The aftermath of the crisis has seen the reputation of conservative sharia banking soar. Four experts in the sector look at how this falling into favour is likely to affect sharia finance's short-term and long-term prospects.
Sharia-compliant assets have had the reputation of being better insulated from the financial crisis than conventional ones. Is this reputation justified in terms of actual performance?
Zeid Ayer: It depends on the asset class. For the two most common types of assets - equities and fixed income - broad market indices can be used as proxies for the asset class by comparing the performance of sharia-compliant indices with their conventional counterparts. If one looks at the performance over the recent bearish market, Islamic equity market indices have outperformed their conventional counterparts. For fixed income, however, such a comparison is difficult to make as the universe of sharia-compliant bonds [sukuk] is much smaller than conventional bonds and there isn't any index that is representative of the global sukuk universe.
Adam Ebrahim: Islamic finance abhors speculative transacting and so sharia-compliant investments, by their very nature, hold less inherent risk. The asset-backed nature of Islamic investments also tends to provide lower levels of risk than their conventional counterparts. While sharia-compliant investments may lag during boom periods, they tend to outperform over the longer term due to lower downside risk during recessionary periods.
Jason Kabel: In the equities sphere, this proved to be the case during the credit crisis since sharia-compliant equities funds avoided conventional banks and insurance companies. However, for the most part the correlation of Islamic equities indices with conventional equity indices has been strong, so arguably there is no material difference in terms of risk or return. In the fixed-income markets, credit spreads in the sukuk market have priced wider following the credit crisis, just as the conventional debt market has. One area where sharia-compliance has made a difference is in the assets held by Islamic banks - many avoided holding structured credit portfolios containing so called 'toxic assets', thereby avoiding heavy losses during 2008 and 2009.
The Panel
- Zeid Ayer - chief investment officer, CIMB Islamic Asset Management
- Adam Ebrahim - CEO and CIO, Oasis Group Holdings
- Jason Kabel - fund manager, Bank of London and the Middle East
- Saqib Masood - regional head of Islamic product development, HSBC Saudi Arabia
Saqib Masood: While the performance of sharia-compliant assets has generally been better than their conventional peers, one needs to be careful in making a generalisation across all asset classes. For instance, sharia-compliant equity indices (using equity indices takes away the bias of an investment manager's over or under performance) have generally performed better than conventional indices during the crises. However, other asset classes such as sharia-compliant real estate and fixed income have performed largely in line with their conventional peers.
In which countries and sectors do you see the best opportunities for sharia-compliant investment?
ZA: We [CIMB] believe that the best opportunities for sharia-compliant investments exist in emerging market countries. These countries are fundamentally more attractive than developed markets, showing a stronger economic growth outlook, more favourable demographics and lower levels of debt at the country, corporate and consumer levels. Within the emerging markets, we see Asia and the Middle East, where a large proportion of the world's Muslim population resides, as particularly attractive. Sharia-compliant investments are also more of a natural fit in these countries.
AE: We see great opportunities in high-quality, large-cap companies in developed markets. Such companies have solid balance sheets, robust cash flows and substantial market shares, which they are continuing to increase by buying out their competition. Another area of opportunity lies in the global listed property sector.
JK: From the perspective of the fixed-income investor, Dubai offers greater yield on the assumption that the United Arab Emirate federal government will always support each emirate. Potentially Malaysia may offer a greater supply of assets if issuers decided to issue more foreign currency denominated sukuk. For the equities investor, there ought to be no difference in [commercial] attractiveness between conventional and sharia-compliant equity markets
SM: We [HSBC Saudi Arabia] think that emerging markets, including the Gulf Co-operation Council region, will continue to play an important part in the global economic recovery and offer attractive, sharia-compliant investment opportunities. We have recently launched an India-China Equity Fund and continue to expand our emerging markets product offering.
Do you feel that there is access to an adequate range of sharia-compliant assets to diversify your portfolio? If not, what more is needed to help the market develop?
ZA: For most investors, their investment portfolios comprise allocations of equity and fixed-income asset classes. For equities, there is a large universe of sharia-compliant stocks. However, for fixed income, the universe of sharia-compliant bonds is very limited compared to conventional bonds. Due to the insufficient supply of sukuk, most investors tend to be buy-and-hold investors and there are very few trades in the secondary market. Thus, typical strategies used to manage bond portfolios are difficult to implement. The sukuk market needs more issuance, in varying maturities and currencies, with more secondary trading and liquidity in order to be on par with the conventional bond market. Overall, the existence and ease of use of more hedging instruments would be desirable.
AE: The market for sharia-compliant assets has made considerable progress over the past number of years and investment product ranges have significantly broadened and deepened to provide investment opportunities in a variety of asset classes such as equity, property and fixed income. In most countries, industry regulations and tax conventions have also been widely extended to cater for and encompass sharia-compliant investments.
JK: The sukuk market is still small in comparison to the conventional market, however there are enough quality assets to diversify my portfolio of sharia-compliant fixed-income funds. Sharia-compliant fund managers would benefit from established corporations issuing sukuk. This would help diversify sukuk portfolios away from Middle Eastern issuers who are often government-backed and with significant exposures to real estate, financial services, or oil and gas production.
SM: The depth and breadth of sharia-compliant assets have developed strongly in the past few years. Equities as an asset class is a prime example. However, challenges remain in the fixed-income space as the available stock in secondary markets remains limited and new issuances have been slow. Adopting globally accepted standards and structures for sukuk will help to broaden the market.
What more should be done to attract investors to sharia-compliant funds?
ZA: Investor education on sharia-compliant investments is important. For those asset classes such as equities where there is long performance history, investors need to be aware that returns are comparable to conventional investments over longer periods, although they may outperform or underperform conventional investments in the short term. Also, sharia-compliant equities are less volatile than their conventional counterparts, both in times of crisis as well as in times of stability. As such, regular sustainable and consistent education is vital.
In addition to that, global asset houses should have dedicated global sales models that can focus on regular investor education. Investors should be made aware that there are currently 600 sharia-compliant products in the global market. While the number is not a small one, there is much room for growth if compared to the 63,000 conventional mutual fund products available globally.
AE: Sharia-compliant funds are not only for Muslim investors, but for any investor seeking to generate competitive returns in an ethical manner at lower levels of volatility. Therefore, investors need to be educated about the benefits of sharia-compliant investing and its principles, which encompass lower risk, asset-backed investing in an ethical manner. Further developments and amendments in the taxation and regulatory environment will also assist in advancing this market. In addition, the emergence and establishment of global organisations of scale supported by regional and local players will drive momentum in the industry.
JK: Investor education needs to happen at all levels - those who have an interest in sharia-compliant funds, and those who distribute such products to investors. Conventional investors also need to be made aware that they too could benefit from investment in this area, and that returns in the fixed-income arena would be similar to the conventional market. In addition, sharia-compliant funds can sit alongside many of the ethical funds available as sharia prohibits speculation or investment in the production or trade of armaments and alcohol products, for example.
SM: Penetration of investment products in markets with affinity to sharia-compliant investments remains low. Emphasis needs to be placed on educating investors about the benefits of investing for the long-term, in diversified portfolios (as opposed to local real estate or local equity only) and the value addition provided by wealth and fund managers.
The issues:
- The performance of Sharia-compliant assets
- Countries ripe for sharia-compliant investment
- How the Islamic finance market can develop
- What can be done to attract investors to sharia-compliant funds
