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Country reportsNovember 1 2013

Where does asset management fit in the Islamic finance picture?

The growth that has characterised the rise of the Islamic finance industry has thus far evaded the asset management segment of the market, with a dearth of institutions focused on the creation of sharia-compliant investment products. John A Sandwick of Islamic Wealth & Asset Management assesses the situation.
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Asset management is the often forgotten sector of Islamic finance. Its development pales compared to the enormous strides made elsewhere in the Islamic banking industry, where substantial advances have been made in competitiveness, customer satisfaction and transaction volumes. Much is written in the Islamic finance press about waves of popularity in Islamic private equity, microfinance and sukuk. We rarely or never read about broad, common interest in Islamic asset management. Walking through the history and structure of the Islamic finance industry can help to explain why.

Some say the Islamic finance industry was born in 1975 with the opening of Dubai Islamic Bank (DIB), followed the next year by Bahrain Islamic Bank (BIB). However, one can argue that establishing a foothold in the somewhat primitive realm of retail banking is not much to crow about. More complex services are required to give credence to the birth of an entirely new industry.

While the establishment and mandate of DIB and BIB was admirable, retail banking is just one of the five major sectors of Islamic finance. But it took a long time to diversify beyond a single sector and develop more complex financial services.

A slow evolution

Any financial industry – whether Islamic or not – needs to have specialised services available for all potential needs, especially as economies grow more complex and financial intermediation needs to fulfil customer demands. Therefore, an economy’s financial services industry should ultimately cover the five fields outlined in the table, in order to reasonably provide intermediation between savers and users of capital.

After the establishment of retail banking, company banking services soon followed. But the more advanced forms of banking that are common in developed economies did not begin until the very late 1990s and early 2000s. Thinking of it this way, the global Islamic finance industry we know today is less than 15 years old.

The late 1990s saw the establishment of the first wholly Islamic investment banks, capable of delivering professionally packaged private equity deals to a market hungry for sharia-compliant investments. Bahrain's Arcapita (then called First Islamic Bank) and Gulf Finance House – established in 1996 and 1999, respectively – launched close to $30bn in private equity deals.

Then came the world’s first global sukuk – the first sharia-compliant cross-border fixed-income security. Since this first issue by the Malaysian government in 2000, total sukuk issued in the past 14 years – both redeemed and still outstanding – numbers somewhere near the $1000bn mark. Along with more complex project finance deal structuring, advances in sharia-purifying legal contracts, and an enormous bank treasury market hungry for mid-term sharia-compliant fixed income, the Islamic corporate finance and investment banking markets rapidly rose to prominence and were well established by the late 2000s.

Narrow base

Today, one can reasonably conclude the first four sectors of Islamic banking are highly developed, economically efficient and serve customer needs on a par with any comparative service from conventional banking. The development of the fifth category of Islamic finance – Islamic asset management – lags far behind these other four. Looking at the global conventional asset management industry and comparing it to Islamic asset management is equivalent to comparing an elephant to a mouse. The differences in scale are initially obvious, but the differences are even greater in terms of sophistication, complexity and resource allocations.

After surveying the Islamic banking industry, one cannot find a dedicated asset management unit anywhere, either in Malaysia, Saudi Arabia or London. There are units carrying the asset management title, but a lifting of the lid shows they are not in fact performing classic asset management services. Rather, they exercise one proportion of asset management, leaving the rest behind.

Asset management is a service provided for capital savers (for example, individuals, pension funds, insurance companies, endowments and foundations) that seek professional asset allocation, security selection and monitoring of a portfolio of assets.

Creating investment products is a subset of the global asset management industry, feeding managers with the securities they need to fill client portfolios. Mutual funds, a favoured vehicle in asset allocation, are therefore not by themselves 'asset management', but an underlying part of the asset management industry. The same is true for private equity funds, commodity funds, exchange-traded funds (ETFs), and the like.

The global mutual fund industry now counts more than $26,000bn in assets under management (AUM), and more than 73,000 individual investment funds. Choice in every asset category is abundant. In comparison, Islamic mutual funds (and ETFs) number only about 800 with not more than $100bn in AUM. Choice is highly restricted.

Greatly outnumbered

Malaysia and Saudi Arabia are prominent sources of sharia-compliant investment products. The two countries have the most evolved Islamic mutual fund industries in the world, with the former currently hosting more than $11bn and the latter more than $12bn in sharia-compliant AUM. These are impressive numbers until one considers the role of sharia-compliant funds in overall AUM and national savings. In Malaysia, home to perhaps the world’s most actively government-supported Islamic finance industry, Islamic fund AUM is still less than 12% of total mutual fund AUM. 

In Saudi Arabia, Islamic funds captured a more impressive 50% share of total AUM, but this should be seen in the context of total savings, where AUM in private equity funds leaped nearly 70% in 2012. Managed AUM in private equity funds equals one-third of mutual fund AUM, or three times the ratio of global private equity AUM to global mutual fund AUM (11%). In other words, both the Malaysian and Saudi mutual funds sectors reflect markets that are each in their own way underdeveloped and imbalanced.

The Malaysian government’s decade-long push to mature and increase the importance of Islamic investment products has yielded benefits, but is not yet measurably impressive when compared with the total size of the managed asset market. Saudi Arabia’s mutual fund sector AUM is a meagre 4% of gross domestic product, while in much of the developed and developing worlds, the figures are much higher (8% in India, 18% in Thailand, 40% in Brazil, 50% in France, 52% in Malaysia and 77% in the US). Even more oddly, private equity is gaining the lion’s share of net new money in Saudi Arabia.

The firms delivering mutual funds in these two economies are mainly universal banks, such as CIMB in Malaysia and National Commercial Bank in Saudi Arabia. But what are these universal banks – and the parallel independent investment companies – doing to improve or promote sharia-compliant mutual funds in the core Islamic asset markets? Given the statistics above and below it appears the answer is 'very little'.

In Saudi Arabia there are 11 domestic banks with licensed investment subsidiaries, and 73 licensed independent investment companies, for a total of 84 active investment houses. A quick survey of these shows virtually none perform asset management as defined above. 

Some have impressive mutual funds units, such as Al Rajhi Capital or NCB Capital. But none perform global sharia-compliant asset allocation for domestic or foreign clients. Instead, they are mostly competing in the local real estate fund market, where almost half of all private equity funds are focused on real estate project investments, outnumbering even local corporate private equity funds.

To give this even more meaning, private equity real estate funds went from AUM levels just below corporate private equity in 2011, to almost double in 2012. And, Saudi public mutual funds had more AUM than all private equity funds in 2011, but by 2012 were only two-thirds of their illiquid brethren. In other words, the resources of Saudi Arabia’s investment sector seem overwhelmingly invested in illiquid, long-term, highly risky private equity, and within that sector, mostly in real estate.

Where does asset management fit in the Islamic finance picture

Enormous potential

This brings us to the question, why care? If the domestic Saudi market is overwhelmingly invested in private equity (with a majority of that in real estate), and Malaysia’s market is overwhelmingly not sharia-compliant even after a decade of government endorsements, then why would anyone want to invest scarce resources into Islamic asset management?

The answer is clear: today Muslim-owned assets under management in global liquid markets must be at least $3500bn, and perhaps more. We know already that nearly none of this is invested according to sharia, and there are increasingly close links between Muslim consumption and Islamic values.

Recent research conducted by bespoke Islamic branding practice Ogilvy Noor indicates a high degree of affiliation between Muslim consumers and any product or service they deem sharia-friendly or sharia-compliant, lending weight to the argument that Muslims respect the sharia (the moral code and religious law of Islam) and want to benefit from adherence to sharia in all aspects of their lives.

'Islamic branding' is now considered a key concept in delivering any kind of product or service to Muslim communities, whether in countries with Muslim majorities or minorities. Ubiquitous financial services are going to be among the first sectors to conform to Muslim tastes and preferences. The Malaysians got it right: build an Islamic asset management industry from the ground up, support it over time, and wait for the 'brand' to gain ever more customer loyalty.

With at least $3500bn at stake, asset managers everywhere should take note.

John A Sandwick is manager of Safa Investment Services at Islamic Wealth & Asset Management (Iwamsa) in Geneva. Iwamsa is a unit of Saudi Arabia-based the Investor for Securities Company.

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