Euromoney GCC asset management guide: product
1 June, 2008Euromoney GCC asset management guide: strategy
1 June, 2008This article is one of seven that makes up the Euromoney Guide to Asset Management in the GCC, distributed with Euromoney magazine in June 2008
Some remarkable numbers are thrown around about the global Islamic finance industry, though debate rages as to how reliable they are; commonly cited figures are US$500 billion in managed assets, and a growth rate of 15 to 20%, underpinned by almost 300 institutions.
So if that’s the case, why isn’t every international fund manager trying to sell Shariah-compliant versions of their global equity products to high net worth people in the Gulf?
It’s one of the complications of this fascinating area. Shariah-compliant investment is clearly of immense importance, but opinion is enormously divided on how to quantify it. At a regional level, it is clearly well entrenched; in Saudi Arabia, 53% of funds, and 72% per cent of assets, are Shariah compliant. That country alone accounted for 103 Shariah-compliant funds at the end of 2007, according to Tadawul, Saudi Arabia’s stock exchange. In most other markets Shariah funds are a minority, but are still a highly important chunk of the market: 87 funds running US$1.3 billion in Bahrain; 33% of the Qatar market, and 30% in each of Kuwait and the UAE. So where are the foreigners?
One easy conclusion is that foreign managers chiefly service institutions, and particularly sovereign wealth funds, who appear to have little interest in Shariah compliant mandates. Take a look at the stakes taken by groups like ADIA, or by Saudi Arabia’s Prince Alwaleed, in international investments banks like Citigroup and UBS. There’s nothing Shariah-compliant about an American or Swiss investment bank, clearly. “KIA will not for the heck of it invest in a Shariah-compliant company, but if the banks have a good local fund which invests in good local companies [and happens to be Shariah compliant] that may tickle their interest,” says one Kuwaiti fund manager.
Consequently some fund managers show little enthusiasm for putting heavy resources into this area. “We see Islamic product as an area where the local banks have more interest at the moment,” says Nick Tolchard at Invesco. “We are able to run portfolios against an Islamic screen, but we are not necessarily going to go into the market with a full set of Islamic retail products. There’s plenty of business to be had in our more conventional product areas.” Another major western fund manager expresses a similar view. “If they
But some fund managers do report increasing interest on the part of Middle Eastern institutions in Shariah compliant products. “I believe it’s a strong institutional story,” says Scott Callander at Axa, although he does add the caveat that the enthusiasm relates to particular asset classes. “We’ve seen an almost exponential rise in the number of real estate transactions under Shariah compliance,” he says. “From the nature of the assets through the tenants to the structure, they are all compliant.” Private equity is another area of interest, as is sukuk, which Callander says “will probably be one of the fundamental building blocks for the capital markets in the region.” Infrastructure is another area of growth in Islamic finance. “There’s increasing appetite to attract external capital into the region and I don’t think that’s going to go away, it’s a key future trend in the development of the region.”
“It’s a retail product, it’s a high net worth private client product, and it’s a corporate product,” says Douglas Hansen-Luke at Robeco in Bahrain. “Any Muslim who is offered an Islamic alternative and is offered a conventional alternative, they are virtually duty bound to accept the Islamic one if it doesn’t leave them worse off.” That accounts for the growing retail presence, which may in turn drive institutional interest as well. Sami Abdo at NCB Capital in Saudi Arabia, one of the leaders in Shariah compliant mutual funds, says “the majority [of demand] is from individuals” but adds: “One feeds into the other. The more individuals demand Islamic, the more they put pressure on companies to become Islamic. Shareholders will have an influence.”
One fund manager believes the time is not far away when shareholder activism becomes prominent in the Gulf, “and good corporate governance, to them, will mean financing themselves and investing in an Islamic way. Shareholder activists will look at the accounts of, say, Sabic, and say: have you borrowed your money in a way that is Islamic?” He also expects that when a pension fund industry really takes root, pensions are likely to have to offer a choice of conventional and Islamic options, and that the Islamic ones will be the ones that thrive.
Besides, there are signs that this could be the year when foreign institutions finally see enough interest in Shariah products to launch their own. At Franklin Templeton, Harshendu Bindal says he is “evaluating that offering quite seriously. We feel that this is something we are going to add to,” though he stresses it is a “work in progress.”
On the face of it it seems the simplest thing for a foreign manager to launch a Shariah version of its global funds. In equities, surely all one has to do is put a screen through it to keep out stocks in unIslamic sectors like alcohol, and to remove inappropriate levels of interest and gearing? Bindal challenges this. “You’re building a whole infrastructure,” he says. “It sounds very simple, but when you want to do it in a globally portable manner – so not for one or two markets, but for every distribution channel – it’s not easy. If we believe we can get economies of scale and can come out with a product that is available for global consumption, we will take the next step.”
Daniel Smaller at Algebra Capital takes a similar view. “Larger asset management groups are maybe not set up to distribute to that client base. The whole marketing approach, setting up a Shariah board; they don’t have experience in that. And it’s not just running a screen. When a fund manager has been running a global equity portfolio and all of a sudden you take away 30% of his stocks, it causes a rethink in his investment process.”
Those multinationals who have tried to launch Shariah products are in something of a minority: DWS, for Deutsche Bank, has done so, and HSBC Amanah. Most other Shariah products from multinationals don’t actually come from the fund management part of the business, but the investment banking arm, and are structured products rather than funds; UBS is an example. Others in the market feel that the Shariah funds “haven’t raised significant assets.”
But where do those economies of scale lie? How much demand is enough to make it worth the while of a Fidelity or a Prudential or an Invesco to make a Shariah product line? “We have a technical number that is very small – every fund class has a certain minimum – but what we look at is: is this really economically viable from a longer term perspective?” Bindal says. “If my strategy is to come out with one fund and say can this be made viable, the math is very different to coming up with a product line. We are working towards the second scenario. So to say we want to do a fund therefore we need 50 or 100 or 200 million, it’s not what we’re trying to achieve.”
For local managers, though, Shariah funds are bread and better. “There is huge demand, in Kuwait and the GCC region, for all types of Shariah compliant funds and products, from retail and from institutional investors,” says Joel D’Souza. “Many new Islamic investment companies are coming up now in the region and these entities cannot invest in or offer non-Shariah compliant funds and products.” Kuwait hosts one of the world’s biggest Islamic financial institutions, Kuwait Finance House. In Saudi Arabia, there are already three entirely Islamic banks (Al Rajhi, Bank Albilad and Bank Al-Jazira) which obviously only sell Islamic product; many of the bigger conventional managers like NCB Capital and SABB are focusing almost entirely on Shariah products for new launches, particularly in equities.
And even when internationals do finally bite the bullet and launch a Shariah range, that’s not going to impede on local managers: locals will offer GCC or single country funds, and multinationals will offer Shariah compliant versions of their existing global products.
One interesting area of Islamic finance is the sukuk market. A sukuk is an Islamic bond, and they represent a sophisticated market for issuance and pay an attractive yield. Everyone would like to hold them, and that’s the problem: they almost never trade.
That’s the biggest reason sukuk funds have been slow to appear, although a few are now underway. The first two came from newly established fund managers in Saudi Arabia, Falcom Investments and Jadwa Investments. Jadwa gets around the liquidity issues by buying up sukuk at a proprietary level whenever they become available, and then selling them on to the fund as demand requires. Next off the rank will be Algebra Capital, with its own sukuk fund due in May. Another challenge for these funds is that views on Shariah compliance vary across the world: Malaysia has a vibrant sukuk fund but because of the underlying assets, they are often not considered compliant by Middle Eastern Shariah scholars. It is understood Saudi Arabia’s Al Rajhi Bank would have launched such a fund years ago if it could get enough securities past its Shariah advisory panel.
Instead, the bulk of Islamic debt securities use a structure called murabaha, and their closest equivalent in conventional finance is money market. These funds are particularly popular in Saudi Arabia, and some of the largest individual funds in the whole Middle East fall into this category.
