Four experts in Islamic finance discuss the issues affecting the industry at present, and look at what the key opportunities within it are likely to be in the coming years.

Participants

  • Adam Ebrahim, chief executive and chief investment officer, Oasis Group Holdings.
  • Jason Kabel, head of fixed income, Bank of London and The Middle East.
  • Datuk Kamso, chief executive, CIMB-Principal Islamic Asset Management.
  • John Sandwick, manager, Safa Investment Services.

Q: The Islamic fund management industry remains in its infancy. Global sharia funds constitute roughly $52.3bn worldwide compared to $22,000bn for conventional funds, according to Ernst & Young. Since more than 70% of fund managers fall below the estimated break-even assets under management (AUM) level of $100m, do you think the key challenge is in growing the size of Islamic funds?
John Sandwick: First, let’s talk about market size. We at Safa Investment Services have what I think is the world’s only database of sharia-compliant mutual funds and exchange-traded funds. Total assets are now nearly $100bn among close to 850 products. Yes, that is miniscule compared to 70,000 conventional funds with $22,000bn, but it’s a start.

Second, a key feature of Islamic funds is randomness, or what I call 'throw it and see what sticks' banking. Many banks create them, but there are no Islamic asset managers to put them together into coherent, professional portfolios. Until you have Islamic asset managers, you won’t have an abundance of diversified sharia-compliant investment products.

Jason Kabel: Increasing AUM will be a significant challenge for all Islamic asset managers over the coming years. The industry has the momentum, but in order to maintain this, [asset managers] must promote their funds to new markets and prioritise education. 

Conventional investors and institutions in particular need to be made aware of the performance of sharia funds, with many outperforming their conventional peers. Some research carried out by Core Data in 2012 found that 60% of independent financial advisors [IFAs] said their limited knowledge of product providers had kept them from recommending Islamic products, with only 5% ever having recommended a sharia-compliant product.

However, this cloud has a silver lining as one-fifth of the IFAs questioned felt that their clients would be interested in learning more about Islamic investments and 60% recommend ethical products. This highlights the importance for Islamic asset management of promoting the real similarities between sharia and ethical principles.

Datuk Kamso: Given that the Islamic fund management industry is still in its very early stages, we believe that one of the key challenges is in educating investors. The mindset and education level of investors is still too varied, which necessitates that industry players such as ourselves assume responsibility to raise the level of awareness on the benefits of Islamic funds. But this will take time and effort.

Another challenge that has a great impact on the growth of Islamic funds is the tendency of asset management companies to issue their investment products in their domestic market. We believe that serious measures should be taken in promoting internationalisation or cross-border distribution, which would help boost the size and growth of Islamic funds in the industry rapidly.

Adam Ebrahim: The global Islamic fund management industry has grown rapidly over the past two decades with growth still being fairly robust over the five years to 2010, at 11% per annum, despite the severe financial crisis experienced in 2008. While the Islamic funds’ AUM, at $58bn in 2010, is small in relation to its conventional counterparts, the industry has made progress and witnessed substantial positive changes. Islamic investment product ranges have significantly broadened and deepened to provide opportunities to investors in a variety of asset classes, such as equity, property and income. In Muslim countries and major Western nations, industry regulations and tax conventions have also been adjusted to cater for and encompass Islamic investments.

The Muslim population globally is estimated at 1.6 billion, or 22% of the world's population. With Islamic funds' AUM representing only 0.3% of the total industry at present, the potential for this market remains enormous. Increased penetration of these products to the massive global Muslim population is the key to unlocking this market. A significant focus around the marketing of the products and improving its distribution is of paramount importance to achieve the global scale necessary. In addition, a global presence of Islamic financial institutions will assist in improving distribution and driving growth in the Islamic funds industry.

Q: Islamic fund products are heavily weighted towards equities, comprising 54% of the global Islamic funds industry. There are particularly large gaps in the availability of products in the fixed-income and money market segments. What has led to this imbalance?

JS: The lack of asset managers is one, but another is the crowding-out effect that real estate and private equity had in the past decade. For a while, Islamic private equity raised in Saudi Arabia and the Gulf was equal to the entire global Islamic mutual funds industry, then $50bn. Where in the world does one see that? Private equity, which is normally a marginal asset sub-category, trumped mutual funds. I blame the banks for failing to educate clients on how to save money. Some bankers will tell you, 'we were only selling what the client wants'. That couldn’t be further from the truth. More likely they were selling what made the biggest commissions. Balance comes with professionalism and education.

JK: Historically, Middle East and north Africa [MENA]-based investors have preferred equity and property funds. They valued investment in a local market that they fully understood. Since 2008 and the crash in global equity markets, Islamic asset managers began to introduce non-equity-based funds such as money market, commodity, and to a larger extent sukuk funds. The greatest shortage is in true fixed-income funds which is why the Bank of London and the Middle East has launched two income funds. 

DK: Unlike sharia-compliant equity investment, which is a subset of global equity, sharia-compliant fixed income (sukuk) is a unique investment space that enlarges the existing fixed-income investment universe. Additionally, the interpretations on what is considered acceptable practice, as well as the regulations on the issuance of sukuk, vary across countries and regions. A sukuk structure acceptable in one country may not be acceptable in another. Consequently, the supply of sukuk would be dramatically smaller. The same applies for the money market funds.  

AE: Significant progress has been made in expanding Islamic investment products globally – with the total number of Islamic funds standing at about 633 at the end of 2011 [Eurekahedge research]. While equities were the area of focus initially, they now constitute about 39% of total Islamic funds. Products in the property, income and commodities space have developed substantially and have been the focus of new launches since 2006.

On the income side, there are long-term products in place such as sukuk that have gained momentum in recent years, with issuances averaging about $50bn per annum since 2010. Importantly, the issuances are broadening from both a geographic perspective, as well as the type of issuer (sovereigns and corporate). On the short-term side, there have been some challenges around commodity murabaha’s compatibility with the relevant legislations. This is in the process of being addressed, with potential changes being discussed to regulations such as UCITS IV [Undertakings for Collective Investment in Transferable Securities Directives IV] in the future. With the major asset classes such as equity, property and income in place, the scene is set for substantial development and growth in balanced (asset allocation) funds in the foreseeable future.

Q: Islamic asset managers are pinning their hopes on the future growth of long-term savings products, such as pension funds and the burgeoning Islamic insurance [takaful] industry. Global takaful contributions grew by 19% in 2010 to $8.3bn and are expected to reach $12bn by the end of 2012. How much potential do you see these two asset classes holding in the short- to mid-term? 

JS: Our main targets at Safa are takaful treasuries and Islamic endowments [awqaf]. Takaful were seduced into the same mania that induced tens of thousands of Saudi and Gulf regional investors into local share markets and real estate, with enormous concentrations of both assets. The results were predictable. Takaful suffered major capital losses. Today, we expect takaful to professionalise their asset management, outsourcing to specialised firms. After all, they are insurance companies, and diversification is just as important for Islamic as well as conventional insurers.

In parallel, there is the much bigger awqaf market, at least $280bn in Saudi Arabia alone. Again, we find [here] the wealth-destroying phenomena of asset concentration and the urgent need for global asset diversification. 

JK: Pension funds that are wholly sharia-compliant or invest in Islamic funds will continue to grow. Not only will they continue to grow in the traditional Islamic markets such as the Middle East and south-east Asia, but on a global scale. The UK National Employee Savings Trust offers an Islamic fund and Australia should see its first Islamic superannuation scheme launched this year.

Takaful, which has its core markets in the Gulf and Southeast Asia, is one bellwether of consumer appetite for Islamic finance. Rising competition is creating a price war which is challenging profitability. As with the conventional insurance market, the operational costs are high, particularly in terms of human capital. For the takaful industry to continue to grow, it will need to improve cost-to-profit ratio and efficiency, while continuing to bring new products to market. We expect to see some consolidation in the market over the medium term.

DK: Pensions and takaful are still a growing phenomenon, contributing positively and substantially to the Islamic funds market. Although its estimated worth is just over 1% of the total insurance industry worldwide (according to an Ernst & Young report), we are generally seeing an increase in activities and interest in both pension funds and takaful.

AE: Both the takaful and pension fund industry provide significant growth opportunities for Islamic fund management over the long term. These sectors require balanced fund products which cover the various asset classes and address the life-staging and risk-profiling needs of investors. These products are in place globally, with the focus required around the marketing and distribution of these products. While both these sectors are currently small in relation to their conventional counterparts, these sectors could grow phenomenally should the marketing and distribution around these products be successful.

There is a major need for pension funds in the MENA region. While the Middle East has significant private wealth and established sovereign wealth funds, these economies are very dependent on the performance of commodities such as oil and gas. Education around the significance of these savings products and their importance in improving the quality of life is paramount. This is particularly relevant where the income disparity (gini co-efficient) is relatively high in these regions, leading to instability as highlighted by the uprisings over the past two years. To address the income inequality and provide a 'safety net' against a decline in commodity prices, a well-established pension fund system is necessary.

Q: Maybank Islamic, Malaysia’s largest Islamic lender by assets, has forecast that global Islamic funds (excluding sukuk) will achieve a compound annual growth rate of 25% between 2010 and 2013, more than doubling in size from $83bn to $170bn. Do you think this is a realistic forecast and which do you think will be the key markets to emerge?

JS: Strangely enough there is not a single bank – Islamic or not – that is setting up an Islamic asset management unit. But, at some point, the Muslim world needs to reorganise how it deals with savings. Without a professional asset management industry, it will continue to be a victim of lopsided allocations that do more capital destruction than wealth preservation. I predict Safa is the first pioneering step toward the normalisation of Islamic asset management. And it doesn’t have to be localised. Already Switzerland is home to at least $200bn in Muslim-owned managed savings, with virtually zero of that sharia-compliant. Eventually there will be full-service professional Islamic asset management. 

JK: We expect to see continued growth in the Islamic fund market. The sukuk market is outperforming conventional bonds and is attracting not only a new group of investors on a global scale, but new, conventional issuers who are looking to access this market. With sukuk emerging as a new asset class for global investors, it is essential to see that the demands of sophisticated investors are met in order to maintain the current growth levels that the Islamic funds industry has achieved. This calls for coordinated efforts in order to further improve the market for both issuers and investors.

However, the forecast growth in equity funds seems somewhat optimistic given the fact that Islamic equity products have been available for some years now, but have failed to gain much traction, with the exception of a few large funds. Growth in this area may be reported if equity markets recover in the next few years, but this may reflect higher valuations rather than an accelerated flow of new capital into the Islamic fund market.

DK: We believe it is going to show significant to aggressive growth because the growth drivers of the Islamic funds industry will continue to support high expectations for expansion in the industry. While conventional funds space is maturing, the Islamic space is nascent. The global Muslim population currently constitutes approximately 20% of the world population. In addition, in a number of Muslim countries, the per capital income is increasing at an accelerated rate. The combination of these factors will lead to a significant increase in the demand for asset and wealth management. We see participation from markets such as Qatar, Dubai and, most recently, Turkey. We also see more heavyweight Islamic banks directing their attention to this market recently, for example, Qatar International Islamic Bank and Banque Saudi Fransi.

AE: Some 1.6 billion Muslims represent a major opportunity, with the 'tip of the iceberg' only being touched. Countries such as Malaysia, Saudi Arabia, Bahrain and the United Arab Emirates, which are major players in Islamic investments, will continue to grow strongly. Today, significant development is taking place in other Organisation of Islamic Countries countries such as Turkey and Indonesia. The large Muslim populations of these countries should drive huge growth in the years to come as penetration and distribution of Islamic investment products improve.

The Western world is opening up to this market with the likes of the US, UK, South Africa and Ireland all establishing Islamic investment sectors. The well-developed wealth management infrastructure and the significant minority Muslim populations of these countries could drive significant growth, potentially surprising on the upside. As an example, the UK has a Muslim population of about 1.7 million, which has a high propensity to save. Taking into account the savings industry in the UK, the potential Islamic investment market size in the UK is about £120bn ($192bn) to $140bn, compared to its current size of about £700m.

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