Islamic FundsBY: CAMILLE PALDI

CEO OF FAAIF

Introduction

As of 2012, more than 750 Islamic Investment Funds have been established

globally managing total assets of approximately USD$60 Billion.

Currently, a broad spectrum of asset classes are available including

equity, Sukuk, real estate, commodities, leasing, trade finance, private

equity, structured products, REITS, and exchange – traded, murabahah,

ijarah, balanced, index, and hedge funds.

Islamic Funds

Hot spots for global Islamic investment funds include Luxembourg and the

Cayman Islands, with Luxembourg offering 3.5% of the total of Islamic

funds and the Cayman Islands with 5.5% of the total Islamic funds offering.

In fact 12 % of the total of Islamic funds are available in Luxembourg,

Dublin, and the Cayman Islands.

In terms of distributing investment products, international fund managers

offer offshore funds in the Middle East by using Bahrain, the UAE, and

Qatar as distribution platforms.

Islamic Funds

Bahrain is a good platform for investors in the Middle East and Africa to

source foreign funds.

The Islamic asset management industry is also growing at a rapid pace in

the Asia-Pacific region including Malaysia, Brunei, Singapore, Japan, South

Korea, China, and Indonesia.

Islamic Funds

According to Noripah Kamso, author of Investing in Islamic Funds, A

Practitioner’s Perspective, Islamic investment funds are no longer seen as

an alternative investment, but regarded as competitive to conventional.

Indeed, Kamso points out that a matured and fully functioning Islamic

financial market must contain asset management to compliment the

demand side of the value chain.

Kamso points out that financial centers from Malaysia, Singapore, Hong

Kong, Bahrain, Dubai, and London are leading the global Islamic

Investment fund initiative.

Why Non-Muslims Invest in Islamic

Funds

Socially-responsible investment.

Comparable Returns to Conventional Investment Over Longer Periods.

Greater Stability of Returns – Shari’ah compliant equities are less volatile

than their conventional counterparts (excessive financial leverage

prohibited);

Embedded Risk Management

In order to meet Shari’ah compliancy, equities must pass a rigorous

screening process, which ascertains whether the companies are

sufficiently capitalized to weather difficult times and liquid enough to meet

short-term obligations.

For this reason, these companies are better capitalized and more liquid

than conventional counterparts.

Bonds Backed by Real Assets

Sukuk are asset-based or asset-backed.

There is an asset underlying every transaction and the ownership of the

asset is transferred to the investors.

Their return is income generated from the underlying asset.

Sukuk-holders have recourse to the underlying assets.

Greater Transparency

Terms and conditions are more clearly defined allowing Shari’ah

compliant investments more predictable results.

Diversification

During the period of September 2007 – December 2009, Islamic funds

fared better than conventional portfolios did, declining less, experiencing

lower volatility, and recovering nearly as much ground lost as the markets

have recovered.

Sukuk

Sukuk grant investors a share in the underlying asset along with the

associated profit and risks rather than paying interest as in conventional

bonds.

In addition, proceeds from sukuk issuance must be used in Shari’ah

compliant activities, which reflect their usage for productive real

economic activities.

Islamic Investment is Popular

Muslims – No interest (riba)

Non-Muslims – same reason and -

Socially responsible and ethical investments

Fiscal Conservatism

Higher Returns than Conventional Funds

More Stable than Conventional Funds

Diversification

Transparency

Embedded Risk-Management with the screening process

Socially Responsible Investing (SRI)

SRI gives investors the opportunity to invest their money in alignment with

their core beliefs.

This is increasingly popular for people who want to support and promote

social good while achieving a good financial return on their investment.

Ethical Investing

No alcohol, pork, gambling, pornography, weapons, etc.

Environmental technology, recycling, wind power generators, pollution,

waste disposal, public transport, safety and protection, alarm systems,

protective clothing, life jackets, health care, hearing aids, housing, food,

and clothing.

Screening for Ethical Investing

Animal testing;

Genetic engineering;

Health and safety breaches;

Human rights for basic social and economic rights;

Intensive farming with antibiotic residue;

Military and nuclear power;

Pesticides

Pornography

Human Cloning

Screening Process for Ethical Form of

Investing

Sustainable timber/deforesting

Third world concerns; profits before principles

Community involvement; donations

Corporate governance for accountability

Disclosure of sufficient information

Equal opportunities

Positive products and services to build a safer world

Supply Chain Issues, including working conditions

Similarities: Ethical and Shari’ah

Share an ethical investment philosophy, which is a value-based approach

to align an investor’s portfolio with his/her beliefs.

Focus on real economic activities, such as improving living conditions and

well-being, establishing social equity and preventing injustice in trade and

commerce.

Focus on protection of natural and environmental resources.

Invest in the same economic sectors, namely industrials, healthcare,

consumer goods, utilities, consumer services, and basic materials.

Both reject investing in tobacco, gambling, pornography, nuclear power,

and weapons.

Similarities Ethical and Shari’ah

Follow a more profound investment principle.

Create more profound effect on organizational culture and behavior and

mankind as a whole.

Recognize that compliant companies are less subject to legal issues

related.

Proven to deliver comparable returns to mainstream investment in the

long-term, exceeding five years.

Established Ways of Investing Ethically

Negative Screening: This means avoiding some types of investments, for

example, gambling and weapons.

Positive Screening: A preference for activities or characteristics deemed

desirable.

Best of Sector: Leading Firms in every business sector are selected based

on their environmental and social performance or sustainability.

Social Responsibility Overlay: Shares for a portfolio are selected in the usual

way, but a process is added for addressing issues related to social

responsibility.

Ethical Funds

Ethical funds tend to hold a higher percentage of shares in small to

medium-sized companies and a smaller percentage in large companies

than their non-ethical equivalents.

Types of Islamic Funds

Equity

Sukuk

Money Market

Gold

Real Estate

Private Equity

Infrastructure

Commodities

EQUITY FUNDS

The oldest equity fund, the Al Ahli Group Trading Equity Fund, was first

offered in 1995 by the National Commercial Bank of Saudi Arabia.

Its AUM has grown to USD255 Million as of November, 2012.

Equity Funds

Among available Islamic funds, equity funds with market share of 46.9%

hold the largest investment portion.

This is due to the easy availability of broad Shari’ah indices offered by Dow

Jones Islamic Markets, Standard & Poor’s, FTSE, MSCI, and Russell.

Islamic equity funds are widely available from onshore funds to offshore

funds registered in Luxembourg, Ireland, and the Cayman Islands.

Equity Funds

The challenge is to offer Islamic equity funds internationally so that

investors in various regions of the world are able to invest.

An investor can look at Islamic global emerging markets or can source for

Islamic funds that invest in more specific emerging markets like Islamic Asia

Pacific ex-Japan, registered on an offshore platform.

CIMB Islamic Asia Pacific ex-Japan

Fund

The top five holdings of CIMB Islamic Asia Pacific ex-Japan Fund were

Samsung Electronics, China Mobile, Taiwan Semiconductor

Manufacturing, BHP Billiton, and Petro China Company.

The benchmark for this fund is the Dow Jones Islamic Markets Asia/Pacific

ex-Japan Index.

Since its inception in June 2006, the fund has outperformed the

benchmark on a cumulative basis of 5.17%.

Oasis Crescent Global Equity Fund

Available on the Irish Funds Platform;

AUM of USD151.4 million as of March 31, 2012.

Equity Funds

Islamic equity funds were initially led by Malaysia and Saudi Arabia, with

domestic equity funds.

However, the range of available funds has grown to include more broad

investment capabilities, from global equity to emerging market equity.

The Irish funds platforms have been managed by investment managers

from France, the USA, Germany, South Africa, and Malaysia.

Equity Funds

The majority of the top 20 Islamic funds were based in Pakistan, Malaysia,

Thailand, and South Africa.

There is a transparent and credible investment performance track record

since 2007 (8 years).

Sukuk

The first sukuk funds were established in Malaysia in 1990 and were Ringgit-

denominated.

Global Sukuk Funds: The fund invests in sukuks that are denominated in an

international currency like the dollar or the euro.

These funds are available on offshore funds platforms.

Sukuk issuance has grown rapidly in the GCC since 2004 and in 2011, the

value of sukuk issuance reached USD26 Billion, there is improved liquidity in

the sukuk market to actively manage a sukuk fund.

Sukuk

In March 2012, Al-Hilal Bank of Abu Dhabi, UAE established the Al-Hilal

Global Sukuk Fund.

The portfolio is composed primarily of US dollar sukuk from the GCC, with a

smaller portion made up of non-US Dollar Sukuk from Malaysia, Indonesia,

and Singapore.

Sukuk

The top five Sukuk make up 38.37% of the total portfolio (as of October,

2012).

1 – Hazine Mustesarligi Varl (Turkey)

2-Emarr (UAE)

3-DP World

4-Dubai Dof (UAE)

5-SQQ (Qatar)

Sukuk v Conventional Bonds

A comparison of sukuk performance, represented by the HSBC/DFIX USD

Sukuk Index versus traditional bonds, represented by the Barclay’s Capital

Aggregate Bond Index, shows that the relative performance of Sukuk

against conventional bonds is comparable over the past few years.

Sukuk and UCITS Framework

It is still not possible for investors to invest in a global Sukuk fund that is

Undertakings for Collective Investment in Transferable Securities (UCITS) –

compliant.

This is due to the stringent liquidity requirements specified under the UCITS

risk framework, which states that investors should receive their investment

proceeds easily upon redemption.

This issue should be resolved as the Sukuk market grows and matures.

Exchange-Traded Funds (ETFs)

Similar to conventional ETFs, Islamic ETFs are generally managed on a

passive basis in which the fund manager aims to replicate the returns of an

Islamic index, like the Dow Jones Islamic Markets Indices, FTSE Global

Islamic Index Series, S and P Shari’ah Indices, and MSCI Global Islamic

Indices.

Since an ETF is traded on a stock exchange, it is able to offer greater

flexibility and convenience in trading the units and higher liquidity than

most types unit trust funds.

In addition, it generally has a lower overall cost of investing relative to an

actively managed fund, making them a desirable investment option.

Exchange-Traded Funds

As of 2011, there were 13 Islamic ETFs with total AUM of USD$382 Million.

The largest contributor is the Malaysian based MY ETF with USD $197 Million.

These 13 ETFs are listed on the UK, France, Turkey, Singapore, India,

Malaysia, and South African Stock Exchanges.

They are invested in the equity asset class on a global (developed and

emerging markets), regional (Europe), and single country (India, South

Africa, Japan, and Malaysia) basis.

The first US Islamic ETFs were listed in 2008.

Exchange-Traded Funds

As of 2011, the global pool of conventional ETFs totaled USD1.25 trillion.

Increasingly, gaining in popularity.

The demand comes from both retail investors and asset managers who will

use ETFs for cash equitization as demand for actively managed Islamic

funds grow.

Money Market Funds

Islamic money market are domestic-centri and only available in Malaysia

and Saudi Arabia.

They comprise 22.2 % of the assets under management of global Islamic

funds.

Limited supply of short-term Shari’ah investment instruments means not

available globally.

Money Market Funds

Islamic money market funds can provide higher returns than bank

deposits.

Islamic money market funds are able to be utilized for a company’s

working capital needs.

Islamic money market funds invests in short-term investment instruments

with a maturity date of less than one year.

i.e. Government Investment Certificate (GIC) issued by the Malaysian

Government.

Islamic money market funds generally have lower risk than Islamic equity

and sukuk funds.

Alternative Funds

They reduce the volatility of the overall investment portfolio returns.

Therefore, it is advisable to include alternative funds in an investor’s overall

investment portfolio in addition to the typical mainstream Islamic equity

and sukuk funds.

There are two primary challenges when investing in alternative funds:

opaque pricing and the relative illiquidity of the assets.

Therefore, these funds may not be easily accessible.

Alternative Funds

Alternative funds generally requires a larger investment amount that can

be locked in for an extended period of several years.

Alternative funds are generally for high-net-worth individuals or institutions.

Real Estate Investment Trust Funds

REITs invest in real estate securities that sell like stocks and also invest in real

estate based on Shari’ah guidelines.

Special tax considerations, better yields, and potentially high payouts to

investors.

Shari’ah compliant REITs do not invest in properties that involve non-

permissible activities.

Real Estate Investment Trust Funds

Malaysia is the only country with guidelines for REITs.

Listed in Malaysia in 2006, the Al-Aqar KPJ REIT is the fist listed Islamic

Healthcare REIT in the world and first Islamic REIT in Asia. (oversubscribed

4.13 times)

Listed in Malaysia in 2007, The Al-Hadharah Bousted REIT is the world’s first

Islamic plantation-based REIT.

Real Estate Investment Trust Fund

The Sabana Shari’ah Compliant Industrial Real Estate Investment Trust is

Singapore’s first Islamic REIT, listed in 2010. (oversubscribed 2.5 times)

USD833 Million in total assets in 2011.

Emirates REIT – Dubai Islamic Bank.

Emirates REIT invests in residential and commercial properties in Dubai and

its asset size grew to USD68.3 million in 2011.

Private Equity Funds

The purpose of private equity is to provide working capital to a target

company to nurture expansion or new product development or to

restructure the company’s operations, management, or ownership.

Shari’ah private equity investing encourages direct ownership of real and

productive businesses.

It follows certain guidelines regarding the permissibility of the business

activities and means of financing.

Private Equity Funds

In a private equity fund, the goal is to exit after a specified time period

(typically five years), having attained a targeted internal rate of return

(IRR).

Therefore, given the portfolio nature of private equity funds, they are

usually long-term and illiquid, require high initial amounts of investment,

and are therefore high-risk, high-return investment alternatives.

Therefore, these funds are more appropriate for high net-worth investors

and institutions that have the knowledge, money, and time to stay

invested over a longer time horizon.

Private Equity Funds

Arcapita, a Bahrain-based private equity firm, acquired Caribou Coffee,

one of the largest American specialty coffee chains through Islamic

private equity.

Investment Dar and Adeem Investment Company are Kuwait based

companies involved in the acquisition of Ford’s Aston Martin – based on

Shari’ah compliant private equity participation.

Carlyle and Blackstone, leading private equity companies, increasingly

invite Gulf Investors for major investment opportunities.

Unicorn Global Private Equity Fund launched in May 2006 can invest in the

GCC, Levant, Turkey, USA, and Southeast Asia.

Private Equity Funds

It is a US dollar denominated fund with a minimum amount of

USD100,000.00 for individuals and USD1 million for institutional investors.

The fund targets well-managed midcap companies across the consumer

products, health care, business services, and light manufacturing industries

with near-term growth potential and annual revenues in excess of USD10

million.

Hedge Funds

Hedge funds were created to hedge (manage) risks against potential

losses of investments due to uncertainty in the market.

The basic Shari’ah principles do not allow the sale of goods without legal

ownership of those goods.

Also, the principles do not allow leveraging positions that are found in the

structure of the hedge funds.

However, based on certain Islamic contracts, it is possible to structure a

Shari’ah compliant hedge fund.

Hedge Funds

Shari’ah Capital, a US based firm, emerged as one of the leading

companies that provide technologies and advisory services to Islamic

hedge funds.

In 2008, Shari’ah Capital and Barclays Capital launched Al Safi Trust

Platform for hedge funds, in which Shari’ah Capital provides advisory

service and Barclays Capital is the prime broker and custodian.

Newedge, jointly owned by Calyon and Societe Generale, which

launched an Islamic hedge fund in 2006 replacing short-selling with a

salam-based Shari’ah alternative.

Hedge Funds

Hedge funds listed on its platform include Al Raed Emerging Markets Fund

(Old Mutual) and the Lucerne Shari’ah Isthimar Fund (Reach Capital

Management).

The Malaysian Securities Commission’s Shari’ah Advisory Council approved

Ijarah-based structure to mirror short-selling.

Lease Funds

Lease funds invest exclusively in lease obligations.

The funds have a fixed tenure and regular income like bond funds, but

have shorter maturities.

Shari’ah based ijarah funds must meet certain requirements.

The asset used for leasing must be permissible under Shari’ah guidelines.

The rental must be fixed and known to both the parties at the time of

entering into the contract.

Lease Funds

Furthermore, the fund must hold all the responsibility following its ownership

of the asset.

The Ijarah fund uses the subscription amounts to buy assets like properties,

vehicles, and machinery for the purpose of leasing.

The fund owns the assets and the lessees pay the rentals.

These rentals form the regular income streams for the fund.

The first such aircraft leasing contract took place between Emirates Airlines

and Al Rajhi Banking and Investment Corporation raising USD$60 Million

through Ijarah.

UCITS Framework

The UCITS framework is the most globally recognized regulatory framework for investment funds, and it is this framework under which most of these newer international funds have been established.

There are 26 Islamic UCITS funds, which are domiciled on the Luxembourg and Dublin international fund platforms (as of May 2012).

Therefore, despite the stagnation of the industry’s AUM growth at USD59 Billion between 2010 and 2011, we now see a tipping point where there will be significant AUM growth traction.

Most of the funds in Dublin and Luxembourg in 2012 have shown a five year track record, which is needed to convince institutional investors to invest.

UCITS Funds

International investors can select from 26 Islamic UCITS funds, which are

available on the Luxembourg and Dublin international fund platforms.

THE END