Islamic Investment Funds: Performance And Where We Are Today

Islamic investment funds represent a core component of Islamic finance’s total product portfolio. Combining an ethical, religious and commercial ethos, these funds are growing in size, profitability and popularity. Rizwan Malik compares Islamic funds with their counterparts and finds the Islamic fund proposition a tantalizing one for investors.

 

Islamic funds are still at their fledgling stage, as compared to Conventional and Socially Responsible Investment funds both in terms of Assets under Management (AUM) and growth in the market. According to Ernst & Young’s Investment Funds and Investments Report 2011, Islamic funds assets have reached $58 billion. Islamic funds witnessed a 7.6 percent growth in 2010- compared to 35 percent for its conventional counterparts- with $25.6 trillion AUM. However, it has been identified by many researchers that Islamic funds perform better in a bearish market whereas conventional funds tend to perform better in a bullish market.

Previous studies show positive results

Islamic funds started in the 1960s with an express remit to only invest in Shari’a permissible assets. These funds go through a strict screening process by experts similar to the scrupulous rigour of Socially Responsible Investments (SRI) funds, but unlike the conventional whose screening is much less meticulous. There are two types of screenings Islamic funds go through: business screening and financial screening. The business screening process looks to avoid companies which are deemed non-Shari’a compliant in terms of business activity. Financial screening is based on the financial performance of the company, paying close attention to its debt position and interest payments and receipts.

There have been many studies conducted comparing the performance of the conventional, Islamic and SRI funds and yet no definitive conclusion can be made. Certain studies concluded that the performance of Islamic mutual funds is no different to the performance of conventional funds while other studies found that Islamic funds performed better. One consideration is domicile, and studies have shown that in countries such as Malaysia, Islamic funds tend to perform better.

A comprehensive study was conducted in 2009 in which the authors carried out research on the performance and investment style of Islamic equity funds from 20 countries in five different regions, spanning over two decades. The study analyses the performance of 262 equity funds. The study revealed that in Western

markets, Islamic equity funds appear to underperform as compared to their conventional counterparts on average. Islamic funds have a limited stock universe to invest in. In contrast, Islamic funds from countries with significant Muslim populations perform similarly

to conventional funds. This underperformance of Islamic funds in the West was due to the fact that there is a lower Muslim population in these countries and thus, lower uptake. Nonetheless, the awareness of Islamic products is increasing amongst Muslims and non-Muslims, especially after the market downturn in which Islamic products were not as gravely affected as compared to conventional and SRI.

Professor Rodney Wilson found in his research that by placing restrictions on their investment choices, ethical investors can reduce the opportunities available to them. However, SRI fund managers still maintain that even with the limitations, they still have a lot of companies to invest in. It is argued that it is possible to invest in SRI funds and receive a higher return than non-SRI funds due to the fact that it all depends on the ability of the fund manager to pick the right stocks that will give better returns.

With respect to Islamic funds, contracts underpinning the fund are transparent; therefore it is easy to trace and track the performance of Islamic funds. Islamic mutual funds do not invest in highly un- certain products and take a calculated risk according to their risk appetite. But, with a diversified portfolio the more investment choices an investor has, the more chances of making a higher return. On a performance basis, the All Country World Islamic Index has outperformed its conventional counterpart this year, according to data from MSCI. The Islamic index fell 14.6 percent, compared with a 15.8 percent drop by the All Country World Standard Core Index.

Similarities and differences amongst the conventional, SRI and Islamic funds:

Similarities:

funds and have similar characteristics in terms of investing.

Differences:

Islamic fund performance

The growth of Islamic funds has been flat since the end of 2008 up till 2010 with 153 funds liquidated and only 69 new funds launched. The growth of 7.6 per cent was primarily driven by market performance, and only marginally from new net money raised by fund managers. While the funds performed better in 2010, it is highly doubtful that Islamic funds would have re- peated their performance in 2011-12 due to the political situation in the MENA region and the sovereign debt crisis in Europe which is testing the market confidence once again in the year 2012. When we analyze the different sectors we see for the new funds launched between 2008 and 2010, institutional funds make up two-thirds of the total funds launched globally, although this is not considering Malaysia. This can be regarded as a structural weakness as well as an overdependence on some institutional investors. Another weakness of the Islamic fund

industry is the actual size of investment available to the fund managers: only 30 percent of fund managers have more than $100m in AUM and the top 10 of the 30 percent have 80 per cent

of the market share. Institutional investors look at the size of the fund rather than the performance of the fund in deciding where to invest. Coupled with this, the Islamic fund market is at its embryonic stages and has fewer avenues to channel investment. The top 25 conventional fund managers are 50 times larger than the largest Islamic fund manager. It is like a 10-year-old being asked to bat against Saeed Ajmal; of course, he is not going to score much. For sustainability and long-term growth, four factors need to be present: involvement of institutional players, asset managers’ strong performance and track record, availability and distribution of products, and passage of time. Further, the industry needs an improvement in the regulatory environment although Saudi Arabia is one example where the regulatory response has helped the industry tremendously.

It is clear that although the size of the Islamic funds industry remains an issue, when it comes to the performance of the funds against the conventional and SRI counterparts, in some cases, Islamic funds have outperformed the rest. While Islamic funds have faced a recent period of flat growth as the market improves, there remain opportunities for growth and with the increased awareness of Islamic finance and the large cash pool sitting in big Muslim states like Saudi Arabia and Qatar, there is an expectation that there will be an explosion of Islamic funds.

Attracting the conventional with aplomb Conventional fund managers managing student property in UK and the

West are looking at launching Islamic funds with the aim that they will tap into the capital in Saudi Arabia, Qatar, Malaysia, Brunei etc. Such funds do not give a very high return, however, they are stable and give a consistent return throughout the vicissitudes of market conditions. Even during market downturns, these funds give a stable return, in essence making it attractive for a risk-averse investor as they remain stable in bear markets. This will be attractive to risk-taking investors only in tough market conditions as they tend to invest in higher return investments in a bullish market. Nevertheless, such type of property funds can be made attractive by adding a development feature to the fund where there is

room for improved performance in future. If we take the aforementioned example, a fund manager managing student property may buy other pieces of land to develop more property. The scope has therefore increased which, in the event more students choose to rent the property, will lead to improved performance in the fund.

Like the Islamic fund

industry, the Islamic finance industry as a whole has high growth prospects, especially with the entrance of new jurisdictions like Kazakhstan, Malta and several African nations driven by an increasingly affluent population, a vibrant commercial sector and policies that encourage expansion. Islamic finance is not only for Muslims; it should be a business decision based on business reasons and should not only be a faith-based decision. In the last few decades, the Is- lambic finance industry has only prospered in countries with a predominantly Muslim population but it is only a matter of time. Increased awareness and resilient performance during market downturns are pulling the crowd towards Islamic finance as an alternative model which is safer and transparent in nature. One recent example witnessed is a poster carried by a woman near the London Stock Exchange (LSE) which read “Let’s Bank the Muslim Way”. Islamic finance had entered the Occupy movement, where a wave of protests by ordinary people in different cities around the world took form, campaigning against the excessive greed of bankers and the inefficacy of regulators and politicians in dealing with the financial crisis. The woman, who looked non-Muslim, obviously recognized Islamic banking as an alternative financial system which connects banking and fi- nance to real economic activities and

prohibits receiving and paying interest (Riba) and also speculative activities based on gambling; both of which underpinned the global financial crisis in 2008. Further, the finance Minister of Luxembourg (a hub and haven for Islamic funds) Luc Frieden declared during his tour of the ASEAN region in October 2011 that “Europe can in- deed learn a lot from Islamic finance through its principles of financial partnership between the creditor and debtor; the absence of speculation and respect for ethical principles”. He also mentioned the willingness of the Luxembourg government to develop Islamic finance as part of the national strategy for diversification and internationalization of Luxembourg as a major financial centre. Frieden continued: “Islamic finance has garnered growing interest from the international financial community, mainly because of the stability it has shown throughout the financial crisis. Islamic finance is now a component of more and more importance in a diversified portfolio of assets. Working together we enrich our cultures and use our various financial products to contribute to the prosperity of all humanity”.