Islamic Asset Management: Summary

Islamic finance has moved from being just another buzzword in last decade to an extremely popular and viable alternative in today’s interconnected financial world.

Islamic asset management involves merging conventional asset management processes with holistic and socialistic principles of Sharia for identification of securities. This responsible investment practice has enveloped the Islamic world significantly and some parts of the developed world adequately.

Below write up is an attempt to demystify current status of Islamic asset management activity across the world, understand current problems, explore future growth opportunities and forecast issues that could crop up in near future.

Islamic Asset Management: A Beginning

Sharia scholars inform that Islamic asset management is definitely not a new discovery and has been around for decades now if not centuries. Islamic asset management essentially means professional investment management of Sharia (Islamic Law) compliant investment avenues like equities, sukuk (Islamic bonds), real estate and commodities. The core of Islamic asset management has been rooted in Islamic financing guidelines which simply aim of bringing integrity, fairness, trust, honesty to an investor’s funds to attain the goal of ensuring equitable wealth distribution. Islamic investing hence is being viewed not as a devotedly guided investment methodology but as a moral form of investing that promotes tangible economic activities which are socially desirable. While the net effect of this investment approach is to ultimately generate competitive investment returns under ethical business practices.

Current Market Base & Locations

A research conducted by Malaysia International Islamic Financial Centre (MIFC) indicates that in 2004 total Islamic AUM (Assets under Management) amounted to $29.2bn which had risen, by September 2014, to $75.8bn. Over the same period, number of active funds has also improved from 285 to about 1161. However research concludes that there is substantial scope for a move upwards. Financial institutions spread across countries in Middle-East like Saudi Arabia, United Arab Emirates & in Asia like Malaysia, Indonesia etc. have begun offering these ‘specialized services’.

Growth Story so far

Buoyed by presence of robust frameworks in South Asian countries of Indonesia & Malaysia, the Islamic AUM has been clocking a CAGR of almost 10% in last five years. Fund managers credit the same to Government authorities which have been quick in fostering an extensive framework for Sharia compliant fund management, renewed confidence in emerging markets as well as favourable demographics and also on account of South East Asian countries benefiting from the new passport regime in ASEAN (Association of Southeast Asian Nations) that permits ASEAN collective investment schemes.

Middle East region, where Islamic asset management school of thought originated long time back, too is not far behind in growth engagements. According to CapGemini World Wealth report, Muslim affluence has exhibited a CAGR of 7% over the period from 2012-15. This jump in the average Middle East HNI’s net worth has contributed in an extremely positive way in the proliferation of new funds. Another reason for the rise in the concept has been proximity to an IFC (International Financial Centre) in Dubai. This proximity allows new Sukuk issues and fund launches in South Asia to be immediately promoted & scaled up for the Middle East geography.

Traditional Asset Management vis-à-vis Islamic Asset Management

Asset management principles are universally applicable to every sub section under the broad umbrella. Traditional and Islamic Asset management differ mostly and extensively in the last step of Asset Management i.e. selection of securities. Though there is not much difference between the products offered in a conventional setup and an Islamic asset management setup, one major talking point is the use of only Sharia compliant products in the latter that sets it apart.

Security selection is where the pivotal differences emerge between Islamic and conventional set up. Along-with the filter of risk return profiles for different investment options under consideration, Islamic investment options have an additional couple of filters to consider.

These filters target investment avenues that do businesses in alcohol, pork, gambling, weapons, tobacco, ‘conventional’ financial institutions, pornography and anything else which is deemed as ‘Haraam’ (unlawful) according to Islam. A second level filter ensures that permitted investments opportunities are performing business according to Islamic laws which prohibit excessive debt, unused accumulated cash, high debtors etc. Finally a list of prospective candidates is arrived at which can be used for investing. By default all the companies are rejected and only after clearing these filters does a company become eligible for selection consideration.

Similar to conventional Asset management, a periodic feedback and update activity is carried out on the portfolio.

Challenges plaguing Islamic Asset Management

Critical Challenges faced by current market entrants both Asset managers & clients include:

1)     Current market size forbids additional activity: Today almost $76 bn of assets are being managed by some 1100 odd funds. These numbers don’t augur too well for increase in activity at least in the near future. Though the current market participants are of the view that this market is still in a nascent state and blooming of the same will take another 5-10 years.

2)     Banking Needs: One of the chief reasons for the burgeoning asset management activity in early 20th century across US and Europe was availability of fewer funds with banks and basic requirement to source funds through alternative channels for funding banking activity. However in Middle East banks find it easier to source funds needed for normal banking activities through deposits raised than rely on fees obtained through advisory or asset management activities.

3)     Geographical Diversification: Another critical issue plaguing this industry is the need for deployment of these funds. HNI investors prefer investing their surplus funds abroad. Reduced activity outside GCC (Gulf Cooperation Council) or South East Asia has thus limited the scope for these funds to be deployed anywhere else essentially leading to much lesser diversification as opposed to conventional asset management.

4)     Semi developed asset classes: Islamic asset management space faces another hindrance in the form of incomplete development of asset classes. Though numerous investment opportunities exist across most of the asset classes, illiquidity and lack of suitable valuation models play a spoilsport. Viability of including alternative investments like hedge funds and private equity funds too is tricky due to Sharia board’ inability to declare them as ‘Halaal’ (Lawful/Permitted Activity). 

5)     Remuneration of Sharia board: Cost of managing an Islamic fund is much more expensive than a conventional fund at least on the regulatory front. Though the Islamic wealth management idea has caught up fancy of many Islamic scholars, the number of funds is increasing much faster than the available expertise on the Sharia front. Remuneration of Sharia board is certainly a significant cost to the fund.

6)     Past Performance: Past performance is definitely not an effective predictor of future performance. But comparison of conventional asset management with Islamic asset management is extremely difficult on the fund performance parameter. Relative to conventional asset management, Islamic asset management is inexperienced and lacks historical performance. Most of the 1000 odd Islamic funds have been setup in last decade or so. Even cumulative performance of Islamic asset managers over this time period hasn’t been out of the world to make an HNI or a Pension fund or an SWF (Sovereign Wealth Fund) to sit up and take notice.

Opportunities to be harnessed

To put things into simple perspective, the current estimate of Global assets under management is somewhere around $63-65 tn growing at the rate of almost 6% compounded annual growth rate (CAGR). Islamic assets under management represent a miniscule part of about 0.12% of the global pie with a CAGR of 9%. So there is tremendous scope for growth and numerous opportunities that could be harnessed.

Opportunities existing in Sustainable Investment & impact investing space are enormous. According to GSIA (Global Sustainable Investment Association), global sustainable investment market has grown from $13.3 tn in 2012 to $21.4 tn in early 2014. If Islamic asset managers play their cards smartly and market Islamic asset management skills well, they can pitch their funds to the wide clientele that invests in socially responsible funds.

New age Islamic investors or current baby boomers, who will start saving from now on for their retirement & future needs, will now have an avenue to invest within the strict tenets of Islam.

Current market for the Islamic asset management is limited to a few GCC & South Asian countries along with European cities like Luxembourg & London. Apart from GCC and Asian Islamic republics, numerous funds have been domiciled in Jersey, Cayman Islands, US & South Africa with total AUM of $16 bn. Studies conducted by MIFC have identified numerous markets outside of Asia including countries in Africa, EU along with US and UK where Islamic population forms a sizable part of the overall population to tap into a latent demand for their asset management needs.

Islamic insurance market or ‘Takaful’ is proposed to grow by leaps and bounds in the future. According to E&Y, Global Takaful market size which is around $15 bn today is estimated to grow to $20 bn by 2017. Some of these premiums will unquestionably be channelized towards Islamic funds.

Finally last but not least several Islamic republics are creating their Sovereign wealth funds which would end up seeking more Sharia compliant product mix. This in turn would spur creation of newer products invariably leading to more Islamic asset management action.

Conclusion

Conventional fund management played a significant role in helping world economy shape up to its current position in last century. Islamic asset management through its systematic and disciplined approach towards investing certainly seeks to occupy the pivotal role in current century.

Current challenges still exist and forthcoming challenges too seem daunting but opportunities seem too great to be ignored. Islamic asset management is an area where early movers have sufficient advantage but newer entrants can ideate to create a position for themselves. Only the iceberg’s tip has been scratched so far.