This chapter will look at the state of the Islamic asset management industry. It will question whether enough is being done to offer investment products that genuinely meet the investors’ needs. And it will demonstrate that the next generation of Islamic asset management will be built on the integration of Environment, Social, and Governance (ESG) information into the Islamic investment process. In reaching this conclusion, it will demonstrate that such an approach will bring Islamic investing in line with innovations in conventional investing, and also bring Islamic asset management closer to the spirit of Islam.
Muslim Population and Islamic Funds
One of the most common perceptions in relation to Islamic wealth management is that, globally, Muslim wealth — including the sovereign wealth funds of Islamic countries — is not being invested into Islamic funds. This should be a wakeup call to Islamic fund managers.
One of the most common perceptions in relation to Islamic wealth management is that, globally, Muslim wealth — including the sovereign wealth funds of Islamic countries — is not being invested into Islamic funds. This should be a wakeup call to Islamic fund managers.
At the same time, Boston Consulting’s Global Wealth Report 2015 observes that private wealth in the Middle East and Africa — regions which are predominantly Muslim — is approximately US$9 trillion2. It also states that private wealth in the Asia Pacific region (excluding Japan) rose to US$47 trillion in 2014. This is relevant given that the Pew Research Centre has reported that in 2010 a staggering 61.7% of the world’s Muslims are from the Asia Pacific region.
Whilst a direct link between these Muslim population and regional wealth figures cannot be accurately made, it is self-evident that Muslims currently hold a significant amount of private and public wealth globally (see Chapter 1). Yet despite such a large potential market, the Islamic asset management industry is estimated to be only slightly above around US$157 billion, of which only US$60 billion worth of funds have some meaningful size3. The conclusion is that only a very small proportion of Muslim assets are being invested in an Islamic manner.
If one were only to consider total banking assets located in the top eight Islamic finance countries — UAE, Malaysia, Saudi, Qatar, Kuwait, Bahrain, Indonesia and Turkey — Thomson Reuters estimates latent demand for Islamic funds to stand at US$73.8 billion, based on the assumption that Islamic mutual funds should account for 18% of total Islamic investable funds, rather than the current figure of 8.7%. Moreover, this is actually a conservative figure when one bears in mind that the ratio of mutual funds to total investable funds in developed markets like the US, Canada, and the EU is as much as 36%. The million dollar question which has therefore beset the Islamic wealth management industry for the past decade is why more assets held in countries where Islamic finance is widely practised are not being invested into Islamic funds.
There are two common responses. First, that Islamic funds do not offer any real diversification from conventional funds in terms of investment strategies. Second, that Islamic funds perform poorly compared to their conventional counterparts.
The Thomson Reuters report states that performance of Islamic funds from 2008 to 2014 has been volatile, with a cumulative performance of 2.32% in 20144, and the same report states that Islamic equity funds have yet to outperform their benchmarks since 2011.
This compares highly unfavourably with the conventional mutual funds industry. A recent study by Goldman Sachs of 248 large cap equity mutual funds with a combined US$730 billion of assets under management (AUM) finds that 43% of the funds outperformed the S&P in 2015.
Added to this is a problem of the lack of regional diversification. Of the 278 Islamic equity funds listed on Morningstar — with the exception of three funds invested into the US healthcare, US mid cap, and US large cap sectors — most of the top 10% performing funds based on daily total returns (over five years annualized) are invested into the GGC and Saudi markets7. Within this top performing bracket, the largest fund has about US$860 million in AUM, and only invests in Saudi equities. The rest of the funds The million dollar question which has therefore beset the Islamic funds, and that the assets managed within this bracket are relatively small. There is quite plainly a dearth of large Islamic global equity funds offering strong performance.
The million dollar question which has therefore beset the Islamic wealth management industry for the past decade is why more assets held in countries where Islamic finance is widely practised are not being invested into Islamic funds.
Islamic Benchmarks
Another problem is the benchmarking of Islamic funds, which are overwhelmingly benchmarked against an Islamic index, with the Dow Jones, FTSE, and MSCI Islamic indices being the most popular.
Research comparing the performance of Islamic indices vis-à-vis conventional indices has shown common and consistent results. Hussein examined the performance of Islamic indices from 1996 to 2003, and found that Islamic indexes exhibited positive abnormal returns throughout entire bull periods, but underperformed their non-Islamic counterparts during bear market periods8. Hassan and Girard (2011) examined the performance of seven Islamic indices and compared these against seven conventional indices including the MSCI All Country World Index (MSCI ACWI) from January 1996 to December 2005, with 1996 to 2000 representing a bull period and 2001 to 2005 representing a bear period. They found that during the bull period, Islamic indices returned an average of 13.51% per annum compared to 8.27% per annum for the conventional indices, while during the bear period, Islamic indices returned an average of funds, and that the assets managed within this bracket are relatively small. There is quite plainly a dearth of large Islamic global equity funds offering strong performance.
Developments in ESG
The failure to convert Muslim wealth into Islamic assets under management should be set against a background in which the Islamic finance industry has, within the last decade, embraced change in an effort to increase the popularity and size of the industry. It has set up institutions and established codes of best practice including Shari’a standards and template documentation in order to spur industry growth and promote the globalisation of Islamic finance. However, despite catalyzing growth in other sectors of Islamic finance, these changes have not assisted with bridging 0.58% per annum as compared to 2.42 % per annum for the conventional indices.
This research exhibits consistent results, confirming industry perception that Islamic indices have a natural, exaggerated performance bias during bull runs whilst showing poor performance in bear markets. In other words, Islamic funds are prone to suffer poorer performance than their conventional counterparts during a market downturn. Therefore, benchmarking against an Islamic index is neither an accurate representation of the opportunity cost of investing in an Islamic fund nor an optimum gauge against which to measure performance.
As a result of all the above, there is a popular perception that despite the increasing number of Islamic funds in the market, they do not offer real diversification, are more expensive, and do not perform as well as their conventional peers. Perhaps it is therefore not surprising that Muslim assets are not being channelled into Islamic funds.
When considering the investment strategies of Islamic funds, and especially Islamic equity funds, it is notable that the strategies mainly differ in terms of industry, geography, and asset exposure, while the underlying Shari’a screening processes undertaken by Islamic fund managers and their service providers, using exclusionary screens, have remained relatively unchanged over the past three decades. This suggests that the industry has been complacent, and has failed to keep up with the conventional asset management sector.
For example, the socially responsible investment industry has undergone major and seismic changes in recent years. It has moved away from restrictive ‘exclusionary’ strategies using negative screening and embraced new Environmental, Social, and Governance (ESG) data, which is becoming available as a result of new regulatory and voluntary reporting requirements, changes in corporate governance, and financial innovation. The level and quality of information on sustainability that is now being made available is unprecedented, and fund houses and data managers are starting to utilize this data in developing advanced and sophisticated investment strategies using ESG factors.
Alongside this development, there has been a shift in the attitudes of investors with regards to the importance of investing in a sustainable manner. A global survey of 163 institutional investors in 2014 revealed that 89% of institutional investors believe that non-financial performance information played a pivotal role in their decision-making at least once in the previous year.
At the same time, global sustainable AUM has increased many fold. According to a recent study by the Global Sustainable Investment Alliance (GSIA), global sustainable AUM grew by over 60% from 2012 to 201411. This is compared to a mere 15% growth in total global AUM during the same period.
Such large inflows of assets is due to a change in attitudes, perception, and practices amongst five key forces: reporting, regulations, stock exchanges, companies, and investors.
The success of large corporates like Coca-Cola, Marks & Spencer, and FedEx in producing significant savings from ESG has helped promote the sustainability agenda, and there is an increasing belief that business plans and operations which incorporate a sustainability strategy deliver financial benefits. Tellingly, a 2014 study from Accenture and the UN Global Compact revealed that 93% of CEOs surveyed believed that ESG issues would be ‘important’ or ’very important’ to the future success of their business. These are the types of seismic changes which need to be reflected in the Islamic investment industry.
Solution
The sustainable investing landscape has undergone extensive changes in recent years. Fifteen G20 countries — accounting for about 78% of global GDP — are currently implementing regulations and guidelines for sustainability reporting, exclusions, and ESG considerations, into the corporate business process.
There are an increasing number of non-financial disclosure and reporting initiatives building across the globe, such as the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB), and the Integrated Reporting Council (IIRC). Last year alone, 4,730 companies published their sustainability reports based on the GRI: a 16-fold increase from 2004.
The recent developments within the ESG investing space are an opportunity for Islamic fund managers to take advantage of the data revolution and offer a more robust stock screening and selection process whilst providing exposure to global stocks, thereby offering not only geographical diversification, but also a fundamental change to the approach to equity selection. A more robust equity selection process which fully integrates sustainability issues would
also reflect the objective of Islamic law, which aims to establish justice, eliminate prejudice, and alleviate hardship amongst mankind.
