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Islamic Wealth Islamic Wealth Managment Management Paul McNamara Copyright Copyright © Yasaar Media Published by Yasaar Media DIFC The Gate District Precinct Building 3 607 Level 6 East PO Box 506765 Dubai, UAE Tel: +971 4 370 0701 Fax: +971 4 370 0702 Website: www.yasaarmedia.com First published 2009 All rights reserved. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that which it is published, without the prior consent of the Publishers. Neither the publisher nor the author make any legal representation or warranty with respect to the contents of the book, and they do not accept liability for any inaccuracy in the material in the book. Design and Layout: James S. Naval II Islamic Wealth Management 2009 Paul McNamara Islamic Wealth Management 2009 Thanks to The publishers would like to thank the following for their help during the preparation of this report: Andrea Weidemann and Sybille Reitz, Dow Jones Indexes Mittal Dave, FTSE Group Ghada Essam, IFIS Carolyn Makin Iqbal Asaria, Yasaar Limited Zawya Islamic Wealth Management 2009 Foreword from Paul McNamara Room for improvement T he area of Islamic wealth management has been sadly neglected by analysts and commentators in spite of the fact that it is a growth area of finance. One reason for this in the recent past has been the fact that many Islamic wealth management portfolios have declined by 15-20 per cent since the advent of the global financial crisis. There have been few asset classes that have held up well demonstrating perhaps that more work needs to be done in structuring a wider palette of instruments for ultra rich Muslims to take advantage of. These instruments will need to be highly diversified in order to overcome the seeming systemic interconnectedness of all traditional asset classes that became evident as equities collapsed, real estate values plummeted, currencies see-sawed and alternative investments virtually disappeared across the world. The report that follows is an attempt to place Islamic wealth management initiatives in their proper context which is within that of the greater realm of wealth and asset management as a whole. But the critical point to note is that these initiatives take Shariah compliance as their start point rather than Shariah compliance being seen as something that is slapped over conventional instruments at the last minute. Perhaps Islamic wealth management portfolios will always offer slightly reduced returns when compared to their conventional counterparts. But if the financial crisis has hammered home any single lesson it is that with greater reward comes greater risk. Shariah compliant portfolios should be more conservative than aggressive conventional portfolios for the simple reason that they have to be approved at every step by a Shariah board and this always tends to remove elements of excessive risk. If this is the case then why have Shariah compliant portfolios not escaped the worst ravages of the crisis? The answer to this has more to do with the all pervasive nature of the financial crisis than weakness in the system of Shariah compliance. Pretty much any portfolio that held assets of any sort was bound to be affected. The question is how Islamic wealth managers make sure that the same thing does not happen again. The mistake might lie in presuming that the Islamic wealth management industry has time on its side to devise a new set of products to ride out the next downturn. If some economists and market observers are correct then we are only biding our time at present waiting for the second collapse of the W-shaped recovery. There could be more of the same to come. In any event smart Islamic wealth managers are already learning valuable lessons from the last 18 months and making sure that the future is more secure than the immediate past. Sadly this cannot mean simply parking all of a client’s assets in US dollars or British pounds sterling and waiting until the future has some certainty. Apart from anything else good old inflation will soon erode such savings presuming they are parked in non-interest bearing accounts. Islamic Wealth Management 2009 Foreword from Paul McNamara The future of Islamic wealth management has to lie in being smart, being international, and perhaps most importantly of all, in being nimble. The wait and see approach simply does not work in the current environment: insight and foresight are what is needed. Conventional wealth managers have been doing this for generations with a great deal of success. The Islamic wealth management industry has to learn to do the same. We hope that the report that follows will prove valuable for wealth managers and investors alike. Our hope is that by the time we come to publish Islamic Wealth Management 2010 there will be a battery of new products to discuss together with the beginnings of some impressive track records. Paul McNamara is the editorial director of Yasaar Media Islamic Wealth Management 2009 Get your copy of each Yasaar Media research report AS SOON AS IT IS PUBLISHED Staying ahead means staying informed – no matter what business you are in. But if you work in an industry as fast moving as the Islamic finance industry then you need to get your hands on the best industry insights as soon as they appear. Doing so has never been so simple: simply email [email protected] with the Subject Line ‘Please send me your research reports immediately on publication’. We will take care of the rest. Could your Annual Report be better The chairman takes an interest. The CEO takes an interest. But it’s your job to get the annual report out on time and on budget If you need to produce an Annual Report for your bank or Takaful house and if it has to be even better than last year’s then perhaps you need a fresh set of eyes to look at it. Because very often producing great marketing isn’t good enough – you need to produce brilliant marketing. Every time. On time. For help with your annual report contact: [email protected] and we will call you to discuss your needs. Introduction Nowhere to run, nowhere to hide The events of last year, meaning the credit crunch, the financial crisis, and the ensuing panic wiped trillions of dollars off investors’ wealth. Some of the worst hit were retail investors and the segment of retail investors that bore the brunt were those with most to lose: the rich and the very rich. Tried and true investment wisdom that they had accumulated over the prior decades proved to be worthless and misleading. Immediately prior to the crash investors had access to a pool of investment vehicles and asset classes previously unheard of. And perhaps this was part of the problem. In the old days investors would have been happy simply to place their funds on deposit knowing they were safe but the plethora of new exotic instruments available caused many level headed investors to believe that they were missing out and that they should jump on board the high-returns ship for fear of missing out. This holds equally true of Islamic investors wishing to capitalise on the fact that the economic tide was rising although in retrospect one of the effects was to push people into illiquid assets that they perhaps did not fully understand. Some of the hardest hit by the crisis were the wealthy families and individuals in the Middle East as the region’s stock markets took a hammering amid the biggest property slump for a very long time. According to the Capgemini-Merrill Lynch 2009 Wealth Report the net wealth of this group dropped by over 16 per cent in 2008. This may not have been the biggest drop of all time but it was big enough to be very painful for those involved and one of the overriding lessons they learned from this pain was to treat debt with more care and attention. The days of excessive gearing have gone. Islamic Wealth Management 2009 Introduction Taken in a global context, a study by the Boston Consulting Group found that overall wealth managed by the asset and wealth management industry dropped by 11.7 per cent to $92,400 billion over the same period. One of the worst hit regions was North America which saw a drop of almost 22 per cent. The Middle East may not have been hit that bad, but it was bad enough. Clearly those worst affected were those who made risky investments during the boom. The hope for Islamic investors is that since they shun excessive risk they should have been spared the very worst of it. Nevertheless it is an undeniable fact of life that the financial crisis has changed everything. Many governments have discovered that their incomes have been trashed as global wealth levels have fallen and unemployment has skyrocketed. One of the follow-on effects of this has been to make governments more determined to ensure that everyone who should be paying tax is doing so. Naturally this is relatively easy on the domestic front, but where governments run into problems is when their citizens are resident abroad or when their citizens have savings and investments in offshore jurisdictions. This has caused these same governments to put pressure on offshore centres and so-called tax havens to come clean and divulge more information about their clients. Such track-andtrace measures affect the ultra high net worth (UHNW) and high net worth (HNW) investor whether his savings are conventional or Islamic: in the eyes of the tax man money has no colour or religion. Mercifully many Islamic investors in these categories are citizens of the GCC and they already live in zero-tax or low-tax environments and so their use of offshore financial centres has little to do with tax avoidance and more to do with secrecy and confidentiality. The undeniable truth is that secrecy and confidentiality are being eroded in the name of the greater good as ‘uncooperative tax havens’ are brought into line. The OECD has made sure that the net has been closing on these havens since 2002. Lichtenstein came to heel by signing an accord with the UK tax authorities in mid-2009 which the UK government hopes will generate an extra £1 billion in tax revenues immediately and further significant amounts on an ongoing basis. Lichtenstein is now in talks with Germany to do the same. The spat between the Swiss authorities and the US tax authorities has also become the stuff of headlines and the net fallout is that there is a fast diminishing pool of areas where the whole idea of banking secrecy in its old form remains. It is against this background that we take a look at the wide area of Islamic wealth management and what it means for both UHNW and HNW Muslim investors. In the recent past there was no such thing as Islamic wealth management services available to Islamic investors and this simply meant that rich Muslims either had to forego the perks of being rich, such as watching their money grow rather than being eroded by inflation, or they could take advantage of conventional wealth management services in the full knowledge that these services were not Shariah compliant. It would be a naive wealth manager who thought that their new wealthy Muslim client would be looking to park all of his wealth in a Shariah compliant way. The truth is that many such investors will not invest more than 25 per cent of their net wealth in this manner. The allure of exotic financial instruments, where the sky is the limit in terms of returns, is simply too appealing to those with the means to take advantage of them. The future for the Islamic wealth management industry lies in trying to secure more than simply the 25 per cent that many clients are comfortable relegating to the Islamic finance sector. The only way this will happen is when there is a much wider palette of instruments available for the wealthy Muslim to use and when the returns promised by these instruments is compa- 10 Islamic Wealth Management 2009 Introduction rable to their conventional counterparts. The alternative is for UHNW Muslim investors to pay a premium for their faith which is something that they have never accepted in the past and are unlikely ever to want to do. One saving grace The global financial crisis has pushed Islamic finance more to the fore as pundits and analysts recognise the reality that Shariah screens mean less risk and therefore less exposure to subprime debt. Doubtless this has meant that some Muslim investors were spared some of the worst excesses of the crisis but it is not likely that the Muslim investor with billions to invest would have found much respite for the reasons that we have already outlined. It is a useful rule of thumb to estimate that the average investor lost around 20 per cent of his net wealth during the crisis: this holds for Muslim investors as well as conventional investors. The singular focus of these investors going forward is in getting their money back somehow, but in general this means looking at products that are capital guaranteed for the simple reason that having been once bitten these investors are twice shy. Taking these factors together means that the Islamic wealth management industry is facing perhaps its most challenging period and at the same time it is facing its biggest opportunity, both for investors and service providers. Investors want to spread their risk across asset classes and across currencies for fear of being caught on the hop again. Diversity and caution are the new watch words of these investors. What about the kids? Presuming that these clients managed to hang onto their wealth through the recent tribulations, they will next be faced with the issue of generational wealth management and this is another area where they will need expert advice and guidance. So complex are the requirements of many Muslim investors in this category that they may need to establish family offices to help them with asset management, business management, and possibly also with legal issues. There are issues of helping their children cope with the problems typically associated with inheriting large sums of money. These issues can range from managing reputational risk, being alert to fraud, structuring a portfolio, to philanthropy and giving. There is an old saying that the hardest part of the wealth equation is not making it but hanging onto it. The problem of hanging onto it is doubly true for the children of the wealthy. While many wealthy parents would not dream of passing on their great wealth to their children for fear that it would corrupt them, change them, or ruin their lives, there are many parents who will pass on such wealth. Islamic Wealth Management 2009 11 Introduction These investors may be parents who themselves inherited the family fortune and feel obliged to pass it on in a suitably augmented fashion but equally they might be the builders of the wealth who simply want their children to have that which they did not when they were growing up. Parents themselves can hope to teach their offspring basic values like honesty and courage but they may be much less well equipped to teach their children how to manage their money once they have it to do with as they please. This is where real expert advice can be indispensable. Thankfully this is not a new dilemma and it is one that has been addressed by a number of banks, predominantly conventional private banks, over the years. Such a service is unlikely to be driven purely by philanthropic motives alone. Once the children of the wealthy have had a greater exposure to the working of a private bank they are much more likely to stick with that bank, presuming that their experience has been favourable. From the bank’s perspective, it simply makes sense to look after their future best customers. Equally importantly it is not in the bank’s interest to have their new generation of high net worth clients fritter their money away on super yachts and gambling. Better that they nurture their wealth and grow it in order that the bank can continue to charge management fees on an ever increasing bank balance. Some conventional banks offer courses for the children of their UHNW clients. The core of such courses looks at: spending and budgeting, investing, the history and function of the City, basic economic principals and trends, types of assets and how to invest, how to read the financial press, how to set up an enterprise, philanthropy, human assets including career and educational advice, personal brand, reputational risk and personal safety. The aim of these courses is to help ensure smooth succession by making sure that the next generation understands wealth management objectives and opportunities. There can be differences of opinion about how family wealth is invested and how it is transferred from one generation to the next. Where there is the added complication of managing a family business, there are often different opinions about how to grow or divest the business, or on succession planning and leadership structures. Without doubt these boot camps for the children of the ultra rich can play a pivotal role in preparing the next generation of wealthy youngsters with the basic building blocks that they will need in order to be both forearmed and forewarned about what lies ahead. Young wealthy people are prime targets for the unscrupulous and the criminal. Without a proper appreciation of the nuances of the financial markets, these kids are also a danger to themselves without the proper guidance. Unfortunately there remains one strand of opinion that thinks that today’s rich kids have grown up in a cocoon of privilege which leaves them unprepared for today’s increasingly competitive job market. They are not good investors and they have a lack of reference points that the rest of the world takes for granted. They are not hungry for success like many others. What seems clear is that there is a vast opportunity for private banks and wealth managers in the Islamic finance sphere to capitalise on this growing niche by offering seminars, conferences and boot camps to the children of their top clients. The main advantage is that it will help the next generation of wealthy clients feel a real affinity with the bank. Another key advantage is that they could help in a very real way to ensure that young people afflicted with great wealth do not end up ruining their lives because of it. 12 Islamic Wealth Management 2009 Introduction The year ahead The next 12 months could be a crucial time for the Islamic wealth management industry as it grapples with the twin opportunities of how to capitalise on the fallout from the financial crisis while at the same time helping clients claw back some of the ground they have lost over the past year. As ever in the wealth management business this will have little to do with luck and a lot to do with planning. These are strange times and it appears that an investor in a quality rare car would have done better during the downturn than an investor in almost any other asset. While it seems that the turnover at classic car auctions has fallen since the financial crisis started, these auctions have still seen significant business. In early August 2009 a 1965 Shelby Daytona Cobra Coupe that had been driven by Bob Bondurant in Reims sold in Monterey for a massive $7.25 million which is the highest price paid for an American car at auction. Such sales are hardly unique in this most unusual of environments. That is why only very clever banks will continue to thrive and do well. Understanding the very complex needs of the client will be of paramount importance, as will offering them solutions that meet or exceed their expectations. These expectations will be built, amongst other things, on the sorts of products and the sorts of returns levels that the conventional world of finance can offer them. The future for the Islamic wealth management industry lies in trying to secure more than simply the 25 per cent that many clients are comfortable relegating to the Islamic finance sector. While Islamic finance is a maturing industry it is still young and relatively naive and product structurers need to ensure that they have cast iron Shariah sign-off on products before they come to market. The industry cannot afford any more second thoughts from scholars who retrospectively change their minds and rule that prior structures are no longer to be deemed Shariah compliant. Investors, especially rich investors, are invariably sophisticated. Investors in Islamic finance are no exception to this rule. Clients will be looking for strong and impartial advice now more than ever and this could be the opportunity that the Islamic wealth management industry has been waiting for. The industry had better make the most of the opportunities presented. Islamic Wealth Management 2009 13 Equities Equities Nothing simple and straightforward about direct equity investing E quities have long been the mainstay of many investors around the world therefore it is hardly surprising that they feature heavily in the realm of Islamic wealth management. One reason for their appeal is that they can offer returns that are very rewarding when compared to many other forms of investment and another is that they can offer diversification for the individual investor across a wide range of geographies and industries thus providing something by way of investor protection. Of course this latter benefit has proven to be less certain over recent times when geographically and sectorally unconnected equities have all fallen in unison as global markets collapsed. However, the Islamic investor cannot simply invest in any equity in any event and must restrict his investment activity to those equities that are considered to be Shariah compliant according to expert third party opinion. Thankfully there are a range of indices that can be used to establish whether or not an equity is Shariah compliant, and these come from FTSE, Dow Jones, MSCI, and S&P among others. Dating from as far back as 1998 these indices effectively constitute the total universe of Shariah compliant stocks. Islamic investors are not allowed to invest in a company that makes most of its revenues from non-Shariah compliant business activities or in companies that are highly leveraged. Shariah indices typically screen companies for Shariah compliance through two separate screens: one based on business activities and the second on financial ratios. Business activities that are forbidden typically involve dealing with pork, pornography, alcohol, gambling, firearms, financial services and tobacco. Clearly it is much easier to tell if a company falls foul of these rules if it is the company’s primary activity, but when its involvement comes from interaction with these areas in a secondary capacity then the application of the screen becomes much more difficult. A classic example would be an hotel chain that happens to sell pork products, pornographic movies on an in-house channel, and alcohol as part of doing business but not as its main focus. A rough 5 per cent rule seems to have become the accepted level of exposure to such haram activities: if a company earns less than 5 per cent of its revenues from haram activities then it can be considered for inclusion in the list of Shariah compliant equities. Because this can be a fairly tricky calculation to make, there is inevitably some difference of opinion as to which stocks make the grade and this in turn means that some fund managers have composite portfolios that rely on stocks across a range of indices. Doing this can help increase the total number of investable companies in the fund manager’s universe although caution must be exercised when assessing the Shariah compatibility of some of the equities included. In practice it can be hard to strip out how much profit an hotel chain makes from the sale of pork products since this is typically not the sort of information that the hotel chain would monitor. FTSE Indices The chart overleaf shows the comparative performance of the FTSE NASDAQ Dubai Shariah Qatar 10 Index, the FTSE Shariah Islamic Wealth Management 2009 15 Equities The real surprise, however, lies in the five year performance chart below which shows how Shariah compliant Malaysian stocks have fared compared to both the All-World Index and the Shariah All-World Index. Both FTSE Malaysian Shariah indices show that Malaysia Shariah compliant stocks performed better in both bad times and good than global stocks as a whole and Shariah compliant global stocks. 3 Year Chart (USD Total Return) Index Level Rebased (31 Aug 2006 = 100) 200 180 160 140 120 100 80 60 40 06 g- Au 31 7 b-0 Fe 28 07 g- Au 31 8 b-0 Fe 29 FTSE NASDAQ Dubai Shariah Qatar 10 Index FTSE Shariah All-World Index 08 g- Au 31 09 g- Au 28 09 g- Au 31 FTSE NASDAQ Dubai Shariah Kuwait 15 Index FTSE All-World Index Source: FTSE Group, data as at 31 August 2009 The key for Islamic investors will lie either in putting their faith in an Islamic index or indices or in cherry picking Shariah compliant stocks of their own. Index Level Rebased (31 Aug 2004 = 100) 5 Year Chart (USD Total Return) 350 300 250 200 150 100 50 04 g- Au 31 5 b-0 Fe 28 05 g- Au 31 6 b-0 Fe 28 FTSE Bursa Malaysia Hijrah Shariah Index FTSE Shariah All-World Index 06 g- Au 31 7 b-0 Fe 28 07 g- Au 31 8 b-0 Fe 29 08 g- Au 31 9 b-0 Fe 28 09 g- Au 31 FTSE Shariah Malaysia Index FTSE All-World Index Source: FTSE Group, data as at 31 August 2009 All-World Index, the FTSE NASDAQ Dubai Shariah Kuwait 15 Index, and the FTSE All World Index for the three year period ending 31 August 2009. The non-Shariah compliant FTSE All-World Index has undoubtedly shown less volatility over the last three years but it undoubtedly performed worse than any of the other indices on almost all occasions. The second worst performer was 16 Islamic Wealth Management 2009 the FTSE Shariah All-World Index whose performance closely mirrored the All-World Index. The two GCC-centric Shariah compliant indices were both tremendously volatile but still managed to outperform the other indices, with the FTSE NASDAQ Dubai Shariah Kuwait 15 Index performing best in the good times although recovering more slowly in the bad times than its sister index the FTSE NASDAQ Dubai Shariah Qatar 10 Index. Equities The following methodological explanation of Shariah screening comes from Iqbal Asaria, who is an expert on the issue of Shariah screening for FTSE/Yasaar Shariah Indices. Shariah screening methodology The Shariah screening process has been designed to satisfy three core principles. These principles are that the screening process should be: 1. Conservative – The process is responsible for en- suring Shariah compliance of the stock universe covered. This responsibility is undertaken with the utmost seriousness both for the comfort of the users of the indices derived by FTSE from the screened universe but also as a core component of the group’s business strategy. As a result the burden of proof is laid upon the process to demonstrate Shariah compliance for a company before it becomes part of the eligible universe. If the data to establish Shariah compliance is unavailable, no assumptions regarding the Shariah status of a company is made under any circumstances. In essence, all companies are non-compliant until shown otherwise. 2. Consistent – We strongly believes that for the process to be valid it must be consistently applied over time and across geographies. With this in mind, Yasaar has sought to remove as much subjectivity from the process as possible. A rules-based approach achieves this by keeping to strict, unchanging guidelines and not relying on the opinion of an individual at any particular time. To ensure consistency across the global securities universe, it is also necessary for these rules to be applied to a consistent global database. To achieve this, we work with an experienced company using some of the most respected sources of global data available. 3. Auditable – The comfort of users of the screens is derived in part from the robust processes established but also from the knowledge that this process has been overseen and monitored by our Shariah Board. The Shariah Board monitors, reviews and audits the process at regular intervals. The screens are updated daily and audit trails of any changes in the Shariah status of companies are available to the scholars for review as well. Shariah principles The screening process is managed in a manner that complies with written guidelines relating to the Shariah. These guidelines have been set by the Shariah Board who also monitor compliance. The Shariah guidelines can be grouped into two separate components: business activity and financial ratios. Business activity The guidelines ensure that the screened universe of Shariah compliant securities does not contain securities where the issuers’ core activity or activities relate to any of the following sectors: • Interest bearing investments including loans and deposits based on interest; • Forward currency transactions; • Securities issued by companies whose income is derived from any of the following activities: w Manufacture or distribution of alcohol or tobacco products w Gaming or gambling; w Manufacture or distribution of weapons and defence related products w Production, processing, packaging or any other business activity relating to pork products; w Conventional banking, insurance or any other interest-based financial services activity; w The production or distribution of pornographic materials; or w Any other activity that is not permitted by the Shariah as determined by the Shariah Board; • Derivatives, including futures, options and contracts for differences; and • Any other transaction that is not permitted by the Shariah Board. Business activity within the screening process is defined according to SIC (Standard Industrial Classification) code. The SIC code list is one of the most detailed classification system available on a global basis with 1009 separate business activity descriptions. Within the data sources sourced by Yasaar, all companies have had their business activities catalogued according to this system. Each company may have up to eight SIC codes allocated to it in order of materiality with associated data giving information as to the percentage of revenues derived from each segment. The business activity screened universe utilises these SIC codes. The criteria is that any stock which has a SIC code allocated to it which is deemed to imply a non-compliant activity is excluded unless it is clear that the sum of all revenues within these segments is less than 5 per cent of all revenues. We have set a pre-determined list of SIC codes that are considered to be non-compliant activates. In instances where Islamic Wealth Management 2009 17 Equities the activities cannot be fully determined to be compliant or not, we have taken the conservative approach and disallowed the entire classification, i.e. wholesale of livestock is not allowed on the grounds that this does not preclude hogs. Positive screening Where adequate information is unavailable via SIC codes, our scholars have considered further investigations on the companies’ activities. These include contact with the companies concerned to determine the exact nature of the activities and their materiality. If upon these further investigations the level of non-compliant activity is found to be below 5 per cent then the companies can be screened as Shariah compliant on a case by case basis. Financial ratios Once business compliance is established, the stock universe is screened for a set of financial ratios. These comprise of: • 5 per cent tolerance for non compliant activities, including any interest income • Debt to total assets ratio to be less than 33 per cent • Receivables and cash should be less than 50 per cent of total assets • Cash and cash equivalents (liquid instruments like CDs) should not exceed 33 per cent of total assets. On changes of a transient nature for companies with financial ratios which are on the borderline of compliance, we seek the opinion of our Shariah Board. After full presentation of the facts and financial history, the Shariah Board may decide that the breech is an aberration and not a change in the business profile of the company. In such cases the Shariah Board, at their discretion may allow the stock to be deemed compliant until the next set of results. For a stock/security to be deemed Shariah compliant it must pass both the business compliance and financial ratios tests. 18 Islamic Wealth Management 2009 The future for equity investing Since the market turmoil of the last quarter of 2008 equity markets around the world have been volatile and unpredictable. While there were doubtless some bright spots to be found, the general trend across equity markets had been downward for many months, with some markets collapsing completely. The markets of several Muslim countries, including those of the GCC, saw huge falls and markets lost as much as 70 per cent of their value in a relatively short space of time. While the summer of 2009 saw something of a break in the downward trend, stock market commentators have almost universally agreed that it is premature to call an end to the decline and they have gone on to warn that further market falls could happen anytime. The Muslim investor looking to take advantage of the equity markets for superior performance will have been disappointed of late, although those investors who chose to invest solely in a spread of Shariah compliant stock have fared better than others. Equities Dow Jones Indexes Performance of the Dow Jones Islamic Market World Index vs. the Dow Jones Global Index over the past 5 years According to Dow Jones Indexes on 10 September 2009, ‘Based on the close of trading on September 22, the global Dow Jones Islamic Market Titans 100 Index, which measures the performance of 100 of the leading Shariah compliant stocks globally, gained 4.25 per cent month-todate, closing at 2011.06. In comparison, the Dow Jones Global Titans 50 Index, which measures the 50 biggest companies worldwide, posted a gain of 4.80 per cent, closing at 167.25’. 180 160 140 120 100 Dow Jones lslamic Market World Index (Price/USD) 6/16/2009 4/16/2009 21/16/2009 12/16/2008 8/16/2008 10/16/2008 6/16/2008 4/16/2008 2/16/2008 12/16/2007 8/16/2007 10/16/2007 6/16/2007 4/16/2007 21/16/2007 12/16/2006 8/16/2006 10/16/2006 6/16/2006 4/16/2006 2/16/2006 12/16/2005 8/16/2005 10/16/2005 6/16/2005 4/16/2005 2/16/2005 12/16/2004 8/16/2004 60 10/16/2004 80 Dow Jones Global Index (Price/USD) Source: Dow Jones Indexes All data is as of August 14, 2009 As we might expect, some geographic markets fared better than others. According to Down Jones Indexes, ‘The Dow Jones Islamic Market Asia/Pacific Titans 25 Index, which measures the performance of 25 of the leading Shariah compliant stocks in the Asia/Pacific region, increased 6.49 per cent, closing at 1813.40. The Dow Jones Asian Titans 50 Index, in comparison, posted a gain of 4.66 per cent, closing at 133.06’. Performance of the Dow Jones Islamic Market World Index vs. the Dow Jones Global Index over the last month 120 115 110 105 Dow Jones lslamic Market World Index (Price/USD) All data is as of August 14, 2009 8/14/2009 8/13/2009 8/12/2009 8/11/2009 8/9/2009 8/10/2009 8/8/2009 8/7/2009 8/6/2009 8/5/2009 8/4/2009 8/3/2009 8/2/2009 8/1/2009 7/31/2009 7/30/2009 7/29/2009 7/28/2009 7/27/2009 7/26/2009 7/25/2009 7/24/2009 7/23/2009 7/22/2009 7/21/2009 7/20/2009 7/19/2009 7/18/2009 7/17/2009 7/16/2009 7/15/2009 7/14/2009 7/13/2009 100 95 Recent experience has shown that while investing in Shariah compliant stocks is not a hedge against equity market declines, at least the declines have been more modest than those from the market at large. It appears that much of the time gains are also less modest than those of the market as a whole. Dow Jones Global Index (Price/USD) Source: Dow Jones Indexes Recent experience has shown that while investing in Shariah compliant stocks is not a hedge against equity market declines, at least the declines have been more modest than those from the market at large While in Europe the same trend was in evidence, ‘Measuring Europe, the Dow Jones Islamic Market Europe Titans 25 Index, which measures the performance of the 25 of the leading Shari’ah compliant stocks in Europe, closed at 2066.95, a gain of 6.67 per cent, while the pan-European blue chip Dow Jones STOXX 50 Index gained 6.11 per cent, closing at 2731.15’. In the USA meanwhile the opposite trend can be seen, ‘Measuring the performance of 50 of the largest Shari’ah compliant US stocks, the Dow Jones Islamic Market US Titans 50 Index increased, closing at 2012.86. It represents a gain of 2.89 per cent. The US blue-chip Dow Jones Industrial Average increased 3.51 per cent, closing at 9829.87’. Finally, in the GCC, ‘Measuring the performance of Shariah compliant stocks of five of the Gulf Cooperation Council (GCC) member states, the Dow Jones Islamic Market GCC Index closed at 1473.51, a gain of 2.38 per cent. The conventional Dow Jones GCC Index was up 2.02 per cent, closing at 1520.71’. Islamic Wealth Management 2009 19 Equities Where to from here Occasional rallies in equity markets around the world are generally welcomed with open arms since the recent problems that markets have witnessed have been not of liquidity but of valuations. Valuing any kind of asset in a time of uncertainty is remarkably difficult to do: only markets themselves can determine true values. To that end many investors are choosing to stay liquid, remaining wary of risk while keeping an eye out for opportunities as they arise. In late July 2009 Dow Jones Indexes announced that Argentina, Colombia, Croatia, Lebanon, Mauritius, Nigeria, Peru, Saudi Arabia, Serbia, Tunisia and Ukraine would be added to the Dow Jones Islamic Market Index universe. This effectively increased the total number of countries in the Dow Jones Islamic Market Index universe to 68 from 57 and demonstrated that the world of Shariah compliant stocks is an ever expanding one. Michael Petronella, president, Dow Jones Indexes said, “The inclusion of these 11 thriving and competitive developing countries in the Dow Jones Islamic Market Index 20 Islamic Wealth Management 2009 130 120 110 100 90 80 8/7/2009 8/14/2009 7/31/2009 2/24/2009 7/17/2009 7/3/2009 7/10/2009 6/26/2009 6/19/2009 6/5/2009 6/12/2009 5/29/2009 5/22/2009 5/8/2009 Dow Jones lslamic Market World Index (Price/USD) All data is as of August 14, 2009 5/15/2009 5/1/2009 4/24/2009 4/17/2009 4/3/2009 4/10/2009 3/27/2009 3/20/2009 3/62009 60 3/13/2009 70 2/27/2009 In September 2009 Dow Jones announced that in their review of the first three quarter of 2009 that 111 components had been added to the Dow Jones Islamic Market World Index while 84 components were deleted. This increased the number of components in the index to 2,410 from 2,383. The total free-float market capitalisation of the reconstituted Dow Jones Islamic Market World Index decreased to $11,320 billion from $11,370 billion. It is not possible to establish how much of this has been invested because of the Shariah compliance of the companies in the index. 140 2/20/2009 Size of the market Performance of the Dow Jones Islamic Market World Index vs. the Dow Jones Global Index over the past 6 months 2/13/2009 The inescapable conclusion is that investing in Shariah compliant equities is a good strategy in volatile markets to minimise the downside for the investor, but even this may be cold comfort to those investors who have seen their portfolio shrink nonetheless. There is no guarantee that investing in Shariah compliant equities will lead to enhanced performance when global stock markets are in a rebound phase and indeed geography seems to play a greater role than Shariah compliance when markets are finding their new equilibrium levels. Dow Jones Global Index (Price/USD) Source: Dow Jones Indexes universe is a reaction to market demand but also reflects the growing importance of these countries for Islamic investors”. The current market uncertainty could remain for some years to come but it is likely that individual stocks will manage to beat the trend. The key for Islamic investors will lie either in putting their faith in an Islamic index or indices or in cherry picking Shariah compliant stocks of their own. The former might yield modest returns for some time to come and the latter might carry too much risk for the investor to stomach but there seems little doubt that equities will underlie many Islamic wealth management portfolios for some years to come. Stock market commentators have almost universally agreed that it is premature to call an end to the decline and they have gone on to warn that further market falls could happen anytime. Real estate Real estate Versatility is the key W here would the typical Islamic investor’s portfolio be without real estate? There is no denying that real estate has become the object of much attention by Islamic investors either directly or indirectly through a fund or other derivative instrument. Whether each of the different investment avenues is uncorrelated to the others remains to be seen. Real estate that features prominently on the radar screens of many Islamic investors as a direct investment vehicle, where properties of varying sizes, values, and locations are secured as part of a Shariah compliant portfolio, are by their nature illiquid and until recently were viewed as the non-speculative part of a portfolio. The pricking of the property bubble globally has led to a reassessment of the proper place of such investments in a balanced portfolio. No matter how specialist and focused the real estate investment, the fact is that the performance of these sorts of investments is necessarily at the whim of the local market. Such issues as the prevailing domestic interest rate and domestic supply and demand clearly affect the continued value of any real estate investment. While this can mean that such investments are uncorrelated to performance of the global real estate market, this is not always a positive. The reality, however, is that some sectors of the real estate market are more volatile than others with unit/flat developments often the most volatile and commercial premises rented on long-term leases the least volatile. The message from this may be that international diversification of property investments as well as diversification across sectors makes sense when trying to even out local property market fluctuations. Direct investing One of the key elements to be considered here, particularly when the Muslim investor is considering properties overseas, is whether the investor fully understands the property rights that are associated with the investment. Are foreigners allowed to buy property there? Are there restrictions on the resale of the property? And perhaps most important for the Muslim investor, is the property investment Shariah compliant? 22 Islamic Wealth Management 2009 Clearly the purpose of the real estate investment will be important in structuring the holding: was the investment made to preserve capital or to grow capital? Or is the investor looking for a regular income stream? Has the investor fully appreciated the ‘management’ time and expertise required to retain the value of the investment? Is the location of the property ‘up and coming’, ‘well established’, or is it ‘going to the dogs’? What is beyond doubt is that direct property investing for the HNW Muslim investor could be a full time job and it is not something that should be undertaken lightly. While the rewards for getting it right can be enormous the risks involved in getting it wrong can be equally large. Shariah compliant real estate funds As the following pie chart from IFIS shows, there is no shortage of Shariah compliant real estate funds for the investor. Islamic Funds 2% 5% 7% 54% 17% 15% 54% Equities 15% Mixed assets 17% Money market 7% Real estate 5% Sukuk 2% Other Source: IFIS Seven per cent of all of Islamic funds are real estate orientated which means that there are a total of 43 funds that are purely focused on this area. This figure does not include some of the private equity funds and other funds that also have a property exposure. The average amount invested in those funds for which IFIS has data is $119 million which would suggest that the total invested in all funds is around $5 billion for all 43 funds. Real estate As the table overleaf shows, the performance figures that are available show that the performance of the funds is very volatile. Apart from anything else this means that it is extremely difficult for the Muslim investor to pick a winner. Since the first fund dates from August 2002 this means that over the past seven years an average of just over five funds per year have been launched and are still in existence although the reality of the situation is that the number of funds launched per year has been increasing each year, with eight funds launched in 2008 and most of them in the first half year. The relatively modest Inovest Real Estate Investment Trust of $80 million is the only fund to have been launched since August of 2008 when the financial crisis swung into its most debilitating phase. Islamic Wealth Management 2009 23 Real estate IFIS Real Estate Funds Table Date 04/08/2009 09/04/2009 25/08/2008 01/07/2008 11/06/2008 27/05/2008 13/03/2008 13/03/2008 28/02/2008 18/02/2008 02/02/2008 01/10/2007 22/08/2007 11/07/2007 30/05/2007 23/05/2007 01/05/2007 27/02/2007 15/02/2007 31/12/2006 01/12/2006 30/11/2006 16/09/2006 01/08/2006 01/05/2006 01/03/2006 24/01/2006 24/07/2005 01/07/2005 01/07/2005 01/07/2005 14/06/2005 17/04/2005 01/02/2005 01/11/2004 30/05/2004 01/05/2004 20/04/2004 01/03/2004 01/10/2003 28/05/2003 01/02/2003 29/08/2002 24 Fund Name Fund Domicile Real Estate Musharakah Notes Inovest Real Estate Investment Trust SHUAA Saudi Hospitality Fund Global GCC Real Estate Fund II Al Imtiaz Real Estate Fund Waed Real Estate Investment Fund Emirates Islamic Global Property Fund- Retail Emirates Islamic Global Property Fund- Institutional Danat India RIA Fund Islamic Turkey Real Estate Fund Taibah KSB Real Estate Fund Global Real Estate Ijarah Fund OSK-UOB Asian Real Estate Fund Amar Real Estate Fund US Retail Realty Fund Markaz Real Estate Opportunities Fund Al Islami US Properties III Fund 4-Year Capital Protected Global REIT Note Samba Real Estate Fund Boubyan Real Estate Sukuk Fund U.S. Development Opportunities Fund Islamic European Real Estate Fund Boubyan Global Real Estate Fund Global Asia Real Estate Fund Asian Real Estate Fund Prime Industrial Real Estate Fund 2 China Realty Modaraba Fund Global US Real Estate Fund Emirates Real Estate Fund - AED Emirates Real Estate Fund - Income Emirates Real Estate Fund- Accumulation GCC Real Estate Fund Awaed Real Estate Fund Amlak First Real Estate Fund Solidarity European Real Estate Fund Islamic Asian Real Estate Fund Al Islami French Property Fund Solidarity International Real Estate Fund Shuwaikh Real Estate Fund The U.S. Commercial Properties Portfolio Fund Makaseb Real Estate Fund (Previously Aayan 1st Real Estate Fund) Markaz Real Estate Fund Al Dar Real Estate Fund United Arab Emirates Bahrain Saudi Arabia Bahrain Kuwait Kuwait Jersey Jersey India Cayman Islands Saudi Arabia Bahrain Malaysia Kuwait United Arab Emirates Kuwait United Arab Emirates United Kingdom Saudi Arabia Bahrain Cayman Islands Cayman Islands Kuwait Cayman Islands Kuwait Kuwait Cayman Islands Cayman Islands Jersey Jersey Jersey Bahrain Kuwait United Arab Emirates Bahrain Cayman Islands United Arab Emirates Bahrain Kuwait United Arab Emirates Islamic Wealth Management 2009 Kuwait Kuwait Kuwait Geofocus UAE Gulf Cooperation Council (GCC) Saudi Arabia Gulf Cooperation Council (GCC) Gulf Cooperation Council (GCC) Gulf Cooperation Council (GCC) Global Global India Turkey Saudi Arabia Middle East and North Africa Asia Pacific Kuwait United States Middle East and North Africa United States Global Global Saudi Arabia United States Europe Global Asia Asia United States China United States UAE UAE UAE Gulf Cooperation Council (GCC) Gulf Cooperation Council (GCC) UAE Global Asia France Global Kuwait United States Gulf Cooperation Council (GCC) Kuwait Gulf Cooperation Council (GCC) Real estate Asset Type Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Base Currency USD BHD SAR USD KWD KWD USD USD AED USD SAR USD MYR KWD USD USD USD USD SAR USD USD EUR KWD USD USD USD USD USD AED USD USD USD KWD USD EUR USD EUR USD KWD USD Fund Size (US$m) N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A Real Estate KWD N/A Real Estate Real Estate KWD KWD N/A 50 79.81 240 500 57.18 52.01 75.4 47 200 150 48.42 100 250 150 100 262 100 75 10.07 39.6 15.65 30 103.15 Fund Manager Type Mayfair Wealth Management Inovest SHUAA Capital Saudi Arabia Global Investment House Al Imtiaz Investment Al Dhow Investment Company Emirates Fund Managers (Jersey) Limited Emirates Fund Managers (Jersey) Limited Khaleeji Commercial Bank Wafra Investment Advisory Group KSB Capital Group Global Investment House OSK-UOB Unit Trust Management Bhd Amar Finance and Leasing Investcorp Bank B.S.C Kuwait Financial Centre (Markaz) Investcorp Bank B.S.C Dubai Islamic Bank Samba Asset Management Boubyan Bank Shamil Bank Wafra Investment Advisory Group Boubyan Bank Global Investment House Kuwait Finance House Kuwait Finance House CIAM-Shamil Asset Management Ltd. Global Investment House Emirates Fund Managers (Jersey) Limited Emirates Fund Managers (Jersey) Limited Emirates Fund Managers (Jersey) Limited Global Investment House Aayan Leasing & Investment Co Amlak Finance Solidarity BSC(c) Wafra Investment Advisory Group Dubai Islamic Bank Solidarity BSC(c) Al Madar Finance & Investment Dubai Islamic Bank Closed Ended Closed Ended Closed Ended Open Ended Open Ended Open Ended Open Ended Closed Ended-(Renewable) Closed Ended Closed Ended Closed Ended Open Ended Closed Ended-(Renewable) Closed Ended Closed Ended-(Renewable) Closed Ended Closed Ended Open Ended Closed Ended Closed Ended-(Renewable) Closed Ended Open Ended Closed Ended Closed Ended Open Ended Closed Ended Closed Ended-(Renewable) Open Ended Open Ended Open Ended Closed Ended-(Renewable) Closed Ended-(Renewable) Closed Ended Open Ended Closed Ended Closed Ended Open Ended Open Ended Closed Ended Aayan Leasing & Investment Co Closed Ended-(Renewable) Kuwait Financial Centre (Markaz) Al Dar Asset Management Closed Ended Closed Ended Source: IFIS Islamic Wealth Management 2009 25 Real estate Performance figures are not available for many of the funds which makes comparison between funds difficult and comparison with other asset classes more difficult still. According to Ernst & Young’s Investment Funds & Investment Report 2009 average returns from Islamic real estate funds fell from 8 per cent in 2007 to minus 11 per cent in 2008 and minus 5 per cent in the first quarter of 2009. It is clear that these funds have been badly affected by the downturn in real estate asset prices. The benefit of holding such units from the individual investor’s point of view is that these collective investments can offer exposure to larger commercial or industrial properties that individual investors would otherwise not have access to. Such investors may also find that these units are far more liquid that the underlying real estate assets themselves. In other words investors can invest in real estate through Shariah compliant capital market instruments that are easily tradable. Islamic Real Estate Funds - Average Returns 30% 25% 28% 21% 20% 15% 10% 13% 11% 8% 5% 0% -5% 2006 2007 -5% -10% -11% -15% Top Quartile Average Return Note: Data includes returns of 17 funds Real Estate Investment Trusts Islamic Real Estate Investment Trusts (REITs) are capital market vehicles for owning real estate and deriving income and they can begin to overcome some of the illiquidity issues presented by real estate funds. These collective investments will pool money from a variety of investors to buy, manage, and sell real estate assets of one sort or another. A REIT can invest in income producing Shariah compliant real estate or Shariah compliant SPVs that hold Shariah compliant assets. Investors or unit holders in an Islamic REIT typically receive a proportion of the rental income generated from these assets as their reward for holding the units. Islamic Wealth Management 2009 Average Return Source: Ernst & Young Islamic Funds & Investments Report (IFIR 2009) Islamic real estate funds can be a useful tool for UHNW Muslim investors although they can prove to be rather illiquid. 26 Q1 2009 -5% 2008 In many regards the Securities Commission Malaysia is a leading light in issuing guidelines on Islamic REITs and their treatment. As far back as 2005 the commission issued a set of guidelines for Islamic REITs. A brief summary of these guidelines would include: • Rental income is derived from permissible business activities. Where a portion of the rental is from non-permissible activities, these rentals cannot exceed 20 per cent of the total turnover of the Islamic REIT • Islamic REITs cannot own properties where tenants operate non-permissible activities • Islamic REIT cannot accept new tenants whose activities are fully non-permissible • Only 20 per cent of the floor area of a property can be occupied for non-permissible activities • All forms of investment, including deposit Real estate and financing instruments, are Shariah compliant • Property insurance must be based on Takaful except where Takaful schemes do not operate Each Islamic REIT must have a Shariah board responsible for ensuring that the Islamic REIT complies with Shariah principles. According to the Securities Commission Al’-Aqar KPJ healthcare REIT was the first Islamic healthcare REIT listed on Bursa Malaysia Securities in August 2006. The second was an Islamic plantation REIT called Al-Hadharah Boustead REIT. requirements appear to provide better historical returns. However, Shariah compliance does not mean that Shariah compliant real estate mutual funds necessarily under-perform relevant indexes when relevant risk factors are considered and allowing for differing sensitivities to benchmark returns’. The authors concluded with the final word on the subject, ‘the acid test will be empirically possible only with time and as more Islamic REITs and real estate funds become established’. What experience over the past three years since the research study was undertaken shows is that REITs as a whole have not performed well in the cold light of the financial crisis as the following chart makes clear. A research study called ‘Shariah Compliance in Real Estate Investment’ was undertaken by Muhammad Faishal bin Ibrahim and Ong Seow Eng Global REIT Index 250 200 150 100 50 2/3/2009 2/1/2009 2/11/2008 2/9/2008 2/7/2008 2/5/2008 2/3/2008 2/1/2008 2/11/2007 2/9/2007 2/7/2007 2/5/2007 2/3/2007 2/1/2007 2/11/2006 2/9/2006 2/7/2006 2/5/2006 2/3/2006 2/1/2006 0 Source: Global Business Monitor International, Eurekahedge, Zawya, Ernts & Young analysis of the Department of Real Estate of the National University of Singapore in 2006 to establish whether Islamic REITs underperform conventional REITs in terms of returns. The exercise had to be theoretical since Islamic REITs were such a new breed that there were not enough real life examples to undertake empirical research. To simulate this exercise Ibrahim and Ong constructed a synthetic portfolio and analysed the returns. They concluded, ‘The key result is that Shariah compliance seems to create a return trade-off and less restrictive compliance Further thoughts There is no escaping the long term appeal of real estate as an asset class for Islamic investors. The suitability of real estate for the individual portfolio of a Muslim investor, however, will depend on a large number of variables. In many ways the performance of a real estate investment in any of its guises will be dependent upon local market issues. As a consequence it can be difficult for a wealth manager or private banker to advise a client on these areas except in a very general way. Islamic Wealth Management 2009 27 Real estate Without doubt REITs and many Islamic real estate funds mitigate the effects of some of these variables although for investment purposes more work has to be done to provide benchmark indices for investors and advisers to use. In particular, the lack of data publicly available on the performance of Islamic real estate funds is an issue that needs to be addressed urgently. 28 Islamic Wealth Management 2009 Shariah compliance does not mean that Shariah compliant real estate mutual funds necessarily under-perform relevant indexes when relevant risk factors are considered and allowing for differing sensitivities to benchmark returns. Could your Annual Report be better The chairman takes an interest. The CEO takes an interest. But it’s your job to get the annual report out on time and on budget If you need to produce an Annual Report for your bank or Takaful house and if it has to be even better than last year’s then perhaps you need a fresh set of eyes to look at it. Because very often producing great marketing isn’t good enough – you need to produce brilliant marketing. Every time. On time. For help with your annual report contact: [email protected] and we will call you to discuss your needs. Sukuk Sukuk The place of fixed income in a balanced portfolio F ixed income has always played a part in any diversified portfolio, and particularly so for ultra high net worth individuals. Bonds, both corporate and sovereign, can offer investors a fixed rate of return over a specified period that is often comfortably in excess of the prevailing rate of interest. As a result such instruments can offer a significant element of stability and predictability to a portfolio that helps to offset the risks represented by more speculative elements of the portfolio. Traditionally the appeal of such instruments was underpinned by a couple of important factors: whether the bonds were rated by a reputable rating agency; and whether they were listed on an exchange and were therefore tradable. Many huge investment vehicles, such as pension funds, can only invest in ‘investment grade’ debt, basically A grade and above, and this may be good advice for private investors too, especially if they are looking only for modest and predictable returns. The rating of Islamic debt instruments, or Sukuk, in the past has not been a mandatory pre-requisite for many investors and indeed many unrated Sukuk have been massively oversubscribed. This might, in the past, have led issuers to believe that a rating was an unnecessary extra expense that they did not need to incur. The same might be said of listing a Sukuk on an exchange where it could be traded. Often, in the past, investors in Sukuk held their investment to maturity simply because there were so few other Shariah compliant avenues open to them. This had begun to change as Sukuk issuance grew to the heady levels that the market witnessed in 2007 and 2008 and trading became slightly more commonplace. HSBC, for instance, became a market maker in Sukuk although the volumes traded were generally rather thin. Islamic Wealth Management 2009 31 Sukuk Malaysia was always a different proposition altogether. In Malaysia there has been a very active primary and secondary market for Sukuk in part because of the strong government and central bank backing of the Islamic debt capital market and in part because every Sukuk issued in Malaysia must have a rating, although generally the rating for ringgit denominated Sukuk would come from one of the domestic rating agencies, RAM or MARC. New realities The financial crisis has been very useful in raising the level of the debt markets of the world. In the first eight months of 2009 global corporate bond issuance went through the $1,000 billion mark for the first time in any single year. According to investment grade, further demonstration that investors are very concerned about finding safe havens for their funds. The other side of this coin is that syndicated bank loans for the first eight months of 2009 are well down on previous years: 52 per cent down on 2008 and 69 per cent down on 2007. These figures reflect the reluctance of banks to lend as they struggle to repair the balance sheet damage inflicted by the credit crisis. According to figures from Zawya’s Sukuk Quarterly Bulletin for the third quarter of 2009, ‘Sukuk issuances in Q3 2009 were up 15 per cent from the previous quarter and almost double compared to Q3 2008’. Global Sukuk Issues ($m) - 3Q09 vs. 3Q08 9,000 8,000 7,000 6,176 6,000 2,534 5,000 4,000 3,369 3,000 1,638 3,642 2,000 1,731 1,000 0 3Q08 Mena 3Q09 Other Dealogic $1,103 billion in debt was issued in the first eight months of the year. There are various reasons for the surge in borrowing levels but undoubtedly the two main reasons are the difficulties that corporates have experienced in borrowing from their traditional bank lenders coupled with the fact that there has been a significant increase in investor interest because of the attractive rates of return offered by corporate bonds. Of greatest interest to prospective issuers and investors alike is the fact that 90 per cent of this debt was 32 Islamic Wealth Management 2009 Source: Zawya Sukuk Monitor The Nakheel conundrum Dubai government-owned developer Nakheel has a $3.52 billion Sukuk which matures in midDecember 2009, together with a roughly $500 million profit payment on the Sukuk. Nakheel has been very hard hit by the financial crisis, particularly since the value of property in Dubai has halved since the crisis struck. There have been reports of Nakheel delaying payments to contractors and this has led to speculation that the developer might try to restructure its debt ahead of the maturity date. Sukuk Developments through the summer of 2009 have suggested that these early concerns were overblown and that Nakheel will repay Sukuk holders in full and on time but this did not stop the price of the Sukuk dropping to 63.5 cents on the dollar in February 2009, although it recovered to around 90 cents by August 2009 and finally leapt to 102.5 cents by mid-September after Dubai’s ruler, Sheikh Mohammed bin Rashid Al Maktoum, offered assurances that everything was OK. However this tightening of spreads is indicative of the Sukuk market as a whole as the charts overleaf illustrate. The financial crisis has been very useful in raising the level of the debt markets of the world. In the first eight months of 2009 global corporate bond issuance went through the $1,000 billion mark for the first time in any single year. Islamic Wealth Management 2009 33 Sukuk HSBC/DIFX HSBC Amanah Sukuk US Dollar Bond Index (HASI) The HSBC/DIFX HSBC Amanah US Dollar Sukuk Index (HASI) is designed as a replicable benchmark tracking the return of an emerging HSBC Amanah sukuk portfolio. It consist of USD/JPY/EUR-denominated fixed/floating rate vanilla sukuk. 896 2009 Year to date 809 722 635 548 461 374 Feb Mar Apr May Jun Jul Aug HSBC/DIFX HSBC Amanah Sukuk US Dollar Bond Index (HASI) The HSBC/DIFX HSBC Amanah US Dollar Sukuk Index (HASI) is designed as a replicable benchmark tracking the return of an emerging HSBC Amanah sukuk portfolio. It consist of USD/JPY/EUR-denominated fixed/floating rate vanilla sukuk. 562 3 months to 23 August 2008 498 470 442 414 386 358 Jun Some weeks before the Nakheel Sukuk matures the government of Dubai will have to repay the $1 billion Dubai Global Sukuk, which was a five year Sukuk from 2004 issued on behalf of the Dubai Civil Aviation Authority that matures early in November 2009. While some observers have speculated that refinancing the Sukuk will be expensive the Dubai Department of Finance advised Zawya Dow Jones in September 2009 that defaulting on the Sukuk ‘isn’t an option’. Other question mark around the industry There have been a few other remarkable developments that have spurred increased interest in the Sukuk market. One has been the bankruptcy filing by East Cameron Partners in the USA which 34 Islamic Wealth Management 2009 Jul Aug was the entity behind the issuance of the USA’s first and only Sukuk. How the courts deal with the bankruptcy will be crucial in determining what happens in to Sukuk under these circumstances in legal terms, since this is largely uncharted territory, and Sukuk holders will be keen to see where they appear on the list of creditors. Of equal interest is the default by Investment Dar of Kuwait on a payment on its Sukuk that matures next year. What these developments show is that Sukuk are no longer viewed as a safe haven that offer predictable returns with minimal risk. Add to this the media-enhanced furore that broke out when it was reported that Sheikh Taqi Usmani Sukuk The reality of the situation is that Usmani said no such thing, and his remarks were confined to non-Ijarah issues, but this seemed to matter little as critics and investors alike scrambled to find out what this meant for the market. declared that 85 per cent of Sukuk were not Shariah compliant and it becomes evident that the industry as a whole still has a lot of growing up to do. The reality of the situation is that Usmani said no such thing, and his remarks were confined to non-Ijarah issues, but this seemed to matter little as critics and investors alike scrambled to find out what this meant for the market. The year to date for Sukuk According to a report from Standard & Poor’s released in early September 2009 new issuance of Sukuk dropped to $9.3 billion in the first seven months of 2009 compared with $11.1 billion during the same period in 2008. Islamic Wealth Management 2009 35 Sukuk Total Sukuk Issuance (2001-2009) (Bil. $) 100 90 80 70 60 50 40 30 20 10 0 2001 2002 Total sukuk issued 2003 2004 Sukuk cumulative total 2005 2006 2007 *First seven months of 2009. 2008 Source: 2009 Standard & Poor’s 2009 Total Sukuk Issuance by Country in 2009* Bahrain 9.79% United Arab Emirates 4.26% Saudi Arabia 22.03% Brunei Darussalam 0.71% Gambia 0.08% Indonesia 16.05% Pakistan 2.04% Malaysia 45.03% The geographic spread of spread of Sukuk issuance shows a marked resurgence of Asia in general and Malaysia in particular. Equally fascinating from S&P’s research was the slide in significance of the US dollar in favour of domestic currency issues. Perhaps this says more about the prospective audiences for the various Sukuk issues, but nonetheless points to an upsurge in domestic rather than international borrowing. This latter factor has great significance for those watching the Sukuk space from a wealth management perspective since investors are unlikely to be attracted to non US dollar foreign currency 36 Islamic Wealth Management 2009 *First seven months of 2009. Source: Standard & Poor’s 2009 Sukuk for the simple reason that such Sukuk leave the investor open to foreign exchange risk. As an example, only wealthy Muslim investors in Indonesia are likely to want to invest in a rupiah denominated issue since the currency itself may collapse quite independently of the issuer. The GCC According to Markaz, most of the issues seen in the GCC so far in 2009 were either sovereign or by corporates that are fully or largely owned by their governments. Indeed such issuance accounts for 92 per cent of the total issuance during the period. As Markaz said, ‘It is interesting to note that all of the Sukuk issuances raised during H12009 were sovereign Bahraini Sukuk Total Sukuk Issuance by Currency in 2009* Bahraini dinar 1.81% Bruneian dollar 0.71% Gambian dalasi 0.08% US dollar 19.16% Indonesian rupiah 45.03% Saudi Arabian riyal 22.03% Malaysian ringgit 45.03% Pakistan rupee 2.04% *First seven months of 2009. Source: Standard & Poor’s 2009 issuances, except for one which was issued by the Saudi Arabia-based Dar Al-Arkan Real Estate Development Company in May 2009. During H12009, sovereign issuances dominated the majority of the amount raised, raising $12.7 billion with a 69.0 per cent share of the total volume; continuing with the trend observed since 2003 except for the peak years of 2006-2007, in addition to 2008, where corporate issuances dominated the market’. In part these sovereign issues can been seen as genuine attempts by regional governments to raise much needed funds and in part as an attempt to breathe some life back into the moribund fixed income sector. Aside from the fully sovereign issues in the first half of 2009 there was also a significant amount of activity from government-linked entities. According to Markaz, ‘Of the $5.7 billion raised by corporations, 74.6 per cent was raised by corporations that are either fully or largely owned by governments, the remaining amount was raised by Dar Al-Arkan Real Estate Development Company and Aldar Properties PJSC; nonetheless, 26.3 per cent of the latter is owned by government entities’. In terms of geographic spread $6 billion, or 38.1 per cent of the total amount raised came from the UAE, $5.8 billion, 31.3 per cent came from Kuwait; Qatar issued $4.5 billion; and Bahrain issued $920 million. Saudi Arabia was the least active among the GCC issuers with only one issue raising $200 million however, according to Markaz, ‘Saudi-based Saudi Electricity Company launched and sold a Sukuk, but did not close the books nor issue the Sukuk, during the last week of H12009’. According to S&P there are still significant issues facing the Sukuk industry in the year ahead. These include: • Difficult market conditions, which are slowing the planned issuance of numerous Sukuk; • The lack of standardisation, notably when it comes to Shariah interpretation; and • The low liquidity of the Sukuk market, which constrains investors trying to exit the market in times of turbulence or access the market looking for distressed sellers. While these undoubtedly represent significant concerns it is likely that they will form only Islamic Wealth Management 2009 37 Sukuk background noise when the industry takes off, which is unlikely to happen until general market conditions improve and the position of Sukuk when faced with a default is clarified significantly. The Islamic Development Bank The Islamic Development Bank (IDB) has often been the subject of discussions concerning Sukuk since the institution has a significant history of issuing landmark transactions over the years. 2009 is no exception and the IDB came to market with a $500 million issue in early September. The roadshow for drumming up interest in the Sukuk took in Saudi Arabia, UAE, Malaysia, Brunei, Tanzania, UK, Singapore and Switzerland showing that oversubscription these days is by no means automatic, even for issues from an institution like the IDB which has a triple A rating from all three of the main rating agencies. According to the IDB, ‘Though the offering will be for a minimum of $500 million, the actual size of issuance will depend on the interest of investors and market conditions, while pricing will be benchmarked against other multilateral development institutions’. The prospects for Sukuk and the wealth management industry There is no doubt that the Sukuk market has reappeared on the radar screens of many investors over the past year. In part this is because, in spite of the tribulations that the Sukuk market has witnessed over the past 18 months, there is still a place for a fixed-income type product in most portfolios. What we are likely to see is a ‘flight to quality’ which could mean that Sukuk from triple A rated issuers that are listed on recognised exchanges are snapped up in favour of issues with no rating and no listing. We might also see a scramble to have nothing but blue chip managers and lead managers working on issues. While this will undoubtedly be good for some issuers and investors it could have the effect of knocking out the smaller issuers that had come to typify the Sukuk market. 38 Islamic Wealth Management 2009 In terms of pricing, it is likely that Sukuk will be priced in a much more competitive fashion in future as they compete with funds from other Shariah compliant instruments, as well as from non-Shariah compliant ones. Many Islamic investors have maintained for years that ‘money has no religion’ and they refuse to pay a premium for investing according to their faith. Recent developments are likely to consolidate these beliefs and indeed may even expand the pool of investors who simply want a safe haven for the funds and are prepared to turn a blind eye to the fact that the investment itself is haram. What seems beyond doubt is that issues from the GCC will start to look more and more like those from Malaysia where a strict cookie-cutter approach is taken to issuing Sukuk. One of the prevalent trends in Malaysia is for Islamic Medium Term Note programmes whereby one set of documentation can be used for multiple issues from the same issuer. These are eminently sensible and could make a useful addition to the battery of dollar denominated instruments that we find in the GCC and the rest of the world. The next six to 12 months are likely to be fascinating for the Sukuk niche, whether or not the much talked about ‘pent up demand’ of $50 billion of Sukuk in the pipeline ever materialises. Middle Eastern business portal Zawya has taken some very interesting steps to encourage debate and discussion on how to encourage and enhance secondary market trading in Sukuk. Zawya has set up a discussion forum that is already throwing up some fascinating insights from market participants on how to bolster and boost the industry. If nothing else, initiatives such as this one from Zawya give some indication that the industry itself is ready to take the next step towards maturity. If this leads to more rated and listed Sukuk on the primary market and therefore healthy trading on the secondary market, then this can only be good news for the UHNW Muslim investor looking for a core of stability and predictability to his portfolio. The rating of Islamic debt instruments, or Sukuk, in the past has not been a mandatory pre-requisite for many investors and indeed many unrated Sukuk have been massively oversubscribed. Islamic funds Islamic funds 40 Islamic Wealth Management 2009 Islamic funds IFIS, the Islamic finance portal from Euromoney, has one of the most extensive databases on Islamic funds and as of the middle of October 2009 had 556 Islamic funds listed with a total value of $22.8 billion. These funds are focused on a variety of asset classes as the following pie chart from IFIS shows: Islamic funds by type 2% 5% 7% 54% 17% 15% It’s been a rocky road P erformance figures from Lipper, the fund intelligence company, show that both conventional and Islamic Arab domiciled funds were worth a cumulative $64 billion in July 2008. By the end of 2008 that figure had dropped to $50.4 billion and then recovered somewhat to stand at $56.9 billion and the end of July 2009. While nothing in these figures will surprise investors or market watchers, they do indicate that funds can be a very volatile beast and need to be handled with care by the UHNW Muslim investor. The problem with investing in any fund, conventional or Islamic, is that the success or failure of the fund depends on the performance of the fund manager. As recent experience has shown past performance is not always a good guide to future performance, particularly when markets are collapsing in tandem all over the globe. Success in investing in funds, therefore, lies not so much in picking the right fund as in picking the right fund manager. Still, investing in funds is often an easy way of allowing investors access to a broad spread of underlying assets without exposing them to the vagaries in performance of any single asset. To this end Islamic funds have for long been a core part of many Islamic wealth management portfolios. 54% Equities 15% Mixed assets 17% Money market 7% Real estate 5% Sukuk 2% Other Source: IFIS Since the start of the summer of 2009 hardly a week has gone by without a new Islamic fund being brought to market to capitalise on the growing interest in Shariah compliant funds. New funds are being launched at an unprecedented rate with some of the most recent coming from non-Islamic finance houses such as NBK which announced the launched of its Islamic KD Ijara Fund II which will offer investors the equivalent of 6.25 per cent throughout the life of the fund. Minimum investment in the Kuwait dinar denominated fund is around $100,000 which suggests that the audience for the fund is certainly amongst an affluent Muslim private investor audience. The fund was fully subscribed within one day of opening. According to NBK the fund was launched as a result of the ‘overwhelming success’ of the first Islamic KD Ijara Fund which was launched in June of this year and was fully subscribed in a matter of days too. Almost concurrent with this launch was the Shamil Solid Return Fund, a Shariah compliant multi-asset investment fund from Shamil Bank of Bahrain. According to the bank the fund is Islamic Wealth Management 2009 41 Islamic funds designed specifically for the expert investor who is looking to diversify investments in the current market. Although only small, at $25 million, the fund will invest in a mixture of assets: Islamic equities, Sukuk, Mudaraba investments, and crude oil. QInvest from Qatar, meanwhile, is setting up a $200 million five year mezzanine fund together with Fortis Bank Nederland to buy shipping assets to take advantage of falling prices in the maritime sector. The Shariah compliant fund will be invested over the next 18 months. International shipping has been knocked hard by the global economic crisis, largely due to overcapacity caused by a construction boom that took place before the slump began which shows that Shariah compliant funds are being used in ever more inventive ways to take advantage of the current market opportunities thrown up by the financial crisis. Abu Dhabi’s The National Investor’s and Kipco Asset Management Company set up a $150 million Islamic fund in early September 2009 as further proof that the Islamic funds space is attracting players from outside the traditional Islamic finance arena. The Shariah compliant fund will be launched within three months and will make six or seven investments with an average equity of $25 million each in mid-size, family-owned companies that require external funding in order to cope with the pressures brought to bear by the financial crisis. In contrast to all of this growth news HSBC told Reuters in mid-September that it had postponed the launch of its first fund investing in Sukuk after investors were put off by a four-year lock-up period. HSBC Amanah had planned to launch the fund in the summer of 2009. “We decided to take some time to redesign the product based on feedback during the marketing phase,” the spokeswoman for HSBC Global Asset Management told Reuters. “The lock-in period was not attractive to investors at the time.” Naturally this phenomenal growth in funds is not restricted to Islamic funds and indeed the latest GCC Fund Market Insight Report from Lipper indicates that GCC equity funds moved into positive territory for the first half of 2009 recording an increase of over 21 per cent. This compares to a 12.5 per cent loss in the corresponding period 42 Islamic Wealth Management 2009 for 2008. Of the GCC-domiciled funds, those funds that invested in emerging markets and sector-based funds, such as information technology and natural resources, were significant leaders. Striking the right balance In terms of a balanced Islamic wealth management portfolio it appears that exposure to Islamic funds of different sorts, in different jurisdictions, with differing underlying asset types and structures may continue to grow in significance and importance as the world climbs out of recession and into a new growth phase. The Ernst & Young Islamic Funds and Investment Report for 2009 now seems almost prescient when it stated, ‘Despite this setback, the fundamentals of the Islamic fund industry remain strong. With almost $50 billion in fund assets under management and a large, expanding and untapped Muslim population, there are likely to be considerable opportunities in the future. This is a time when strategic choices have to be made and market participants have to adapt to survive’. The following graph illustrates the remarkable growth of the Islamic funds industry since it first emerged as a significant part of the overall Islamic finance industry: investing in funds is often an easy way of allowing investors access to a broad spread of underlying assets without exposing them to the vagaries in performance of any single asset. Global Islamic funds industry (Estimated AuM. (US$) 50 45 40 35 30 25 20 15 10 5 0 Number of funds 41 43 44 34 700 600 29 20 800 500 23 400 300 200 100 2003 2004 2005 2006 Assets under management (AuM) 2007 2008 Q1 2009 0 Number of Islamic funds Source: Eurekahedge, Zawya, Ernst & Young analysis What these figures are in danger of concealing, however, is that the average returns on Islamic funds over most of 2008 and the first part of 2009 have been far from spectacular. While it is true to say that most asset classes suffered badly over this same period, Islamic funds were Islamic funds certainly not been immune to the collapse in asset values around the world. The following graphs all come from the E&Y report and demonstrate the parlous performance of all Islamic funds up to the end of the first quarter of 2009. The fees debate Few investors welcome paying fees to their fund manager but are generally happy to do so if they hold the belief that the returns offered by the fund manager will be sufficient to outweigh these costs. But when returns are below par or below the expectations of the investor then questions start to arise over fee size. According to research undertaken by Eurekahedge, ‘average management fees of Islamic funds have gradually increased, in particular with regards to equity funds and this has been more pronounced with mandates in Middle East (the average fee now at 1.7 per cent) and Asia Pacific (the average fee now 1.59 per cent)’. Logic would suggest that poor fund performance would put fund management fees under pressure and the groups most able to resist such pressures would be those groups with the most market presence. In such a case then groups like NCB Capital, with 21 funds to its name with a total value of over $10 billion, are better placed to resist fee pressures than those will less clout. Islamic Wealth Management 2009 43 Islamic funds The road ahead The Islamic funds industry, like the rest of the funds industry, seems to be filled with fund managers more concerned about hanging onto their job than producing stellar results. Indeed, just matching an index these days is deemed to be the important thing. What seems clear is that the next 12 months will show a lot more volatility and we can expect to see the individual performance of funds fluctuating in line with the markets. Islamic funds can still play a central role in any risk balanced portfolio but the core consideration when choosing a fund has to be track record rather than asset class or investment philosophy. Shariah compliant funds are being used in ever more inventive ways to take advantage of the current market opportunities thrown up by the financial crisis. Islamic Equity Funds - Average Returns 60% Islamic Fixed Income Funds - Average Returns 51.7% 9% 50% 9% 8% 8% 40% 27.0% 30% 20% 6% 4.8% 3.4% 10% 0% 2006 -10% 2007 2008 -3.7% Q1 2009 -30% Top Quartile Average Return 4% 0% Islamic Cash Funds - Average Returns 25% 15% 10% 7.2% 5% 5.2% 3.4% 0% 0% 3.9% -5% 1.8% 2% 0% 2006 2007 Top Quartile Average Return Q1 2009 Average Return 23.2% 21.2% 10.5% 10.0% 2008 -15% Q1 2009 -25% Average Return Islamic Wealth Management 2009 2.2% 2.2% 2006 1.8% 2007 2008 Q1 2009 -10% 0.7% Source: Bloomberg, Eurekahedge, Zawya, Ernst & Young analysis 44 2008 20% 8% 4% 1% Source: IFIS, Zawya Sukuk Monitor, Eurekahedge, Ernst & Young analysis 30% 10.5% 6% 2007 1% Islamic Commodity Funds - Average Returns 12.2% 10% 2006 Top Quartile Average Return Source: Eurekahedge, Zawya, Ernst & Young analysis 12% 4% 3% 3% Average Return 14% 4% 1% -39.0% -40% 5% 2% -20.9% -20% 7% 7% 23.0% -20% Top Quartile Average Return Average Return Source: Merrill Lynch, Eurekahedge, Zawya, Ernst & Young analysis Private equity and venture capital Private equity and venture capital The elephant in the room I n 2006 Abraaj Capital announced its $2 billion Infrastructure and Growth Capital Fund (IGCF) as a Shariah compliant private equity fund that was to be co-sponsored by Deutsche Bank and Ithmaar Bank. The very simple idea behind the fund was that the GCC has a tremendous need for infrastructure investment and that a fund to address this need that was structured to be compliant with Shariah would have no shortage of takers. Infrastructure was defined to include not simply physical infrastructure like roads, airports, desalination plants and so on but also ‘soft infrastructure’ such as schools, universities, hospitals and the like. When the fund closed in December 2007 it was fully subscribed and according Abraaj Capital, ‘The fund made a total of four acquisitions in 2007 deploying close to $1 billion of fund capital. The fund made a further seven investments during 2008, reaching over 90 per cent deployment at year end. IGCF also made a distribution of $300 million in July of 2008, representing 15 per cent of its capital’. According to Zawya’s Private Equity Monitor no other Shariah compliant private equity or venture capital fund comes anywhere near the size of the Abraaj fund. Indeed the monitor shows that there are only 17 such funds in existence with a total value of just over $4 billion. Shariah Compliant Private Equity & Venture Capital Funds October 2009 Status Full Name Closing Fund Manager Date Investment Focus Geographical Focus Fund Size Fund Raising Al Fares Private Equity Fund - Al Mal Capital Buyout MENA - Investing Al Mal Capital Market Funds L. P. Apr 08 Al Mal Capital Buyout MENA $ 40M Investing Alimtiaz Investment Fund - Alimtiaz Investment Company Buyout MENA - Fund Raising CMH Enterprise Fund 1 - Capital Management House Buyout GCC - Fund Raising CORECAP Islamic Private Equity Fund I (CIPEF I) - CORECAP Buyout MENA - Investing Eastgate MENA Direct Equity L.P. Nov 07 Eastgate Capital Group Growth Capital MENA $250M Investing GCC Real Estate Fund 2005 Global Investment House Real Estate GCC $100M Investing Global MENA Financial Assets Jul 08 Global Capital Management Limited Buyout MENA South Asia, Turkey $500M Liquidation Gulf Spring Real Estate Fund - Unicorn Investment Bank Real Estate GCC - Investing Infrastructure and Growth Capital Fund 16Oct07 Abraaj Capital Buyout MENA $ 2,000M Buyout GCC $ 150M Real Estate Kuwait $ 84.41M Mezzanine Capital GCC $ 199.92M Announced Kunooz Islamic Opportunities Fund - Investing Markaz Real Estate Fund Feb 03 The National Investor KIPCO Asset Management Company Kuwait Financial Centre Investing Mezzanine Investment Partners II Limited 30Oct08 SHUAA Capital Amwal QInvest Fund Raising NBD Sana Capital Feb 08 Sana Capital Buyout MENA, Turkey $ 500M Investing Rasmala MENA Private Equity Fund 2 30Nov08 Rasmala Investments Holding Buyout GCC $ 120M Investing Shefa Healthcare Fund E.C. Aug 07 Injazat Capital Buyout MENA $ 60M Investing The Libya Fund Q4 2007 Tuareg Capital Venture Capital Libya $ 30M Source: Zawya’s Private Equity Monitor For asset classes that could potentially offer the Muslim HNW investor double digit returns these twin avenues of private equity and venture capital remain sadly unexplored in the world of Islamic finance. Indeed both private equity and venture capital have not been the focus for the kind of exploratory rigour that many other areas of the industry have. It is worth highlighting that the largest single Islamic PE fund was conceived, researched and launched by Abraaj Capital, which is an acknowledged expert in the private equity field but is demonstrably conventional in most of its operations. 46 Islamic Wealth Management 2009 Private equity and venture capital Islamic Wealth Management 2009 47 Private equity and venture capital The failure of Islamic venture capital Venture capital investors are a very particular breed and it is not likely that many UHNW Muslim investors will be unduly interested in direct venture capital investing. Venture capital here is defined as the provision of seed capital for a new venture in the process of being established, rather than the provision of capital to a small business to facilitate its growth. If a potential investor understands a specific sector, such as biotechnology, then he may be drawn to speculate in that area but will not consider other areas on the simple grounds that he does not understand them. Rather like its conventional counterpart, Islamic venture capital appeals most to investors who understand a sector or an industry intimately and are prepared to risk a portion of their capital on the strength of a business plan, the management team of the proposed business, and their own ability to pick a winner. Other similarities between Islamic venture capital and conventional venture capital include the fact that deal sizes are small when compared to private equity transactions, since the start-up capital that is required for a burgeoning small businesses tends not to include monies for grandiose marketing and advertising plans but tends to be much more conservative in its outlook. What this should mean is that venture capital funds are more appealing to UHNW Muslim investors because they can offer a spread of investment exposure albeit within a limited sector, again such as biotechnology. As the chart above shows, there has been a great lack of any Shariah compliant venture capital funds for these investors to access. Funds that do exist can tend to be misnamed private equity funds or even straightforward real estate funds with a venture capital gloss. In this regards few governments of Muslim countries have done much to encourage the growth and development of Islamic venture capital funds. The exception is the government of Malaysia which has take some steps to promote the industry and has launched a fund, albeit a small $10 million fund, to help show the way. Rather like its cousin private equity, venture capital is a mode of investing that seems perfect for Islamic finance through the application of various Islamic financing 48 Islamic Wealth Management 2009 concepts, with the Mudarabah concept being the most common. Principles used Mudarabah financing involves a contract under which the investor, or rabal-maal, brings financing to the table and the entrepreneur, the mudarib, brings expertise, effort, and in the case of Islamic venture capital, a business plan. Collectively the parties share the proportionate profit from the results of the enterprise as per their pre-arranged agreement. The entrepre- Private equity and venture capital In the context of Islamic venture capital Musharakah financing is a partnership formed between parties to finance a business venture where the parties contribute capital either in the form of cash or in kind. Profits are distributed based on a pre-agreed ratio. Losses are shared on the basis of capital contribution to the venture. In Wakalah financing a contract from one party gives the power and rights to another party to act on his behalf, based on the agreed terms and conditions. Reasons for slow growth neur cannot be placed at risk of losing money since he has contributed only expertise. If the business venture fails, then the most the entrepreneur could lose is the investment he has already made in the business and the time and effort he had put into the venture. In other words no one can come after the entrepreneur for cash compensation. In a similar way, no one should expect the venture investor to have any say in the management of the company or any responsibility for it, since his part of the deal is to providing financing only. The sector of Islamic venture capital had been largely ignored in the GCC until recently because of the lack of an ‘entrepreneur class’ which is essential for the development of a healthy venture capital environment: young, bright people with great business ideas and a determination to make a success of ‘their’ business. As the world becomes more of a global marketplace, and as the education and skills level of young people in the region increases, then venture investing along Shariah compliant lines may become more common. On the other hand countries such as Egypt, Lebanon and even Turkey have long had an entrepreneur class of their own and the VC industry is consequently more developed in these countries. In much of the GCC there have been impediments to foreigners or non-GCC nationals owning their own businesses outright and this had naturally led to an absence of such businesses in the marketplace. As countries like the UAE have introduced ‘free zones’ such as Dubai Internet City, Dubai Media City, Dubai International Financial Centre, Jebel Ali Free Zone, and so on where foreign nationals and corporates can own 100 per cent of their own business then the market for venture capital has opened up. Naturally the business idea that will attract Islamic venture capital has to operate within the constraints of Shariah and must not dabble in haram areas. But having a young entrepreneur class is only half of the equation. The other half of the equation is having venture investors with the risk appetite to back the business plans presented to them with hard cash. This is not simply a matter of having the money, it is also about having the tools to analyse the business plan, Islamic Wealth Management 2009 49 Private equity and venture capital structuring a deal, and ensuring that the short, medium, and long term investment interests of both the entrepreneur and the investor are the same. This requires a level of education and expertise that had been lacking until relatively recently but has arrived in the region on the back of the tidal wave of oil revenues and increasing globalisation. While the Malaysian government’s endeavours are to be applauded it seems likely that the sustained growth and development of a strong and healthy Islamic venture capital an industry will rest in the private sector. If the Malaysian government can help to kick start such industry domestically then so much for the good. Perhaps what the industry needs more than anything else is a catalogue of success stories that will pique the interest of wealthy investors with a penchant for backing small business. A series of success stories in the Islamic venture capital field could prove to be just the fillip that the industry needs to spawn dozens of funds from the private sector looking for the next big Shariah compliant thing. It seems a safe bet that successful Islamic venture capital investing in the future will be the speciality of Islamic investment banks rather than specially focused Islamic venture capital firms. The rationale here is that, as we have already observed, the quantum of individual venture capital investments tends to be small and therefore may not be lucrative enough in the short term to finance all but the most boutique of firms. Early signs would suggest that the industry is likely to flourish in Malaysia before anywhere else, in large part because of the initiatives of the government. What seems beyond doubt is that the industry at present is tiny, certainly smaller than $100 million, and probably worth less than half of that. When the global recession is over, Islamic venture investing could easily be one of the fastest growing sectors of the industry, if for no other reason than it is coming off a very low base. Islamic private equity There is a close relationship between Islamic tenets of investing and private equity. By its nature private equity is participatory in nature and inevitably it must lead to the sharing of both risks and rewards. As long as the company seeking the private equity infusion is not operat- 50 Islamic Wealth Management 2009 ing in a haram area of business such as pornography or liquor, or is not heavily indebted, then few forms of co-investing could be more pure from a Shariah compliance perspective than private equity. The reality of the matter is that there is a close relationship between Islamic private equity and conventional private equity and therefore as private equity has grown in size across the globe then we might have expected its Islamic counterpart to have done the same. How big is big Industry estimates suggest that the global conventional private equity market is worth around $2,200 billion. The volume of transactions completed in the first quarter of 2009 showed that the industry was in for a rough ride. According to Greenpark Capital, a specialist secondary investor in private equity, deals closed in the first quarter of 2009 amounted only to $2 billion. Figures for the Islamic private equity industry are much harder to come by, but estimates from Yasaar Media research coupled with Zawya’s Private Equity Monitor suggest that the industry is around $4 billion in funds raised and deals done, much of it in the MENA region which is a far cry from the $40 billion that observers suggested was the level that the industry would reach by 2011. For an overall Islamic finance industry whose size is estimated at around $800 billion then it is not hard to see that private equity does not play a very significant part in the industry yet. The Islamic private equity industry is still in its infancy both in terms of overall size as well as numbers of players in the market. One of the core developments that will be needed for the mature development of the industry is for more and better qualified human capital: more people with a higher level of training. This is a requirement that afflicts much of the Islamic finance industry and the same dilemma applies here: does the private equity firm employ private equity experts and teach them Shariah? Or does it employ people who understand Shariah and then teach them the art of private equity? This applies both to those experts charged with structuring products as well as those on the marketing and relationship management side of the business. In order to address this issue fully, however, there needs to be a greater level Funds that do exist can tend to be misnamed private equity funds or even straightforward real estate funds with a venture capital gloss. Private equity and venture capital of standardisation across countries to ensure common levels of compliance. In this way the Gulf-based Islamic private equity practitioner can engage staff from Islamic markets in Asia and vice versa without the usual culture shock that so badly affects Islamic retail banks trying to ferry staff in from overseas to meet demand. The future for Islamic private equity and venture capital When the recession is firmly behind us it seems certain that the private equity industry will once again take off. Unless the Islamic sphere wishes to lose out then it will have to try to compete with the conventional world in terms of invest- ment from HNW and UHNW Muslim investors. Islamic private equity and venture capital can be appealing and alluring and investors love them in part because they can offer stellar returns in an otherwise moribund market. There seems little doubt that the appetite will be there for such investment avenues when normalcy returns. The question will be whether the talent bench of the Islamic private equity sector is deep enough to be able to compete or whether the Islamic finance industry will sit back and watch as conventional investment banks and private equity houses bring a string of attractive Shariah compliant PE and VC funds to market right under their noses. Islamic Wealth Management 2009 51 Hedge funds Hedge funds The hedge funds debate T here has long been frustration over the lack of Shariah compliant avenues for investors to park their cash and this has led financial engineers to try to manufacture a bigger pool of investment alternatives. Over the years this has led down a number of paths but perhaps one of the most controversial has been that concerning the use of hedging structures in Islamic finance. There have been a number of initiatives on this front beginning in 1997 when The International Investor launched the Al-Khawarizmi Market Neutral Fund which was followed by an offering from SEDCO in Saudi Arabia with the Al Fanar Hedge Fund, using a long/short strategy with a Salam contract managed by a single manager. Perhaps not the first but certainly one of the highest profile attempts to introduce a hedge fund into the mix was the ‘black box’ introduced by Eric Meyer of Shariah Capital around October 2004. The black box in question purportedly replicated the effects of shorting without actually doing so and thereby allowed investors looking for hedge fund type returns a Shariah compliant alternative. The product was to be promoted through Noriba, the Bahrain-based Islamic investment bank from UBS. While the fund was still some way from closing it ran into a roadblock that effectively meant that it had to be put on the back burner and eventually shelved. Even before this, as far back as January 2003, Meyer Capital had tried to launch an Islamic hedge fund product proving that tenacity is a prerequisite for survival in the Islamic hedge fund business. In a Middle Eastern context Dubai Islamic Bank in conjunction with both Goldman Sachs and Deutsche Bank attempted to launch a retail-focused Islamic hedge fund replicator product in June 2007. Structured by Deutsche Bank and managed by Goldman Sachs Asset Management, the Dubai Islamic Bank fund used five-year capital protected notes that were linked to a hedge index. The idea of the product was to offer investors a hedge fund type return while investing in purely Shariah compliant equities. Through what Dubai Islamic Bank described as a Shariah compliant mechanism, the bank’s fund was to be benchmarked against an index that measured the performance of a group of hedge funds. In the event the product caused some dissent amongst Shariah scholars, some of whom felt that the very act of trying to replicate a hedge fund return was in itself not Shariah compliant and therefore every subsequent attempt to launch a product in this area has to be viewed in the same light. Sheik Yusuf Talal DeLorenzo told Arabian Business at the time, “It is a sad day for Islamic finance when an industry leader falls victim to the mistaken notion that just because a Muslim customer’s money will never go into a potentially non-Shariah compliant investment, the returns to the customer will actually be halal”. Islamic Hedge Funds - Performance Year to Date 11/10/09 Date Fund Name Fund Domicide Geofocus Asset Type Base Currency Fund Size (US$m) Fund Manager 2009/05/13 LM Australian Alif Fund Australia Australia Hedge Fund AUD N/A LM Investment Management Ltd. 2009/01/01 DSAM Global Resources & Mining Fund Cayman Islands Global Hedge Fund USD 65.10 Dubai Shariah Asset Management Ltd. 29.22% Open Ended 2009/01/01 DSAM Kauthar Energy Fund Cayman Islands Global Hedge Fund USD 350.00 Dubai Shariah Asset Management Ltd. 25.60% Open Ended 2009/01/01 DSAM Kauthar Gold Fund Cayman Islands Global Hedge Fund USD 72.10 Dubai Shariah Asset Management Ltd. 33.05% Open Ended 2009/01/01 DSAM Kauthar Natural Resources Fund Cayman Islands Global Hedge Fund USD 46.30 Dubai Shariah Asset Management Ltd. 0.25% Open Ended Total Returns (US$m) Type Open Ended Source: IFIS Islamic funds database Islamic Wealth Management 2009 53 Hedge funds This leads to the question of whether there is a place for hedge funds in the world of Islamic finance at all as well as whether there is a place for Islamic hedge funds in the portfolio of the UHNW Muslim investor. Conventional short sales involve selling a stock which has been borrowed; as a result, such a transaction would violate the Shariah rule of ‘do not sell what you do not own’. However, using a Salam contract can replicate a similar economic outcome. This mechanism was perhaps best described in 2005 by Michael Gassner who explained, ‘(Salam) was used, for example, to sell wheat on a future date against payment today. As an exception to the general rule, it is subject to certain conditions, which the Shariah scholars ... have accepted will be applied if the contracts and documentation is properly adjusted. Salam fixes the price I get for wheat at 100, which I receive today. I could buy the commodity in three months for 90 if prices are falling, making a profit of 10. If the price goes up, I have a loss. To reach the high water mark, the high return goals set, hedge funds typically use leverage techniques; borrowing money from their broker. Money, however, cannot be accepted to be lent against money. The way Islamic hedge fund operators look at this point is to apply a Murabaha contract for the long position, which replicates the standard margin facility economically. Similar to normal margin finance, the Murabaha deal gets liquidated with losses if the price goes down below the level at which the bank would no longer be protected. There is no waiting period. The stocks are used as collateral immediately. The leverage for the short position is much more delicate. A Salam contract requires that the full amount be paid immediately and therefore leveraging does not take place and the short position is not replicated as it would be in a conventional hedge fund. The fund of fund concept of Eric Meyer from Shariah Capital therefore uses the Arbun contract. Arbun could be translated as down payment. The buyer pays 10 per cent of the price for the stocks as a down payment. If the price in the future is below 90 per cent of the price on the transaction date, the buyer will buy the stock cheaper in 54 Islamic Wealth Management 2009 the market place. His down payment remains with the seller. If the price goes up instead, the seller has to buy the more expensive stock and take a loss. With Arbun there are two concurrent sayings of the prophet (pbuh), one permitting and one forbidding Arbun and consequently the different schools of thought interpret Arbun differently. The Hanbali School generally accepts it while the Hanafi school seems to declare it Haram. Any Muslim investor seeking to look into such a model should therefore ask for clarification of how the majority of the school he aims to follow interpreted this issue’. The urge to carry on trying The prize of structuring a product that would be acceptable to a discriminating set of very Hedge funds wealthy investors and that also offered hedge fund type returns is the goal that has kept many others trying to square this particular circle. In late 2007 Ryada Capital tried to set up what it claimed was one of the first Shariah compliant hedge funds run out of the Middle East and that was aimed specifically at high net worth individuals in the Middle East: the Siraj Global Fund. According to the fund’s sponsors, ‘The Siraj Global Fund is a hedge fund that seeks capital appreciation of above 20 per cent net annual returns by combining extensive fundamental research with market momentum analysis to exploit opportunities in global equities and other types of investments provided that they are in compliance with Shariah law. Additionally, the fund will maintain prudent risk management parameters and portfolio diversification’. Ryada allegedly spent one year on structuring the fund compared to the usual couple of months that a non-Shariah compliant fund would take. The fund was not allowed to invest in companies involved in areas such as gambling, alcohol, or pornography and it had to pass strict criteria laid down by its Shariah board. The fund managers used a non-refundable deposit from investors. Laura Stone, vice president of alternative investments at Ryada told AME Info at the time, ‘You put down a deposit to have an option to buy at a specific price. You are making a commitment to purchase the stock but you have the right to cancel if you decide not to exercise the option’. But is it all Islamic? The truth is that many of the strategies dreamt up by product structurers would be difficult to implement properly because they would simply be too expensive to structure in a Shariah compliant manner or because the tools themselves are haram. In April of 2009 Fares Mourad, head of Islamic finance Bank Sarasin told Reuters “You cannot have longshort hedge funds, because the idea of short selling, or selling something that you don’t own, runs contrary to the principles of Islamic finance. I have not seen a credible structure that resolves this”. There is a prevailing view in some quarters that the world of finance is complex enough to keep product structurers busy for a very long time and that the Islamic finance industry has no need to waste time and resources developing highly controversial hedge fund structures that might never see the light of day or which might fall foul of the Shariah scholars at some point in the future. As ever with such matters the final word on the success or otherwise of Islamic hedge funds will rest with investors. If there is sufficient demand for these products then no doubt investment specialists will carry on developing them. If there is insufficient demand hedge fund managers will have to focus on the conventional sphere for future business. Monthly Returns Siraj Global Fund performance Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov 2007 2008 0.13% 1.27% 20.40% 0.68% 0.39% 1.00% 0.21% 2009 -1.00% -0.84% 0.80% 3.03% 7.54% 3.22% 2.48% -5.83% -1.17% -6.86% -3.57% Dec YTD -0.15% 0.15% -3.14% 1.11% 15.98% Source: SIRAJ Global fact sheet As the chart shows the hedge fund went into negative territory in August 2008 but has recovered ground from March 2009 onwards. The fund has $29 million under management. Islamic Wealth Management 2009 55 About Yasaar Media Yasaar Media is a specialist media house that focuses exclusively on the Islamic finance domain. The founders of Yasaar Media recognise that there is a serious need for an information provider in the Islamic finance space: a provider that produces in-depth reports and studies on specific market niches, asset classes and countries. These reports are designed to be market-defining works that will become the benchmark in their field. As the Islamic finance industry grows and expands so too does the need for high quality analysis and comment that is produced in a timely fashion. The founders of Yasaar Media have, between them, decades of experience in talking to and writing about the Islamic finance industry. By bringing these decades of experience together Yasaar Media offers a level of insight and knowledge that few could match. The Yasaar Media team has first hand experience of publishing newsletters, magazines and books focused specifically on the Islamic finance sphere. The products produced by Yasaar Media are aimed at filling a void in the Islamic finance data set that is often overlooked by others. While magazines and newsletters can provide news and views they often struggle to supply a comprehensive overview of a subject. That is because there is no single data provider with the insight, the resources, the experience and the market clout to deliver such an overview. About the author Paul McNamara is co- founder of Yasaar Media, the leading Dubai-based Islamic finance media entity. In 2004 Paul co-founded CPI Financial, publisher of Islamic Business & Finance magazine in Dubai after having spent two years in London with Euromoney Institutional Investor where he launched Islamic Finance Weekly, one of the first Islamic finance periodicals in the world. Prior to that he was publisher of Asia-Inc magazine in Singapore and Brunei and also worked in Australia for eight years with Fairfax Business Publishing. Paul started his career at the Financial Times in London where he worked for nine years. He holds a BA Honours degree in Politics, Philosophy and Economics from Christ Church, Oxford. By the same author • Qatar Takes Off • Half a Century of Banking in the UAE – with Philip Dew • The Mystery of the Old Soldier • Smart Marketing for Islamic Financial Institutions • Islamic Investment Banking 2009 56 Islamic Wealth Management 2009