Secular trends underline long-term growth for Islamic asset management
This article was first published in Islamic Finance news Volume 17 Issue 41 dated the 14th October 2020
S&P global ratings expects Islamic finance industry (USD 2.4trillion) to witness subdued growth in low single digits for 2020/21 after registering strong growth of 11.4% the previous year, on the back of robust issuance and strong performance of Sukuk. We expect Islamic funds, which accounts for 4% of the overall Islamic finance industry, to fare better than industry as the demand for shariah compliant assets are on rise following their outperformance over conventional peers and favorable tailwinds such as development of new products, and increased regulatory support.
Islamic Asset Management Landscape: An Overview
Islamic asset management industry as evidenced by Islamic funds currently stands at approx. USD 100billion that is spread over 1,700+ funds including equity mutual funds, money market/trade finance, sukuk, and Exchange Traded Funds (ETFs). However, the Assets under Management (AuM) remain concentrated within the markets of Iran, Malaysia and Saudi Arabia accounting for more than three-fourths of the total AuM.
The stock markets have performed poorly and the economic outlook for core Islamic markets such as Middle East and North Africa (MENA) and Southeast Asian countries remains worrisome. However, expanding investor base, outperformance over conventional funds, increasing investor preference for Environmental, Social, and Corporate Governance (ESG) funds and Socially Responsible Investing (SRI) funds, introduction of new products and regulatory support could support the development of Islamic asset management industry.
- For Kuwait, Oil accounts for 86% of its total exports – highest among GCC countries.
- Saudi Arabia has improved its position the most – surging past 30 countries, in Ease of Doing Business rankings for 2020.
- UAE could continue to enjoy surplus trade position in 2020.
Shariah funds outperform conventional peers during COVID-19
Performance of most funds, shariah and conventional, took a hit in March 2020 as markets worldwide plunged. Global economic activity came to a sudden halt following imposition of strict lockdowns and closing of international borders, to prevent movement of people in a bid to contain the spread of COVID-19, throughout the world. However, shariah funds were able to outperform their conventional peers, as they lack exposure to conventional banking, and entertainment industry (alcohol, gambling, tobacco, and cinema) – businesses that took a big hit due to the lockdowns. Consequently, overweighting sectors such as technology and defensive sectors including telecom and healthcare have led shariah funds to outperform conventional funds. For instance, Islamic Global Equity Fund has returned 20.6% for the year, as of September-end while its conventional counterpart Global Equity fund has managed to return only 5.4% for the year (Data shown for HSBC Fund).
Improved and better performance of shariah funds could perpetuate fresh inflows in the short-run and entice new set of investors, not limited to those seeking shariah-compliant solutions. The trend could be evident among retail investors who typically act by buying into the best performing funds. This presents an opportunity for retail Islamic asset managers to attain scale that is most sought after in the fund management business.
Incentivizing retail participation in Sukuk
Recent sovereign sukuk issuances from the GCC countries witnessed enthused response from international investors, including pension funds and insurance funds. However, retail participation have remained minimal due to various challenges including complex sukuk structures, larger issue size and difficulty in acquiring them in primary/secondary market. Minimizing issue size, enhancing disclosures to improve transparency and increasing the range of sukuk that could be offered for retail investors could incentivize their participation. Having wide-ranging options in fixed income helps in portfolio diversification and shall boost returns to meet investor objectives.
Islamic ETFs: An Emerging Opportunity
ETFs being passive in nature act as low cost, easy-to-access investment option. In conventional landscape, they have grown to be the leading choice of investment vehicle for retail investors. However, ETFs remain a small proportion – amounting to less than 10% of overall AuM in the Islamic fund landscape offering immense potential for growth. The largest single country Islamic ETF was launched in 2018, Al Rayan Qatar ETF with assets of USD 120million – to capitalize on foreigners interest post the upgradation of Qatar market into MSCI Emerging Market Index. Similar such initiatives could be a source of opportunity for Islamic asset managers to widen their product offering globally.
Considering a flurry of sukuk issuance, both from sovereign and corporates especially in the GCC region, establishing ETF vehicles for sukuk could make it easier for retail participation. In August 2019, Al-Bilad Investment Company established an open-ended ETF that seeks to track the performance of Saudi Sovereign Sukuk Index.
Riding the ESG wave for better positioning and reach
Islamic investments apply negative filters on business activities that are haram (prohibited) by shariah principles. These include ‘sin’ businesses such as conventional lending (banking and financial institutions), entertainment industries (gambling, alcohol, tobacco, music, and cinema), arms and defense companies. They also apply financial screens and prohibit investments in firms that have high debt and those that receive interest income.
Investors are increasingly paying attention to incorporate ESG component in their portfolios. Shariah compliant investments naturally overlap with ESG and SRI requirements. This could allow Islamic asset managers to tap a wider investor base outside of traditional target markets.
To conclude, Islamic retail asset management offers immense opportunities in terms of product development, expansion into new markets, and widened investor base. We believe that the favorable tail winds and regulatory support, along with stronger thrust on social nature of the Islamic industry could extend the growth story for years to come.