with target cash-on-cask yields of 8-10 per cent. It has a five-year term and is targeting a final size of up to £100 million (over $150 million).
Looking ahead, innovation in addition to fund flows will be central to the continued evolution and long-term success of Islamic asset management. We think there is a major opportunity to bring balance and choice to the industry with our fixed income offering and believe that in the years to come the Islamic asset management market is poised to go from strength to strength with further product development buoyed by a growing Sukuk market.