Just how big is Islamic asset management?

Cerulli Associates, Global Edge

Author’s note: this is one of three articles in a Global Edge special report on Islamic asset management. It was followed by an intensive, 200-page report on Islamic finance published in January 2009, with detailed proprietary data. That report cannot be published on this site but can be purchased from www.cerulli.com

The Shariah-compliant asset management industry is by now a key component of the world fund industry. Just how key, though, is a moot point.

It is commonplace to hear people refer to Islamic finance as consisting of around US$500 million of managed assets, handled by 300 institutions. Some think higher still: literature from the Malaysia International Islamic Financial Centre expects to reach a trillion-dollar Islamic wealth and fund management industry before long.

It is trickier, though, to find the source of these figures, and to ascertain what is meant by ‘managed assets’. Cerulli is conducting its own research to try to come up with a definitive number, which will be released at the end of this year, but it is already clear that mutual funds account for barely 10 per cent of that figure: there are approximately 650 such funds if one includes the various different investment classes of the same fund separately (EurekaHedge, a leading database of Islamic funds, counted 662 as of late July) and between them Cerulli estimates they contain around US$50 billion in assets.

To put that into perspective, there are believed to be around US$800 billion in Islamic bank deposits. A mutual fund figure equivalent to 6% of bank deposits is not particularly high, and there is certainly scope for growth, particularly since bank deposits themselves are also on an upward trajectory.

The dynamics for Shariah fund management growth start with the strong positions of many Islamic economies, most obviously the Middle East. In today’s miserable global credit environment, the Gulf states are some of the only nations with anything positive to say in economic or market terms, largely a consequence of the high oil price. At both an individual and an institutional level, wealth is growing, and at the same time, the willingness to invest in diversified portfolios of managed assets is growing too.

In the major Asian Muslim countries, the picture is varied because the disparity of wealth is wider, from the high standards of living and individual wealth in Malaysia to the poverty of half the population in Bangladesh. Indonesia and Pakistan, the two most populous Muslim countries in the world, fit in between. Nevertheless all of these countries boasts a high GDP growth rate, and growing per capita income, and in each location (bar Bangladesh, where intermediated financial services are in their infancy) the mutual fund industry is growing.

That’s half the story for growth. The other half is the increasing interest in Shariah investment styles. The degree to which this has taken off varies widely from place to place, and the two locations that stand out for their progress are Saudi Arabia and Malaysia.

Saudi is one of the few countries where Shariah funds outnumber conventional ones, both in terms of assets under management and overall number. The most recent data from Tadawul, Saudi Arabia’s stock exchange, lists 229 funds available in the country, of which 127, or 55%, are Shariah compliant. Measured by assets, the picture is sharper still: Tadawul shows that of the 84.65 billion Riyals of net asset value in Saudi mutual funds, R65.09 billion of it is from the Shariah funds – that’s 77% of the total.

Malaysia stands out for different reasons. Shariah funds are not nearly as dominant as they are in Saudi Arabia, but in sum they are more numerous: according to the Securities Commission, as of June 2008 there were 136 Shariah-based unit trusts out of a total of 530. By assets, though, they are much smaller, with a NAV of RM17.98 billion out of a total industry of RM159.85 billion, or just 11.2% of the industry.

Where Malaysia stands out, though, is in the lengths it has gone to to build an environment that is accommodative to Islamic finance. It has the most sophisticated regulatory, legal and training environment in the Islamic world. In other areas of finance the effects of this approach are much more clearly visible – in 2007, for example, 76.4% of approved bonds were the Islamic variety, called sukuk – and there is expectation at a regulator and policy level that unit trusts will eventually follow the same pattern (although the true popularity of these structures is still in some dispute – see distribution section).

In particular, Malaysia has been notable for its willingness to open its doors to others to come in on favourable terms. Earlier this year the Securities Commission approved three financial institutions – Kuwait Finance House, DBS Asset Management and CIMB-Principal Islamic Asset Management – to launch Islamic fund management companies in Malaysia. The idea is that by being inclusive of foreign participants, the overall industry, and Malaysia’s role in it, is strengthened.

Elsewhere, Shariah funds are significant if not dominant: 33% of the Qatar market, 30% apiece in Kuwait and the UAE. They are a vital area for Bahrain, which like Kuala Lumpur has attempted to set itself up as a regional hub for all things Islamic finance, including asset management; by early this year it hosted 87 Islamic funds managing US$1.3 billion, although only a minority are physically run from Bahrain itself. (Many Kuwait funds, for example, are domiciled in Bahrain, which is considered to be an easier place to do so.) In Indonesia and Pakistan, considered two markets of great potential for Islamic finance, development is very much in its infancy: only 1.7% of mutual funds in Indonesia are Shariah compliant, and in Pakistan, 2% of banking assets generally, although both nations expect rapid growth from here. Islamic fund management industries also exist in several non-Islamic countries, notably the UK, USA, Canada and South Africa; still other states are attempting to establish themselves as centres for Islamic finance, which will likely include asset management, despite having negligible Muslim populations of their own, chiefly London, Singapore and Hong Kong.

While Islamic asset management will doubtless grow at a local level in all these countries, the big question is when – if ever – the multinational fund managers will start launching ranges of Shariah compliant funds. Only two of note have done so: Deutsche’s DWS arm and HSBC Amanah, and neither is believed to have had huge success so far, although naturally both have gone in with a long term view. Many groups have produced Shariah-compliant investment products, but these often come from the investment banking arms of these businesses and take the form of structured products. UBS is a prominent example.

There are signs of multinationals coming on board. Franklin Templeton is understood to be launching a range later this year. And when Cerulli surveyed international managers who were active in the Middle East last year, 87 per cent of those who responded said they planned to launch Shariah funds in the future – a remarkably high number given that, again according to Cerulli research, only 0.26% of assets under management for international fund managers in the Middle East were Shariah-compliant at the time of the survey.

On the face of it, it seems very simple: apply a Shariah screen to an existing global equity product, and you have a Shariah-compliant international share fund to sell in the Gulf or southeast Asia. But fund managers point out that it’s not as simple as that. Simply screening out a certain percentage of stocks skews allocations in a way that portfolio managers may not be comfortable with; a whole separate portfolio construction model needs to be used.

But the reason more multinationals have not launched mutual funds is because they are not convinced of the market. If an institutional client such as a sovereign wealth fund wants a portfolio to be managed in a Shariah compliant way, most big international fund managers are quite capable of doing that (although, as the distribution section of this report points out, not that many do make such requests in practice), but the infrastructure and expense involved in setting up a mutual fund is not taken lightly. It is common for fund managers to talk of US$100 million, or sometimes twice that, as a minimum level of subscription they need to be sure of before launching such a fund. Invesco, for example, can run a Shariah screen if a mandate requires it but does not feel the need to go out and launch a range of Shariah products.

The disconnect between the supposed riches of this sector, and the unwillingness of international fund managers to launch product to cater for it, basically comes down to a widespread belief that Shariah-compliant asset management is at heart a retail story, and reaching that part of the market requires a particular approach to distribution. In brighter economic times a year ago it looked very much as if the tipping point was being reached where foreign managers started to tackle the Islamic opportunity in earnest. Today, fund managers have other things on their minds, though it’s surely a question of delay rather than abandonment. But how to approach the market? That’s the subject of the following article.

Author’s note: this is one of three articles in a Global Edge special report on Islamic asset management. It was followed by an intensive, 200-page report on Islamic finance published in January 2009, with detailed proprietary data. That report cannot be published on this site but can be purchased from www.cerulli.com