In 2010 it seemed that the Islamic asset management industry was taking off when it recorded a 7.6% increase in its assets. But with most sharia-compliant vehicles not satisfying global industry standards, and a large number of relatively small, equity-heavy funds in the sector, growth is needed in many other directions before the industry can fulfil its potential.

With Islamic finance only really beginning to emerge at the very end of the 20th century, the focus of the industry has largely been on the creation of sharia-compliant banking institutions. Since 2002, Islamic finance has been developing at a galloping pace, culminating in a watershed moment earlier this year when global sharia assets crossed the $1000bn mark.

This has resulted in the proliferation of many areas of Islamic finance, but sharia asset management remains very much in its infancy.

Early days

The Islamic fund universe comprises of about 100 fund managers managing 765 global Islamic mutual funds – a fraction of the 60,000 equivalent conventional funds.

According to the Islamic Funds and Investment Report published by Ernst & Young in early 2010, just over half of Islamic funds had less than $50m under management and almost 70% had less than $75m at the end of 2009. At this time, conventional funds worldwide accounted for $22,000bn, compared to the $52.3bn accounted for by the global Islamic fund management industry.

Of course, a long-established fund industry should not be compared with Islamic funds, which have been trading for less than a decade. But the Islamic investment fund industry also accounts for the smallest proportion of the Islamic market, which has been dominated by products such as murabaha (cost-plus financing), bai bithaman ajil (deferred payment), Ijara (leasing), tawarruq (cash management) and sukuk (Islamic bonds).

Global sukuk has been the runaway success in Islamic finance. Last year was a record year for the asset class, with $50bn of total issuance, and by 2011 the global sukuk market was valued at about $135bn.

Heavily concentrated

John Sandwick, Geneva-based Islamic finance specialist

John Sandwick, Geneva-based Islamic finance specialist

Aside from sukuk however, Islamic finance growth has been limited. Fund products have been heavily weighted towards equities, and commodities to a lesser extent, without offering the comprehensive diversification of conventional funds, which allocate a large proportion of capital to fixed-income instruments.  

Research carried out by Malaysian bank Maybank Islamic in 2009 showed that equities comprised 54% of global Islamic funds, mixed assets and money markets a respective 15% and 17%, real estate constituted 7%, seed capital just 5% and ‘others’ represented 2%. 

“Most funds are simply a form of equity fund. But true asset management requires you to diversify across the full range of products,” says John Sandwick, a Geneva-based Islamic finance specialist, who set up the Sanad sukuk fund in 2006. “It is about choosing the assets that are best for your client on a universal basis, without concentration on a particular asset class, geography or industry. But few banks anywhere offer a full range of Islamic funds or have created a comprehensive database that enables them to methodically filter through products.”  

Mr Sandwick adds that there are particularly large gaps in the availability of products in the fixed-income and money market segments. 

Most funds are simply a form of equity fund. But true asset management requires you to diversify across the full range of products

John Sandwick

Compliance complacency

Of equal, if not greater importance, is the fact that many of the Islamic funds that are up and running do not satisfy global industry regulations. While there are more than 20,000 approved equity-related conventional mutual funds, Mr Sandwick estimates that there are not more than 35 equivalent sharia-compliant funds that meet global standards for performance, transparency and reporting.

Even well-known Western banks have been criticised for selling derivative-based structured products under the ‘Islamic asset management’ umbrella. (Most derivative contracts are prohibited in Islamic finance because of the uncertainty involved in the future delivery of the underlying asset.)

Against this backdrop, there is a clear need for investment banks and asset management firms to improve and diversify their sharia fund portfolios. However, with industry professionals now predicting that the Islamic fund industry is set to take off, there is a clear opportunity. According to Ernst & Young's 2011 funds report: “A shift was witnessed in 2010, with the number of new funds launched in alternative asset classes outnumbering traditional types.”

Meanwhile, Maybank Islamic has forecast that global Islamic funds (excluding sukuk), will achieve a compound annual growth rate of 25% between 2010 and 2013 – more than doubling them from $83bn to $170bn.

Saudi Arabia and Malaysia are by far the two largest markets for Islamic investment funds today, both in terms of the number and size of funds. But Luxembourg, Ireland and South Africa are all vying to become the next centre, with Malta also expressing an interest recently. And heavyweight Islamic banks have started directing their attention to this young market.

“Our key focus today is to facilitate the asset and fund management side of the business,” says Samad Sirohey, chief executive of Citi Islamic Investment Bank and head of global Islamic banking. “The traditional array of products in the fixed-income world may not all be do-able and convertible, but there are plenty of products that are. With banking systems now under considerable stress, there is a growing desire to channel sharia-compliant capital directly into Islamic finance opportunities without intermediation.”

Takaful potential

Nigel Denison

Nigel Denison, head of asset management, Bank of London and the Middle East

HSBC Amanah is also eyeing up the asset management sector, but with a particular focus on managing the estimated $1000bn to $1200bn of wealth in the Gulf Co-operation Council countries. These countries have accumulated substantial liquidity since the onset of the global financial crisis in 2008, as investors have sought to diversify away from a dependence on dollar-denominated instruments.

Islamic asset managers are also pinning their hopes on the future growth of pension funds and the burgeoning Islamic insurance (takaful) industry.

Global takaful premiums expanded by 31% from $6.9bn in 2009 to $9.15bn in 2010, and are expected to touch $12bn this year, compared with growth of about 15% in the conventional insurance market. With 70% of all premiums, the Gulf accounts for the lion’s share of the global takaful market. Saudi Arabia is responsible for about 80% of these due to the recent introduction of compulsory medical insurance. It is expected that other countries in the region will introduce compulsory insurance in the near future.

“The biggest gap in the Islamic finance market is in the development and use of long-term savings products such as pensions and takaful,” says Nigel Denison, head of asset management for Bank of London and the Middle East (BLME). “This comprises a very small segment compared to Europe and the US, where you have a huge pensions and savings industry. In the Middle East, that role is taken up by private wealth or sovereign wealth funds but that will gradually change.”

In conventional finance, asset management funds depend on two main types of clients – small investors, that have neither the capital nor expertise to build their own portfolios, and institutions such as pension and insurance companies. But it is the latter that drive most of the business.

The biggest gap in the Islamic finance market is in the development and use of long-term savings products such as pensions and takaful... This comprises a very small segment compared to Europe and the US

Nigel Denison

As Mr Denison points out, there is not currently a great need for private pension schemes but that will no doubt change given the young demographic bulge – two-thirds of the Middle East and north Africa (MENA) population is estimated to be under the age of 18.

However, despite the strong growth trajectory of the Islamic insurance industry, Ernest &Young estimates that it is currently worth just over 1% of the total insurance industry worldwide. Therefore, takaful products will not play anywhere near as significant a role in the funds market as conventional products do, for many years to come.

Less to invest

BLME launched a US dollar income fund back in March 2009 that invests in Islamic money market instruments, sukuk and ijara (an Islamic lease contract), and as Mr Denison acknowledges: “The challenge is in growing the size of the fund – it is smaller than $60m, which is tiny compared to conventional funds. And this is a challenge that applies to the entire industry given that 80% of Islamic funds are less than $100m in value.” 

With the majority of Islamic funds having only been set up in the past few years, it is inevitable that they are both small and illiquid, but achieving scale is even more critical to ensure long-term sustainability. As Ernst & Young notes in its 2011 funds report: “[More than] 70% of fund managers fall below the estimated break-even assets under management level of $100m; big will get bigger as the going gets tougher to win investors’ trust. The addressable universe for Islamic fund managers is in excess of $500bn, and still growing by at least 10% to 15% annually.”

The Islamic funds’ industry grew 7.6% to $58bn in 2010 which is hugely positive given its flat performance in the preceding years. However, a 10% to 15% forecast will no doubt have to be revised in light of both the prevailing Arab Spring, which has wreaked havoc on several MENA economies this year, and the continued threat of a double-dip recession – both of which are dampening investor appetite.

There is enormous room for growth but this will not happen overnight. Certainly, the fact that global Islamic banks such as Citi Islamic Investment Bank and HSBC Amanah are now talking seriously about dedicating their time and resources to asset management bodes well for the industry. 

But for now, one can only hope that newcomers to the market do not simply pile further into equity funds, but rather, seize the opportunity to innovate new products that are genuinely Islamic and generate positive returns, ultimately raising the profile and accessibility of sharia asset management across the globe.  

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