We live in times where consumers are increasingly aware of their choices and demand that values and purpose are embedded into products that they consume. In the financial context, today’s generation seems less driven by the narrow definition of investing to generate returns and considers the social and environmental impact of the companies they invest in to be an important part of investment decision-making.
Table 1: Market performance up to Q3 2020 |
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Benchmark |
Shariah compliant index |
Conventional index |
Outperformance of Shariah indices |
DJIM World Index |
14.3% |
0.9% |
13.5% |
DJIM Developed Markets |
13.8% |
1.3% |
12.6% |
DJIM Emerging Markets |
19.3% |
-2.1% |
21.3% |
Source: S&P Dow Jones Indices; index performance based on total returns in the US dollar |
Millennials view their investments as a way to express their social and environment values, according to a US Trust survey on wealthy millennials. The structural shift that the investment industry is undergoing has profound implications for Islamic asset management. Consequently, purpose-driven investment solutions that promote responsible behavior, an inherent part of Islamic finance, could soon find itself in the mainstream.
Shariah compliant investments abide by Islamic tenets against usury and uncertainty. Shariah forbids irresponsible profiteering at the expense of others, and shuns businesses that harm the environment and damage our society.
For instance, interest or excessive interest that leads to slavery is prohibited in Islamic finance. It also prohibits investments where the payout is uncertain such as gambling or speculation. Investment in businesses such as those that deal with weapons/arms manufacturing, alcohol and brewing, tobacco or pork-related products are avoided. Islamic principles thus strive to create a sustainable and socially responsible financial system that largely appeals to the millennial investing attitude.
As the younger demographic cohorts push values-based investing to the forefront, Islamic funds along with environmental, social and governance (ESG) investing have emerged as the fastest-growing segments within the financial industry.
However, not all is rosy and the industry is faced with multiple challenges. Islamic assets remain concentrated, with the markets of Iran, Malaysia and Saudi Arabia accounting for more than three-quarters of the total assets. There is a prevailing notion among investors that screening for businesses that adhere to Islamic principles would lead to an additional layer of costs in terms of research and certification.
Review of 2020
Shariah compliant funds outperform conventional peers
Global funds, as measured by the performance of their benchmark indices, recouped most of their losses and entered positive territory in the third quarter of 2020 (Q3 2020). However, across the region, Shariah compliant benchmarks have outperformed their conventional peers.
For instance, the performance of the Dow Jones Islamic Market (DJIM) World Index stood at 14.3% (year-to-date, as of Q3 2020) while its conventional peer gained 0.9% for the same period.
The outperformance of Shariah compliant funds could be explained by differing sector allocations. Islamic funds lack exposure to conventional banking and the entertainment industry (alcohol, gambling, tobacco and cinema) — businesses that took a big hit due to the lockdowns. The information technology sector, driven by FAANG (Facebook, Amazon, Apple, Netflix and Google) stocks that contributed to most of the positive performance, has an overweight allocation in Shariah indices compared with the conventional peers, while financials that performed poorly among various sectors remain underweight in the Shariah index.
On the product side, we witnessed the launch of the first actively-managed Shariah compliant exchange-traded fund (ETF) — the Almalia Sanlam Active Sharia Global Equity ETF in September 2020. The ETF, currently listed in the London market, has the Royal Bank of Canada as the lead market maker. The introduction of actively-managed Shariah compliant ETFs would provide more choice to investors.
Preview of 2021
Despite the strong performance, scalability of business has remained a sore point for Islamic asset management. In the upcoming year, the robust outperformance of Shariah funds could perpetuate fresh inflows and entice a new set of investors — not limited to those seeking Shariah compliance. The trend could be evident among retail investors who typically act by buying into the best-performing funds. The opportunity could be capitalized by retail Islamic asset managers, aided by appropriate marketing efforts to attain economies of scale that are most sought-after in the fund management business.
Presently, ETFs remain a small proportion — amounting to less than 10% of overall assets under management in the Islamic fund landscape. Considering the flurry of Sukuk issuances, both from sovereigns and corporates especially in the GCC region, establishing ETF vehicles for Sukuk could make it easier for retail participation. The ETF segment offers immense potential for growth and we could see further products.
Conclusion
To conclude, potential opportunities are plenty for Islamic retail asset management in terms of product development and the widening investor base. Favorable tailwinds in the form of strong outperformance and enhanced focus on socially responsible investing have thrust Islamic asset management into the limelight. The industry should thwart the existing challenges and position itself favorably and scale up.
Raghu Mandagolathur is the managing director of Marmore MENA Intelligence. He can be contacted at [email protected].