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Thursday, 22 November 2012

The alchemy of Islamic asset allocation

Despite the growth, the industry hasn't focused yet on defining a proper asset allocation framework for Islamic investments. Historically, the Islamic portfolio approach has been mainly "return driven", paying less attention to the risk and liquidity profile. The lack of some clusters may have justified this. Increasing allocation to sukuk, the selected use of Shariah-compliant derivatives and a risk parity approach to asset allocation can represent the base for a more effective Islamic portfolio management.
Over the past 10 years, the Islamic funds industry has grown to USD 60 billion at the end of 2011, with an annual increase of circa 4%. The outlook is still bright considering that the potential demand is at least 10 times bigger than the current size of the industry.
Over this period Islamic asset management experienced three main important trends: (a) an increase in the number of funds offered to investors (over 800 funds); access to a wider number of asset classes and strategies; and (c) the evolution of the business model from a simple offering of funds to a more comprehensive wealth management service.
Despite the significant growth, the industry hasn't focused sufficiently on identifying an appropriate framework for asset allocation of Islamic investments. The development towards a more comprehensive wealth management approach to Islamic portfolios and the consequences of the recent financial crisis highlighted the need for a more effective asset allocation to Islamic investments.
Historically, Islamic portfolios have been skewed towards alternative investments (in particular real estate and private equity) and local/regional equities. Reasons can be indentified in the intrinsic nature of Islamic investing with the preference for tangible assets, the absence, for a long time, of some clusters (the fixed-income component) and the "return driven" approach to investment (focusing only on the IIRR).
This allocation ended up creating a sort of "skewed Yale model" incorporating high liquidity and risk premiums that, in many cases, haven't been addressed properly at the time of the investment. 
(Zawya / 21 Nov 2012)
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