2016 has been a year filled with surprises and in this report, RAMLIE KAMSARI seeks to dissect what these surprises mean for Islamic finance, particularly for the institutional asset management business and to further discuss what the landscape looks like for 2017.
Review of 2016
There were quite a few surprises in 2016 as follows:
1. Unexpected political developments:
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Brexit: The Sukuk market rode on the broader bond market rally which followed the ‘Leave’ outcome of the Brexit referendum. Despite concerns surrounding the fiscal health of GCC economies due to the weakness in hydrocarbon prices, the GCC Sukuk market held up well. Interest in GCC debt is self-evident from the strong demand seen in the jumbo debt issuances by GCC sovereigns. Notably, Saudi Arabia’s
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record-setting issuance of US$17.5 billion-worth of conventional bonds in October 2016 received bids almost four times that size (Islamic Finance news, the 9th November 2016). The Saudi finance minister also announced that Sukuk will be part of the country’s future fundraising plans.
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Trump’s victory in the recent US presidential election has thus far resulted in no observable impact on Islamic finance despite the initial rhetoric to limit Muslims’ entry into the country. However, given his fluid position on various issues post-election, it remains to be seen if, and how, his administration will craft his campaign pledges into actual policy-making. Despite uncertainty surrounding his administration’s social policies, markets appear convinced that his economic policies will result in meaningful fiscal stimulus for the US. The prospect of a wider budget deficit has convinced market participants that US growth, and by extension, inflation, will accelerate. While this has been unambiguously good news for the US equity market, this expectation has led to a sharp reversal of US bond yields. Following that, more debt issuers in the Middle East, including the IDB has delayed the issuance of Sukuk to observe the impact of Trump’s leadership on the regional bond market in general.
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The benchmark 10-year treasury has risen above 2.3% versus 1.8% just prior to the US presidential election. Rising bond yields in the US have resulted in the rout spreading across global bond markets, with emerging markets being particularly impacted. Sukuk markets have not been spared, and saw yields rising sharply on large emerging market outflows. Sukuk yields are expected to remain elevated in the short term amid a potential Fed hike, with market expectations of higher inflation levels.
2. Instability in the oil price:
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The decline in the oil price has shown to be positive for the fixed income market in general, including Sukuk, whereby huge issuance has been stemming out of the GCC region as a debt financing tool. For instance, Qatar in the second quarter of 2016 has seen a vast oversubscription of US$14 billion for the global bond issued (US$9 billion of issue against US$23 billion of orders). (Bloomberg News, the 26th May 2016)
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While markets are still awaiting clearer policy direction from the Saudi government on the implementation of Saudi Vision 2030, a Saudi Arabia with a more diversified economy is expected to result in a deeper and wider corporate Sukuk market. At present, the Saudi debt market is dominated by a handful of quasi-government issuances with thin liquidity in the secondary market. A larger private sector typically leads to an increase of corporate issuances. On the demand side, a more matured financial market in Saudi will naturally lead to stronger demand for Sukuk issuances.
Resilient Shariah equity performance
Shifting the discussion into Shariah equities, the S&P Dow Jones Shariah indices have shown evidence that most Shariah portfolios outperformed their conventional counterparts. For example, in the recent quarter, the exclusion of financial sectors combined with overweight positions in information technology within the index became the positive contributors for the overperformance.
Similar overperformance is mirrored in the Malaysian equity space. The FBM Emas Shariah Index recorded higher three-year returns against the FBM KLCI Index and the FBM Top 100 Index from November 2013 to November 2016 as illusrated in Chart 1.
Increased interest stemming out of non-Islamic regions for Shariah investment solutions
The recent addition of Sukuk to some global indices put Sukuk on the radar of more investors from non-Islamic regions. JPMorgan’s recent decision to include Sukuk in its EMBI Global Diversified, GBI-EM Global Diversified, CEMBI Broad Diversified and JACI indices is expected to boost the growth of the Sukuk industry as a whole from the existing assets under management (AUM) of US$370 billion, according to Bloomberg News on the 29th August 2016. This inclusion comes after the addition of Malaysian local currency sovereign Sukuk into the Barclays Global Aggregate Index in March 2015.
Notable trends and regulatory changes within the asset management industry
Let’s direct our attention to Indonesia where the financial regulator, Financial Services Authority (OJK) has made it mandatory for investment managers to create dedicated Shariah outfits within the respective firms, as reported by Islamic Finance news on the 23rd November 2016.
This follows the earlier announcement by OJK to approve investment managers to invest between 51-100% of their Shariah mutual funds in overseas securities which has been welcomed positively by asset managers in Indonesia such as Schroder Investment Management Indonesia, BNP Paribas Investment Partners, Manulife Asset Manajemen Indonesia and Aberdeen Asset Management by launching their first global Shariah funds respectively, according to Asia Asset Management on the 2nd March 2016.
In Malaysia, the initiative by one of the largest pension funds in the world, the Employees Provident Fund to grow investments into Shariah assets via the introduction of a Shariah compliant savings scheme recorded a 50% take-up rate from the initial RM100 billion (US$22.4 billion) allocation for the scheme since its launch in August 2016 and is getting the attention of fund managers.
Islamic pensions in Turkey and the rest of Europe, the Middle East and Africa also seem to be showing growth, especially in the privately funded funds. The Global Islamic Asset Management Report 2014 by Thomson Reuters suggested that a much more significant input could still come from state-funded schemes should the political factor be there.
Preview of 2017
What is in store for 2017? Despite the surprises that have been discussed earlier, global economic momentum has accelerated considerably in the past few months and the current upward trajectory is likely to continue into 2017. We uphold cautiously optimistic views that secular themes in the equity space will drive industries including healthcare and technology to benefit from this economic trend. As for the fixed income landscape, with uncertainty surrounding the recent political changes, global rates may remain elevated into the first quarter of 2017.
Conclusion
There are still ample areas for growth and innovation within Islamic asset management. Industry players need to figure out ways to attract more institutional investors for the sector to spur growth. In comparison to conventional funds, only 20% of total AUM are contributed by institutional investors whereas for the conventional side, AUM are at 70%. Islamic funds could also become more attractive to some non-Islamic investors that invest in socially responsible portfolios, a subsector that has grown a lot in recent years.
To achieve the aforementioned mission, the potential from Islamic pensions has to be explored. With the expansion of the middle class group and the emergence of a new generation who place heavy emphasis on social security, Islamic investment solutions can be seen as a promising avenue for building the stable nest for the future.
Ramlie Kamsari is CEO of Nomura Islamic Asset Management. He can be contacted at [email protected].