Islamic asset management mainly a retail story

Cerulli Associates, Global Edge, October 2008

Author’s note: this is one of three articles in a Global Edge special report on Islamic asset management. It was followed by an intensive, 200-page report on Islamic finance published in January 2009, with detailed proprietary data. That report cannot be published on this site but can be purchased from www.cerulli.com

The most frequently asked question about Islamic funds management is: is it just a retail story? The answer is: not entirely – but mainly. At this stage, religious conviction is far more likely to dictate investor behaviour at an individual rather than an institutional level. And this has a big impact on the distribution models that people use to reach them.

Retail is not where the really big money in the Islamic world is. This is the sovereign wealth funds, particularly in the Middle East, and a handful of extremely wealthy families, again mainly in the Middle East. This is an area of immense importance to international fund managers, who devote great effort to servicing their needs, but at this stage a track record in Shariah asset management is not considered a prerequisite to win mandates from them.

To take an obvious example: the Abu Dhabi Investment Authority purchased a $7.5 billion stake in Citigroup last November. Another: the Saudi Arabian Monetary Authority bought mandatory convertible notes bringing it a stake in UBS the following month. Clearly, there is nothing Shariah-compliant about multinational banks, particularly with large investment banking arms; the whole idea of interest is prohibited under Shariah. Outside the Gulf, Khazanah, the closest thing Malaysia has to a sovereign fund, has major stakes in CIMB of Malaysia and Bank Lippo of Indonesia, neither of them Islamic banks (though CIMB has a large Islamic subsidiary).

That said, fund managers do report an increasing number of institutions who either want Shariah compliance in some or all of their mandates, or will look at such ideas if they appear to offer good returns, diversification or an improvement of their risk profile. Sovereign funds are sophisticated and pragmatic institutions whose first priority is to deliver good returns; if that can be done with Shariah compliance, they’re quite likely to take a look.

Distribution at this end of town does not necessarily require a local presence: many banks have served institutions like these through suitcase banking for years, flying in from London or Geneva.

One step down from the sovereigns, there are some large families or institutions which do require Shariah principles. Kuwait is an example here: the Central Bank of Kuwait lists 48 Islamic investment companies as of July 2008, with combined assets of KD7.9 billion, compared to 45 conventional companies with KD10.6 billion in total assets. It is only this year that Islamic investment companies have become the majority (albeit not yet by assets). At this stage, no nation requires its institutions to follow Islamic principles, although Malaysia is said to be strongly encouraging government agencies to consider Shariah compliance in their portfolios. If this approach becomes widespread, it will require both local and international businesses to take their skills in Shariah portfolio construction more seriously.

Some suggest that, in time, retail demand for Shariah compliance will be reflected in institutions too. This theory suggests that as a pension fund culture becomes more entrenched in the Middle East, investors will expect to see some Shariah-compliant options for them. If more and more people select them, the institutions necessarily become more Shariah compliant. As shareholders, individuals are also likely to drive companies to become more shariah compliant too. This suggests a greater need for multinational fund managers to offer Shariah-compliant expertise, as the mandates from this institutional/high net worth tier (in the Middle East in particular, and in southeast Asia too to an extent, the line can be blurred) carries considerable wealth. However, multinationals have again tended to service this client base through London or Swiss offices, or perhaps increasingly through regional hubs in Bahrain or Dubai. Consequently very few foreign fund managers have built product expertise in the Middle East or Malaysia, instead staffing their presences with sales professionals.

It’s at the retail and mass affluent level that one finds the broadest appeal for Shariah-compliant product. In some markets, this is close to becoming the only way to invest, notably Saudi Arabia. All new products for retail from the biggest fund managers, NCB Capital (affiliated with National Commercial Bank) and HSBC, are Shariah-compliant, while three other providers associated with the biggest banks are 100% Islamic, including Al Rajhi, by some definitions the biggest Islamic bank in the world. It is notable that newly licensed boutique entrants in Saudi Arabia such as Jadwa Investment, Falcom and Bakheet Investment Group, have only launched Shariah-compliant funds since their inception. And this, remember, is in a country where investors at the very top end – such as Prince Alwaleed, through Kingdom Holdings – hold investments in non-Shariah businesses like Citigroup, demonstrating that the trend starts at grass-roots level, not from the top.

At the retail and mass affluent end, in the Middle East distribution is commonly done through the branches of a bank that either owns the fund manager or is affiliated with it. For example, in Saudi Arabia, until recently all mutual funds were sold through the 11 major banks in Saudi Arabia; the fund managers were part of the same institution. Even now, with the Capital Markets Authority requiring all asset management and investment banking businesses to be put in to separate businesses distinct from commercial banks, in practice they do all of their retail distribution through the branches of the banks they are linked to. There is no third party sales of these funds, and a consuming question is just how the new entrants into Saudi Arabian asset management, such as Jadwa and Falcom, are going to reach people on the ground without huge distribution networks. It is widely suggested that the arrival of all these new licensees will eventually lead to third party sales and a form of open architecture, but there is little sign of it happening yet.

In the Middle East, there is very little intermediation through financial planners or advisors, or through investment platforms, although the development of one such product in Saudi Arabia hints at progress in this area.

In Malaysia, the situation is a little different. The most successful institution in Malaysia’s retail Shariah market is Public Mutual, and has achieved its success not so much from its own branches but a large agency force, which is well keyed in to the (majority) Muslim community. Financial advisors are much more prevalent in Malaysia than in the Middle East, though direct sales are an important distribution mechanism too. In Indonesia and Pakistan, sales tend to be direct or through a related bank, but in both areas the sector is in its infancy.

For multinationals hoping to distribute Shariah product to retail and mass affluent investors, the method rather depends on who they are. Banks like HSBC, Citi and Standard Chartered have huge distribution networks in the Middle East and are able to reach a large number of end investors directly. Of those, Standard Chartered does not manufacture its own funds, Shariah or otherwise; HSBC does offer a Shariah range; and Citi offers a global equity portfolio managed by SSB Citi Asset Management.

Others tend to manufacture product and distribute them through other channels. Deutsche, for example, does this with its own Shariah range under its DWS Noor range; it can also create investment products which can be sold through a range of other sources, often under the distributor’s own names. In this approach, banks have a choice between the multinationals mentioned above with the big branch networks; selling through the big western private banks, such as Merrill Lynch, UBS or ABN Amro; or selling through local banks. Many couldn’t go direct to retail if they wanted to: businesses registered in the Dubai International Financial Centre, for example, can only sell product to people with over $1 million in investible assets.

Multinationals who do sell through local banks report quite high costs in doing so, and sometimes a lack of transparency. Some use white labelling approaches, others sell under their own name through local distribution channels.

In Malaysia, the door is wide open for foreigners thanks to the formation of the Malaysia International Islamic Financial Centre, which  invites foreign fund managers to establish fully-fledged Islamic fund management operations in Malaysia, with free mobility of funds, freedom of source of funds, no currency restrictions, and tax breaks. Fund managers from Kuwait and Singapore (Kuwait Finance House and DBS respectively) have taken advantage, while Prudential stands out for its success in raising capital there through eight Shariah retail funds, but it’s early days for these groups to establish the necessary distribution base and track record to reach Malaysian retail.