Shariah-compliant market tests perceptions

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 $500 billion in managed assets, and a growth rate of 15–20%, 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 $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 [clients] ask us for Shariah compliant products we can certainly cater for them. But at the sovereign wealth or pension fund level the need for Shariah-compliant funds is not strong. It’s growing much more within the core affluent, high-net-worth area of private individuals."

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."

Foreign managers’ views on Shariah offerings, 2007

Source: EIU, QFC Authority

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 un-Islamic 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."