The rise of Islamic investors has been rapid, driven in part by the increased wealth from the Middle East, but products aimed at this market are becoming interesting for other reasons.
Conventional investors, fund managers included, are finding opportunities in a familiar asset class but one that operates differently from traditional products. Outside of investing directly in such products, some managers are also targeting the producers of these ranges in an attempt to capture knock-on growth.
Products aimed at Islamic investors must address certain traits present in more conventional assets, the central one being the payment of interest. In addition to interest-bearing instruments and products, such as bonds and current accounts, Shariah principles prohibit investment in gambling as well as the sale of that which is unseen, such as the use of complicated derivatives. Shorting, commonly used in hedge funds, is also forbidden as it is investing in something that is not owned.
Investment in tangible assets is a cornerstone to Shariah compliance in financial products and is why many tend to involve real estate and commodities.
It is estimated that Shariah-compliant assets are worth more than $500bn worldwide and growing fast. Variations of bonds, mortgages, insurance, mutual and hedge funds now exist that are Shariah-compliant and one of the most popular at present is what is known as an Islamic bond or sukuk. There are now many forms of Shariah-compliant sukuk in existence and which differ from conventional bonds in that they represent partial ownership of the underlying assets.
PricewaterhouseCoopers says such products look to replicate conventional bonds and can be bought and sold in a similar way to fixed interest. Investors get a flow of regular payments derived from the asset it is linked to, but not from interest. Sukuk tend to have a fixed life of three to five years.
PricewaterhouseCoopers senior manager Jamal Dar describes the number of sukuk coming to the market, including the UK, as growing exponentially. In March, UK Treasury minister Ed Balls indicated that the UK could issue its first sukuk bond later in the year.
One attraction of sukuk is the lack of correlation to what has been happening in the credit crisis. According to Gartmore, the sharedownership principle, together with the emphasis on real assets, is of interest at a time when there has been concern about the degree of leverage used in some financially engineered products.
Gartmore head of emerging market research Andrew Marshall notes that since the credit crunch intensified, global issuance of sukuk has been estimated at $30.4bn and, according to Moody’s Investors Service, could expand by 35 per cent in 2008.
Marshall says: “Concern about the quality and market value of some banking assets has prompted major financial institutions in the US, Europe and the UK to begin capital-raising. A greater degree of caution within the banking sector is making it more difficult and costly for borrowers to gain access to finance. The mood has intensified interest in Islamic finance. Its appeal was initially defined by religious affiliation but has now spread beyond the world’s 1.6 billion Muslims.”
He points out that the Gulf states earned $1.5 trn in oil revenue between 2002-06 and have financial institutions with limited or zero exposure to the troubled US mortgage market. They have organisations that want to raise capital using debt instruments closely linked to underlying assets.
Marshall says: “This is a market with plenty to invest and borrowers with strong ratings – appealing features in the current market.”
Gartmore’s global emerging markets portfolios contain selected overweights in banks with experience of shariah-compliant finance, including the Indonesian Bank of Central Asia and Bumiputra-Commerce Holdings of Malaysia.
Also emphasising the growing interest in investing according to Islamic principles and the broadening range of products was the recent creation of a hedge fund platform by Barclays Capital and Shariah Capital.
The Al Safi platform launched in mid-June with the first five Shariah-compliant hedge funds, all of which are commodity-based. Toqueville Asset Management is operating a gold portfolio, Lucas Capital Management an energy, oil and gas fund, Zweig-Dimenna a natural resources fund, Ospraie Management is featured with agriculture and BlackRock with metals and mineral funds.
To get round the issue of shorting, which is forbidden under Shariah, Barclays Capital devised a way of establishing ownership of a stock before it is shorted.
Equity investing is largely accepted under Shariah so long as it does not involve gambling stocks or alcohol companies but Laura Cox of PricewaterhouseCoopers notes that there are still some hurdles even in straightforward investing, in that companies do not necessarily disclose enough information to ensure it is a suitable investment.
However, analyst coverage in this area is on the rise and out of that has come the launch of Shariah-compliant stock indices. Product providers are creating other investment vehicles, such as capital-protected structured products, and, with low minimums to these products, Cox foresees Islamic finance reaching a wider audience than the more institutionally focused sukuk.
More needs to be done in this nascent industry but, like the ethical financial arena, it is taking hold and product development is opening up. Like ethical funds, which have sparked mainstream interest, it is likely that these products will find a broader appeal.