ISLAMIC FUNDS (2) By: Camille PaldiCEO of FAAIF

SHARI’AH INVESTING IS FOR ANYONE In Malaysia, the CIMB Islamic Commodities Structured Funds 1 and 2 garnered 57 percent non-Muslim investors during its initial offer period.

In the USA, Saturna Asset Management, a Shari’ah investment management based in Bellingham, Washington, disclosed most of its AUM for its Amana Global Equity Fund is from non-Muslim investors.

MANAGEMENT FEES

An analysis of the 26 Islamic Funds on the UCITS platform in both Dublin and Luxembourg shows that management fees chargeable to these funds range from 150 basis points to 225 basis points, just like those of conventional funds available on the UCITS platform.

Comparable charges for conventional and Islamic funds.

ISLAMIC PRODUCTS ARE NOT COMPLICATED Equity screening is done in two stages, business and financial screening.

Business screening ensures that the investments in goods and services that are prohibited by Shari’ah are excluded.

Financial screening further excludes stocks with high debt, high receivables, and idle cash reserves.

This ensures stability of investments with a moral dimension.

ISLAMIC PRODUCTS ARE NOT COMPLICATED Similarly, the profit-and-loss sharing nature of Sukuk eliminates the rigidity of debt contracts, which provides no flexibility to the borrowers.

Sukuk proceeds are used for real economic activities that, again, confer social benefits and productive use of money.

Nevertheless, the screening ensures that the investments are stable and prohibit excessive risk taking. Screening also ensures avoidance of high borrowing and exploitation of contracts.

ISLAMIC INVESTMENT UNIVERSE If one were to construct a global Islamic equity portfolio from components of the Dow Jones Islamic World Index, one can select from a broad universe of 2413 components with an impressive market capitalization value of USD18.35 trillion.

The Dow Jones Islamic Market Asia/Pacific Index has 1,146 components and a substantial market capitalization of USD4.37 trillion.

Similarly, the amount of sukuk outstanding during the first half of 2012 has grown impressively to USD210.8 billion.

ISLAMIC INVESTMENT UNIVERSE Islamic Funds demonstrate a higher return.

Over the longer period from the end of December 2008 – 2012, comparing the Dow Jones Islamic Market World Index to the conventional Dow Jones World Index, the cumulative total return demonstrated an outperformance of 9.91% over the conventional index.

ISLAMIC INVESTMENT IS IN HIGH DEMAND There is a higher demand today for investment solutions that are structured with certainty, fairness, ethics, and without speculation.

RESPONSIBLE INVESTMENT

The Islamic investment process comes with the structured capability to manage risk as the screening provides an embedded risk management overlay at the portfolio level.

This screening, via the application of three financial ratios based on debt, receivables, and cash, results in a more financially sound pool of constituents to select from.

RESPONSIBLE INVESTMENT

The Sukuk structure by definition requires that funds raised from the issuance of Sukuk must be utilized for real economic activities.

ISLAMIC INVESTMENT IS ALREADY WIDELY USED IN THE WEST Most American, European, Japanese, and Australian pension houses have provided specific allocation for SRI portfolios and ethical investment.

It goes beyond a traditional ethical investment approach because an additional layer of risk management exists on top of the SRI/ethical screening.

High quality assets with strong fundamentals and low debt-to-equity ratios.

CONVENTIONAL V ISLAMIC FUNDS Conventional Funds: 19 Trillion; 70,000 Funds

Islamic Funds: 65 Billion; 750 Funds

Conventional Index: 3589 Constituents with a total market capitalization of USD12.1 Trillion

Islamic Funds: 1,146 Constituents with a total market capitalization of USD4.37 Trillion as of December 2012.

SHARI’AH AND CONVENTIONAL INDICES When we compare the top 10 constituents of both the conventional and Islamic index, there are three common constituents: BHP Billiton, Samsung Electronics, and Taiwan Semiconductor.

Other familiar names that make up the top 10 list of the Shari’ah index are Canon Inc., Petro China Co. Ltd., H Shares, and China Mobile Ltd.

The Shari’ah Index is more spread out and exhibits diversification of risk from the standpoint of country and sector allocation.

SHARI’AH AND CONVENTIONAL INDICES Although the total number of Shari’ah compliant constituents is only 1,065, its market capitalization is at USD4.0 Trillion, which is about 40.25 percent of the conventional market capitalization.

ISLAMIC INVESTMENT UNIVERSE Although Islamic investing is based on a more limited investment universe, that universe has sufficient breadth and depth to construct a portfolio of good quality stocks with sufficient liquidity.

To illustrate this further, as of 2012, the Dow Jones Islamic Market World Index (DJIM World) has a universe of 2,413 stocks, which is only 35.5 percent of the Dow Jones Global Index of 6,850.

However, its market capitalization of USD18.35 million constitutes 41.5 percent of the Dow Jones Global Index’s total market capitalization of USD44.12 Trillion.

GLOBAL MARKET INDEX

The Dow Jones Islamic Market World Index outperformed the Dow Jones Global Index, with a cumulative price return of 3.83 percent compared to -6.08 percent over this period (August 2006 – December 2012).

It has been observed from past years that Dow Jones Islamic and conventional markets move in a similar volatility pattern, proving better risk-adjusted returns fro the Dow Jones Islamic Market World Index.

EUROPE MARKET

The Dow Jones Islamic Market Europe Index returned a higher cumulative performance of -8.26 percent compared with -21.80 percent by the Dow Jones Europe Index (E1DOW) in this period.

JAPAN MARKET

In Japan, in the same time period, the Dow Jones Islamic Market Japan Index also outperformed the Dow Jones Japan Index (JPDOW) by 6.77% over this period.

INVESTING IN ISLAMIC FUNDS Similar to the conventional investment process, the investment manager can optimize a portfolio by anticipating market trends and constructing a portfolio from the available investment universe to deliver certain performance characteristics, which could be based on stock picks, sector weightings, or both.

This is then applied across different investment capabilities such as global, Asia-Pacific ex-Japan, and ASEAN.

WEIGHTINGS

Higher weightings in the basic materials, energy, health care, telecommunications, technology, and industrial sectors are expected to contribute to the strength of the Shari’ah investing approach, as opposed to a conventional investment portfolio, which typically has higher weightings in the financial sector.

THE EUROPEAN SUKUK WORLD The UK is well-positioned to become the international hub for Islamic capital markets, worth USD 271.0 million Sukuk outstanding (2012).

Ireland and France are close behind, with both governments passing a law enabling the issuance of Sukuks in 2009.

Luxembourg has issued sukuk.

Malta has passed a budget for Islamic finance in 2014/2015.

Spain is considering Islamic finance.

THE AMERICAN SUKUK WORLD The States of New York and Illinois have both passed legislation enabling sukuk transactions.

Goldman-Sachs issued a USD$500 Million Sukuk.

East Cameron Gas and General Electric have issued Sukuk.

THE SUKUK WORLD

Ernst and Young predicts the sukuk market will reach USD$917 Billion in 2019.

THE SUKUK WORLD

Investment exposure to sukuk can offer diversification benefits.

Sukuk prices generally hold up well because they are often treated as a buy and hold investment.

This gives an additional layer of insulation against volatility relative to conventional fixed incomes.

An easy way to access the Sukuk asset class is through a fund that invests in diversified portfolio of global investment grade Sukuks such as the Al Hilal Global Sukuk Fund.

THE SUKUK WORLD

Launched in 2012, the Al Hilal Global Sukuk Fund has delivered a performance of 4.3 percent in only six months since its March, 2012 debut.

The fund invests in a diversified portfolio of Shari’ah-compliant Sukuks issued by sovereign, quasi-sovereign, and corporations and aims to generate regular income as well as capital appreciation.

THE SUKUK WORLD

There is evidence that diversifying a portion of one’s overall investment portfolio to Sukuk investments away from traditional fixed income will show an improvement in the Sharpe ratio without diminishing investment returns.

The Dow Jones Sukuk Index (DJSI) produced superior returns over the conventional index over 2 years as of September 2012.

THE SUKUK WORLD

Sukuk investing is unique in that it enlarges the existing conventional fixed-income investment universe to grant conservative investors attractive opportunities in a completely separate class of fixed-income assets.

Sukuks issued by financial institutions constitute the second-largest sector in the DJSI (about 30%).

This enables conventional fixed-income investors to diversify the quality of their overall portfolio’s exposure to the financial sector as they can gain experience to Islamic Banks.

SHARI’AH COMPLIANT UCITS FUNDS Most Shari’ah compliant funds cater to the domestic market, where the funds are meant for investors in that country. These funds are generally small and issued only in the home currency, and foreign investors can view that as an impediment.

They would prefer the fund base currency to be an internationally accepted currency i.e. the dollar or the euro.

Small fund sizes result in investor concentration risk and can be illiquid.

The Shari’ah investment track record is too short to grant confidence.

SHARI’AH COMPLIANT UCITS FUNDS Fund performance figures are generally not calculated according to global investment performance standards (GIPS).

As a domestic fund, it may not have internationally acceptable Shari’ah interpretations.

UCITS FUNDS

The UCITS fund structure was initially designed as a European regulatory “passport” in order to sell funds across the European Union, and its acceptability has now expanded to other regions around the world, including Latin America and Asia.

These types of funds are available in regulated offshore fund platforms like Ireland (Dublin) and Luxembourg.

UCITS FUNDS

The UCITS structure is flexible enough that it can be offered in multiple asset classes and multiple currencies to a broader investor base.

As such, it can more easily build scale internationally.

Such platforms are popular in the conventional space and offer a good platform from which to launch Shari’ah compliant funds.

Due to the common European standard, UCITS funds are regarded globally as very well regulated funds that have robust risk management procedures and a strong emphasis on investor protection.

IRELAND

Under the Finance Bill Act of 2010, which took effect January 1, 2010, the Irish Ministry of Finance introduced some significant amendments to facilitate Islamic finance transactions in Ireland, especially Sukuk.

In 2011, the Securities Commission Malaysia and Central Bank of Ireland signed an MOU to provide an arrangement for the two regulators to exchange information and cooperate in the area of regulation and supervision of authorized entities offering collective investment schemes.

The Securities Commission Malaysia signed a similar agreement with Luxembourg in 2012.

UCITS FUNDS

CIMB-Principal Islamic Asset Management established a UCITS funds platform in Ireland in December 2011.

CIMB Principal Islamic has launched three Shari’ah UCITS funds – Islamic Global Emerging Markets Fund, Islamic Asia Pacific ex-Japan Fund, and Islamic ASEAN Equity Fund for international distribution.

CIMB Principal Islamic is offering its Shari’ah compliant funds in seven jurisdictions.

UK, Switzerland, and Germany (Europe).

Saudi Arabia, UAE, Bahrain (Middle East).

UCITS FUNDS

Saudi Arabia currently has the largest Islamic fund assets under management (AUM) in the world at USD 19.9 Billion.

A total of 26 Islamic UCITS in Luxembourg and Ireland were first made available to international investors on global fund platforms like Ireland and Luxembourg in 2000.

However, the majority of the funds were launched from 2008 onwards.

UCITS FUNDS

Shari’ah Compliant UCITS funds that currently exist on these platforms were established by conventional global asset managers from non-Islamic countries: the US, Germany, the UK, France, Australia, and Switzerland.

SHARI’AH COMPLIANT EQUITIES AND SUKUK The widest selection is in global equity UCITS funds.

In regards to global Sukuk, there is only one fund available in Luxembourg, however, it is not UCITS-compliant.

UCITS FUNDS

Although Shari’ah compliant UCITS are referred to as Islamic, they were mostly established by conventional asset managers.

Shari’ah compliant UCITS funds investors will be reassured by a regulatory framework that is clear, straightforward, and easily understood.

UCITS FUNDS

Shari’ah compliant UCITS are globally offered, but currently the market is very small and totals 26 funds in Ireland and Luxembourg.

UCITS Fund structures are similar to a European passport that enables to sell funds order across the European Union.

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