Islamic funds seem to have been left in the shade, eclipsed by the progress made by the rest of the Islamic finance industry. Isla MacFarlane explores ways for the Islamic funds industry to step out of the shadows and enjoy the success of the rest of the industry.
Islamic funds have had a hard time of it. Despite the vast economic strides made by the Islamic finance industry, the Islamic funds industry has failed to follow in its footsteps. The recently published Islamic Funds & Investments Report 2010 by Ernst & Young (see page 18 of this magazine) revealed that global Islamic fund assets barely grew in size at $52.3 billion in 2009, compared to $51.4 billion in 2008. To pour salt in the wound, the global conventional fund industry is beginning to exhibit signs of recovery from its lows of $19 trillion in 2008, reaching $22 trillion in 2009.
However, there is some cause for cheer. The Shari'ah funds industry might be crippled, but institutional investors can put the spring back into its step. Even as an alarming number of Shari'ah funds are liquidated - no less than 27 funds were liquidated out of the 29 that were launched in 2009 - there are funds that have managed to flourish by having institutional 'cornerstone' investors.
In early June, the world's first Shari'ah-compliant data-centre fund, the Securus Data Property Fund, had an initial closing with $100 million from Middle Eastern and Asian institutional investors including Perbadanan Tabung Amanah Islam Brunei as a cornerstone investor. The fund is co-sponsored by Keppel Telecommunications & Transportation, a subsidiary of Keppel Corp, in which Temasek has a 21 per cent stake. The other co-sponsor is a company of Saudi Arabia's Al Rajhi Group. The fund's initial closing of $100 million exceeds most Islamic funds' assets under management.
And there's more good news. Research has shown that overall Shari'ah-sensitive investable assets have grown, and that the Shari'ah-compliant investable wealth pool grew about 20 per cent to $480 billion in 2009, with the GCC being the biggest contributor. This means that there are substantial untapped opportunities for the savvy Islamic fund manager who can understand and respond to their investors' new, post-crisis needs.
Investor needs
But how exactly have investor's needs changed? According to Capgemini and Merrill Lynch's annual World Wealth Report 2009, post-crisis investor appetites have shifted away from fund investments in traditional asset classes, such as equities, to safer and more tangible investments such as fixed income and cash deposits.
Since 2008, approximately 50 per cent of investments were classified as low margin asset classes compared to 35 per cent in 2006 prior to the global crisis. High net worth individuals (HNWI) are seeking safer and more tangible investments, as wealth is being allocated to fixed income and cash deposits. However, according to Raja Teh Maimunah, Global Head of Islamic markets at Bursa Malaysia, Islamic fund managers have failed to respond to this change.
He said, "We are still dominant in equities; we do real estate and Sukuk funds. What have we done to respond to the change in investor behaviour following the crisis? Nothing yet."
Globally there are 671 Islamic funds valued at $64.2 billion, consisting of 49 per cent equity funds, 17 per cent mixed funds and 11 per cent money markets. Kuwait Finance House Research suggests that one reason for choosing equity above others is that equities are more liquid and have extensive company and sector coverage from brokers.
However, this trend is set to change in the future. According to Ernst & Young, mass affluent investors are expected to lower allocations in cash/money market funds in favour of riskier investments. It explained that 2009 saw a panicked shift by the mass affluent towards liquid, short-term and safe assets. In the wake of improved market performance and economic recovery, this segment is expected to seek higher exposure to equities and fixed income products in 2010. Nonetheless, the mass affluent being the most cautious segment, is expected to take a 12-24 month period to return to the pre-crisis risk-return profile.
Alternatives
Similarly, HNWI/UHNWIs are expected to shift towards riskier assets. According to Ernst & Young, 2009 saw a tactical allocation shift by UHNWIs/HNWIs towards more liquid investments in the face of market uncertainties. As the market stabilises in 2010, allocation to higher return asset classes including equities and private equity, among other alternatives, is expected to increase.
However, alternatives are scarce in an industry where such innovation has yet to achieve global acceptability. Jarmo Kotilaine, the Chief Economist of NCB Capital, said, "These alternative asset classes are almost remote; the absence of these products barely provides choices or alternatives to the GCC investor."
According to Teh, Islamic fund managers should improve plain vanilla products and consider defensive instruments, such as Ijarah structures, which are predominantly issued through Sukuk structures. He said, "There is more to Ijarah structures. We could have a lot more Ijarah funds such as shipping leases or aviation leases, [which are] very defensive in nature, and far better than fixed income or deposits."
However, Monem Salam, Director of Islamic investing and Deputy Portfolio Manager at Saturna Capital, does not agree, and believes that Islamic fund managers should move away from the idea of product sophistication and go back to basics. He said, "We're so caught up with innovation and coming up with the newest products, but what good are these products when the retail investor doesn't understand them?"
The answer is probably a bit of both. Ernst &Young's report confirmed that institutions with the broadest product set tended to outperform during the crisis, as they could offer clients more alternatives. According to Ernst & Young, many asset managers are now seeking to add a broader array of products through joint ventures or white labeling to be able to meet their clients' investment needs.
FEES
So, clients are demanding a greater choice of financial products that best meet their wealth management needs, and what's more, they are not prepared to pay as much for it. Ernst & Young highlighted that clients are demanding more for their money, which includes not standing for the high fees. Therefore managers will have to be creative about their offering as well as cost/price structures.
In addition to negotiating on fees, clients are asking for the provision of a lot more detailed information on the investments within the fund and justification for purchase as well as supporting evidence for any expected returns.
Ernst & Young suggested that the fixed management fee and incentive fee (fee charged over a defined hurdle rate) structure that funds have typically levied will no longer be applicable in the current economic environment. In addition, the growth of lower-cost alternatives such as ETFs and the pressure by institutional investors to cut costs is forcing changes in the fee structure, moving away from the proprietary model towards an open architecture approach.
Of course, just like clients, fund managers are also keen to save money. Maznah Mahbob, the Chief Executive of AmInvestment Bank Group funds management division, believes that regulators should consider collaboration to establish a platform in a more cost-effective jurisdiction.
He said, "A platform such as the one available in Luxembourg is costly. And for Islamic fund managers, cost is a huge factor. The larger distributors can take advantage of Luxembourg or Dublin, but what about the smaller managers who can't bear the cost? This could be an alternative that would help fledgling Islamic fund management companies gain footing during this particular phase of development of the Islamic fund management industry until they reach critical mass and start performing."
According to Mahbob, an established platform can allow the Islamic fund industry to access multiple distribution channels through retail and private banking networks or independent funds in order to market themselves efficiently. Because such a trading platform would ensure that funds are listed, it would create a more transparent and streamlined transaction practice, which in turn creates faster traction.
However, arguably the biggest challenge that Islamic fund managers are facing is regaining the trust of clients, which, according to Ernst & Young, has been has shaken to the core over the last year. Due to the losses suffered, investors have lost confidence in their investment managers who promised returns they could not deliver.
So how can they win it back? According to Ernst & Young, with strong customer relationship management and greater transparency. Ernst & Young said that the fundamentals of asset management must be handled with unflagging professionalism; rebuilding trust is going to take some time and will not be accomplished without a sustained and serious effort by all stakeholders including managers, regulators and governments. It is as simple, and as difficult, as that.
© Islamic Business and Finance 2010
