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Wednesday, 8 October 2008

Islamic funds - Islamic finance is finally breaking into the mainstream

Islamic funds

Islamic finance is finally breaking into the mainstream. The driver for much of the growth in demand comes from Muslims who are looking for financial services that observe core Shariah ethical principles. However, another key factor has been growing oil wealth, with demand for ethical investments soaring in the Gulf region. Local stock markets have struggled to cope with this wall of money, forcing many Gulf-based investors to look overseas - and to London in particular with its many Islamic-compliant services. The UK also boasts a number of Islamic-compliant banks (five in total), including London-listed The Islamic Bank of Britain, which opened for business in 2004. This wave of new products and Islamic institutions has touched the debt markets, too – in April this year, the London Stock Exchange listed Sukuk, a Sharia-compliant bond.

The fastest growth, though, has been in the funds space: Islamic assets already total around $1 trillion (£560bn) globally, estimates the Asian Development Bank, with annual growth of 10 to 15 percent a year.
This huge wall of money has sparked a frenzy of new financial structures and ever more complex interpretations of religious guidelines and rules. Crucially, this innovation has been centred on working out ways that allow believers to invest in the developed world's stock markets, alongside markets in Islamic countries, knowing that they're not buying an asset of which their scriptures would disapprove.
Equitable distribution
The fact that Islamic laws prohibit paying and receiving interest doesn't mean that that they frown on making money or encourage reverting to an all-cash or barter economy. At its core, Islamic finance is about linking the return to productivity and the quality of the project, thereby ensuring a more equitable distribution of wealth, based around a contract that manages risk.
In practice this means that in the funds space pretty much any structure can work if its ethically designed with expert opinion and approval – funds targeted at private Islamic private investors range from a Shariah-compliant baby bond from the Children's Mutual through to Islamic hedge funds. Commodity funds specialist ETF Securities has even launched a Shariah-compliant commodity funds platform, based on spot prices via physical ownership of key precious metals.
Last month saw London's first specialist Islamic closed-end fund list on stock market. Called the Family Shari'ah Fund, this Cayman Islands-registered but Bahrain-based fund is the UK's first actively-managed listed investment vehicle dedicated to Islamic finance. Its stated objective is to generate "stable long-term capital appreciation across a market cycle through a diversified pool of investments" including money-market instruments, leasing and fixed-income sukuks – real estate, private equity and structures replicating hedge funds returns – plus equities.
Exchange-traded funds
The biggest growth has been seen in the index tracking or exchange-traded funds (ETFs), in part because the idea of an Islamic stock market index is far from new. The first Shariah-compliant indices from a major provider were launched by Dow Jones Indexes in 1999, and FTSE followed suit with its own family in 2000. Later entrants include S&P (tracked by a new family of Deutsche DBX funds) and indices from MSCI. It's important that investors understand that not all Islamic indices are created in the same way – the S&P index, for example, screens out those companies that engage in the trading of gold and silver as cash on a deferred basis, while the MSCI indexes screens out companies involved in the music industry (including radio broadcasting), hotels and the film and television industry (including television broadcasters, cable providers and theatres).
Over in the ETF fund provider space, the key innovator has been Barclays' iShares unit. Traditionally, it is very good at spotting new and alternative investment ideas – iShares' range of alternative asset and property funds is still the most comprehensive by a considerable margin and it's constantly churning out new ideas like its emerging markets infrastructure ETF. Not surprisingly, then, it was also the first to launch Islamic index funds using the MSCI index – there are three funds on the market allowing Islamic investors to invest in the US, Emerging Markets and a wide World Developed Markets index. But iShares is not alone – it's now facing stiff competition from its arch rival Deutsche DBX, which has just launched its own range of three ETFs that are (bar one fund) considerably cheaper than the iShares' funds.
Looking at the funds in detail, you need to be aware that the key decision to exclude financials (traditional banks) does have two major effects. First, these indices have avoided some of the credit-crunch panic, but at the risk of increased exposure to energy and resource stocks. Holdings of these kind of resource stocks in the iShares ETFs range from 34 per cent (US fund) through to 48 per cent for the emerging markets fund. Second, healthcare becomes an important sector – although, in bear markets, that may be something of a plus as most healthcare stocks are fairly defensive by nature.
Still, with all sorts of ethically 'challenged' companies deliberately screened out, it comes as no surprise to learn that some non-Muslim socially-responsible (SRI) investors have started taking these funds seriously. Many Christian investors, for example, would probably share many, if not most, of the same ethical views as Islamic investors – the only key difference seems to be that some Islamic funds do not exclude weapons manufacturers but they do exclude banks, which tend to past most SRI tests. Apart from these inconsistencies, investors might also want to question whether they're entirely comfortable with the idea of the advisory committees setting the ethical screens – these tend to be comprised of a small number of supposedly religious/business experts who set the standards based on their interpretation or reading of the key religious texts. Investors also need to be aware that these ETF funds are all still very small – they might be closed if not successful – and still very much focused on mainstream equities with no exposure yet to bonds or alternative asset classes.
(Investors Chronicle)

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1 comment:

Ron Robins said...

You have a very informative blog on Islamic finance. I have chosen to include you on a links page on my site at

Best wishes, Ron Robins

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