One of the few positives that emerged from the coronavirus pandemic has been the resilience shown by the global financial system amid unforeseen economic turbulence. More importantly, the crisis has put sustainable investing under the spotlight and accelerated its adoption. Investors of the current generation look beyond investing purely for returns and consider the social and environmental implications of their investments. With responsible investing gaining more traction, there is a structural shift in the investment industry that could favor the Islamic asset management space. As responsible investing is an inherent part of Islamic finance, the ongoing trend bodes well for the industry in the coming years.
The growth in the Islamic finance and banking industry over the past few years has led to the Islamic asset management industry emerging from its infancy, with a continuously expanding portfolio of compliant products.
The market size of the Islamic asset management industry stood at US$143.8 billion at the end of 2020, and is spread over 1,600-plus funds including equity mutual funds, money market/trade finance, Sukuk and exchange-traded funds (ETFs).
However, the assets under management (AuM) remain concentrated within the Southeast Asian and GCC markets, with Saudi Arabia, Malaysia and Iran together accounting for more than 80% of the total assets.
Despite the positivity, challenges continue to persist. Diversity from a geographical perspective seems to be lacking due to the under-penetration of Islamic asset management outside core markets such as Saudi Arabia, Malaysia and Iran.
Competitive pricing of Islamic products relative to conventional funds becomes a challenge due to the additional cost incurred to screen companies with regard to their adherence to Islamic principles. In addition, the lack of available products and the varying interpretations of Shariah continue to hinder the progress of the industry.
Review of 2021
Global equity markets continued to scale new heights in 2021, supported by the reopening of economies and the presence of high levels of liquidity. Despite supply-side shocks and a surge in commodity prices, financial markets continued to march ahead.
During 2021, the performance of Shariah compliant benchmarks has been on par with conventional peers despite the significant run-up in previous years. When assessed on a medium-term basis, in the past three-year period, Shariah compliant indices across markets have outperformed conventional indices by a noticeable margin.
The outperformance could be attributed primarily to the differences in sectoral exposures between conventional and Islamic indices and the investment thesis of Islamic funds. As Islamic funds lack exposure to sectors such as conventional banking, insurance, entertainment, etc, they are overweight on sectors such as information technology and healthcare, which have outperformed the broader markets in recent years.
In addition, Islamic funds, by principle, tend to take longer-term positions in conservatively managed companies with solid balance sheets and avoid highly leveraged companies that boost their returns through excessive debt.
Sukuk issuances dried up in the second half of the year due to the reduction in issuances from GCC sovereigns. The lower funding needs of GCC countries owing to the surge in oil prices during the second half of 2021 have been the primary reason for the reduction in issuances from GCC sovereigns.
Preview of 2022
The Islamic asset management industry is expected to witness sustained growth in 2022, due to rising demand for Shariah compliant investments. The shift toward alternate investment strategies is likely to continue into 2022 and beyond. The growing adoption of sustainable investment principles and the rising population of high-net-worth individuals who require higher returns amid a low interest rate environment are expected to be the positive triggers for growth in the coming years.
As Shariah compliant investments have outperformed comparable conventional investments in recent years, their customer base is expected to expand beyond those who are primarily focused toward faith-based investing.
During the pandemic, Shariah assets proved to be more resilient compared with their conventional counterparts, which could also improve investor perception toward them as safe havens relative to conventional assets.
The issuance of Islamic instruments is also expected to grow in 2022 due to their alignment with environmental, social and governance principles. Islamic fund managers could tap into these opportunities through targeted marketing initiatives to attain economies of scale.
Progress is expected to be made on the regulations front as well in 2022, as the Dubai Islamic Economy Development Centre and its partners continue to work on a unified global legal and regulatory framework for Islamic finance.
The ETF space is one that offers immense potential for growth. As oil prices begin to stabilize, the growing funding needs of sovereigns, especially in the GCC, are expected to trigger further Sukuk issuances.
Therefore, launching Sukuk-based ETFs could improve retail participation. As the awareness toward sustainability increases, penetration in non-core markets is expected to gradually increase in the years ahead.
The increased adoption of sustainability principles and the investor search for alternate asset classes with attractive returns are expected to be the key themes driving the growth of the Islamic asset management industry in 2022. As the world continues to recover from the pandemic, the Islamic asset management industry could be set for a watershed moment, both in terms of product development and a widening investor base.
Raghu Mandagolathur is the CEO of Marmore MENA Intelligence. He can be contacted at [email protected]