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Consumer choice
For a long time, it was thought impossible for a financial institution to develop investment products that complied with Islamic law.
The belief was that most corporations were so involved with interest and other proscribed activities that the only solution was to avoid most investments.
However, with increased affluence in the Muslim world, demand for Islamic investments has become so overwhelming that Islamic finance institutions have developed ways in which they could meet this growing demand.
The result is a basket of investment vehicles such as real estate funds, sukuks, mutual funds, tracker funds and more complex asset-backed securities.
Islamic investments funds stay away from companies that charge interest; they screen out companies involved in alcohol, pork, weapons and gambling; and they impose limits on the amount of interestbearing debt owed by any company they invest in.
This last, and perhaps least understood stipulation, typically cuts out companies with debt of more than 33% of market capitalisation.
Buying and selling stocks has been seen by some as gambling, especially if an investor was bouncing in and out of the market in search of short term gains, although nowadays experts draw a distinction between this and productive speculation.
The general rule for Muslim investors is that investments in stocks are permitted as long as they are in companies whose business is Shariah-compliant.
Fund managers specialising in Islamic investments do more than just choose investments in companies whose primary business meets Islamic guidelines.
“No one expects devout investors to sacrifice returns,” says Mohammed Hassan Isameel, director, global marketing, HSBC Amanah.
“In terms of performance, Islamic investment funds are increasingly like for like with conventional products.
Of course, Islamic funds are by nature less risky and more conservative but still manage to perform well.”
Another Islamic banker told Arabian Banking & Finance: “On the issue of debt and interest, it can be argued that if companies do not overextend themselves it means lower volatility.
You can make money, but according to the rules of Islam and the Shariah law.
Funds that follow the Islamic way tend to stick to a formula skewed toward newer companies that raise money on equity markets rather than through banks, which can lead to strong performance.”
Even if the equity side is not doing so well, as is currently the case, there are plenty of Islamic investment alternatives, including funds based on commodities, hedging , real estate and leasing.
Saeed Al Qattami, senior vice president & head of wealth management, Dubai Islamic Bank (DIB), says: “In the GCC, a number of banks have launched GCC/UAE equity-based funds as a direct result of the pent up demand for equities in this region.
The GCC audience will have a natural bias towards opportunities within their own region.
“Historically, equity markets have always outperformed the fixed income asset class over a long period of time.
Although there is a wide variety of mutual funds, both conventional and Islamic in the region, I also believe there is still a requirement for some sort of Sukuk mutual fund.”
Since the launch of the Dow Jones Islamic Market Indexes in early 1999, the mutual funds industry has been through an initial period of growth, followed by a slowdown when stock markets crashed in 2000, followed by a period of recovery.
Innovation and development in the Islamic mutual funds space was actually accelerated as a result of the dot-com bust in 2000, a time when Arab investors lost money in North American markets.
In response, investors immediately began demanding a better way to manage risk.
The industry’s answer was to turn to the development of Shariah compliant principal protected instruments and to the development of Shariah complaint hedge funds.
“Dubai Islamic Bank tries to provide its clients with a range of products within each asset class and that includes the fixed income asset class,” says DIB’s Al Qattami.
“We possess a wide range of Sukuks and have sold various Shariahcompliant funds to our clients.” They also pick stocks using three financial ratio tests.
Companies are excluded if their total debt divided by total assets is equal to or greater than 33%, if their accounts receivable divided by total assets is equal to or greater than 45%, and if their nonoperating interest income plus prohibited income divided by total revenue is equal to or greater than 5%.
The AZZAD/Dow Jones Ethical Market Fund, for example, is overseen by a three-member Shariah board that applies this filter.
In a world where it is nearly impossible to find businesses with no interest income, portfolio income in Islamic funds is ‘purified’ by removing amounts that are related to interest or other prohibited earnings and donating it to charitable organisations.
Most Islamic scholars consider the acceptable limit for the amount a business may earn from interest to be 25 to 33.3%.
Other considerations are that the fund must be overseen by a Shariah Advisory Board of scholars that will advise the fund managers on questions of compliance.
Any mutual fund, or even stock broker account, will have some cash reserves that will allow investors to withdraw their holdings completely or partially.
This cash may generate some interest, and has to have a well-defined purification process applied.
With these rulings in mind, the key question for the institution is whether or not Muslim investors have to compromise on returns, choice and even service.
The Islamic finance industry will say that is simply not the case.
DIB has recently launched the Commodity Linked Individually Capped Performance Note.
This follows a series of investment products launched by DIB during 2006, which includes Al Islami Shipping Fund, Al Islami Capital Protected Note, GCC Equity Fund, Al Islami Saving Scheme and a Pan European Real Estate Fund.
“We are striving to offer a clear product mix with various asset classes, including equity based products as well as fixed income type products,” explains Al Qattami.
“Our mandate is to provide our customer base with a wide range of innovative and exciting products.
“In doing so, we will not only develop our own in-house products through our asset management division, but also source alternative solutions from other asset management companies and either white label products or, as we recently did with the 3yr CLIP Note, co-brand products.
This decision on what model to undertake depends on various factors and our own internal capabilities.”
Investments are made through a number of vehicles.
The Islamic mutual fund is perhaps the best understood, with two kinds of fund available.
Income funds are designed to provide the investor with a regular income stream by investing in securities that pay regular dividends.
Growth funds are focused on appreciation in the value of the underlying securities and tend to be riskier.
The upside is that risk is spread over a large number of securities, but fees and commissions can be significant.
The Islamic principle protected fund functions like a conventional capital guaranteed fund.
But whereas conventional funds rely on interest from securities, Islamic issuers use murabaha transactions to generate income.
“Purchasing a product within a fixed income asset class will provide the customer with a relatively less volatile investment than his current equity holdings,” says Al Qattami.
“Within the [conventional fixed income] class, one would find government and corporate bonds and various LIBORrelated products.
Within Islamic banking, the fixed income category becomes quite tricky, as Islamic finance instruments are not allowed to provide an interest income stream.
Alternative solutions have been Sukuks and Shariah-complaint real estate funds,” he continues.
The increase of real estate funds and real estate investment trusts (REITs) reflects the conservative approach of Muslim investors.
The attraction lies in the liquidity of the REITs, which are traded on nearly all the world’s stock markets.
A Sukuk is a securitised asset that is often compared to a conventional bond.
A Sukuk needs to have an underlying tangible asset and it limits the debt to the value of the underlying assets.
Sukuks have been issued by many large regional corporations such as Emirates Airlines and DP world, although there is a debate as to how tradable they are.
Most Sukuks tend to be held by institutions and there is limited liquidity.
Overall, however, the choice for the Muslim investor is greater than ever before.
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