Photo Credit:Reuters/Ho New
Does Islamic funds' extra coating of compliance mean investors or managers pay a higher price for their principles? Islamic Business & Finance does the mathsIs it just one's conscience that gets rewarded when investing in Islamic funds? Ask any Islamic fund manager (and believe me, I've asked a lot in my time as Editor of this magazine) why someone would choose an Islamic fund and the answer is always the same - Muslims are more comfortable investing in Shari'ah-compliant products. Then ask if that means Islamic funds only appeal to Muslims, and you will, again, get the same answer - no, they will appeal to anyone interested in ethical investing or looking for an alternative to conventional finance.
Ask any investor why they chose a particular fund and the answer is usually the same too - price versus profit. So must Muslim investors make the choice between their values and value for money? And can conventional investors be tempted towards Islamic funds when there is an enormous universe of ethical funds to choose from?
To get an idea of the true cost of compliance, Islamic Business & Finance compared hundreds of funds from different providers around the world using Bloomberg data. To keep things fair, we chose funds at random from similar sectors and included data on conventional ethical funds. Of course, our results represent a small sample of the funds available, but nonetheless hint at just how competitive conscientious funds can be.
Based on our sample, management fees are marginally higher for Islamic funds. Conventional ethical funds came in a fraction cheaper, but still more costly than conventional debt and asset allocation funds. The price differential, however, is not as wide as one might expect given the extra costs involved with managing funds which involve a strict screening process.
"Islamic fund fees are generally in line with conventional fund fees as there is a requirement to be competitive with conventional funds, similar to what is practiced in Islamic retail banks to remain competitive," Nida Raza, Director of the Global Islamic Center of Excellence at Ernst & Young, told Islamic Business & Finance. "The result is that Islamic fund managers may suffer lower margins due to the additional costs which need to be absorbed."
Similarly, the average expense ratio is predictably higher for Islamic funds. However, according to Moinuddin Malim, Chief Executive Officer of Mashreq Al Islami, this needn't be the case and is unlikely to affect an investor's returns. "There shouldn't be any management cost differential for Islamic funds compared to conventional funds, even with a Shari'ah screening mechanism or requirement of an annual Shari'ah review and Shari'ah audit of the fund as this cost is minimal and is spread across all investment products," he told Islamic Business & Finance.
TOP PERFORMANCE
Indeed, Islamic asset allocation funds outperformed their conventional counterparts in our sample, and were only fractionally behind conventional debt funds in terms of performance. With these two sectors combined, Islamic funds outperformed conventional funds by 1.33 per cent.
"If we are comparing similar fund types then one could say that over the long term, Islamic funds should provide better returns due to the nature of Islamic companies, which have limits imposed on them in terms of business type, leverage and business conduct, which provide for a more stable performance platform," said Raza. "We have seen that Sukuk funds have recently outperformed their conventional bond funds for the same period."
Islamic funds' performance translated into a marginally higher return for the investor, suggesting that an Islamic fund's higher operating costs may eat into profits slightly, but an investor need not expect a worse return because of this. According to Malim, an investor shouldn't expect an Islamic fund's return to differ from that of a conventional fund. "There are no reasons why an investor should receive a better or worse return from investing into an Islamic fund which is a function of systematic risk, unsystematic risk and capability of the fund manager," he said.
Kronfol agrees that returns are down to individual funds and economic environment, rather than whether a fund is Islamic or not. "You're going to go through periods where Islamic funds out-perform, and periods where many under-perform," he said. "That's largely a function of banks or financial companies contributing to conventional funds, amongst other things. If we're in an environment where growth is strong and leverage contributes strongly, then that tends to favour conventional funds."
Of course, the real winner in our sample is the conventional ethical fund segment, which delivered double the returns of Islamic asset allocation, our second highest performing category. This bodes well for investors who are looking for just rewards as well as financial ones, for whom Shari'ah compliance isn't a prerequisite. However, even for the non-Muslim investor Islamic funds do hold some advantages worth considering. "Some conventional ethical funds do not have exposure to the new emerging/frontier markets, whereas Islamic funds have full exposure to these markets as many of them have large Muslim populations," said Raza.
"Islamic funds will provide diversity even to investors who are non-Muslim and invest in ethical funds," he added. "An additional advantage to Islamic funds is the requirement to limit leverage on the asset which is in an inherent advantage in times of liquidity or credit crisis as it has been found that low leverage companies are able to fare better in tough credit conditions. The asset-based nature of Islamic funds provides additional performance comfort to investors as they have tended to be a little more immune to credit cycles."
QUESTIONABLE ETHICS
The definition of an ethical fund also varies widely, whereas an Islamic investor more or less knows what sectors the fund will shun. "Ethical funds adopt different investment criteria, so what one fund may consider an ethical stock, another might not: some funds will not hold shares in oil companies because they are harmful to the environment, while others will hold those oil companies that they consider 'best of breed' and think will cause less damage or look for greener solutions," Patrick Connolly, a UK-based financial planner at AWD Chase de Vere told UK-based newspaper The Times.
When we leave out conventional ethical funds and combine our sectors, the differences between an Islamic fund and a conventional fund are negligible, suggesting an investor doesn't need to compromise their religious beliefs or financial returns when choosing a fund. However, there are other factors an investor should consider.
"Currently Islamic funds have limitations in the type of sectors or investments they can make due to the lack of assets to invest in," said Naza. "Many times Islamic funds invest in fairly illiquid investments to enhance returns. Furthermore, we do not see that there is much liquidity in Islamic funds so performance can be unduly represented if an investor is comparing net asset value. As more Islamic products and assets become available in the market and new emerging economies tap the Islamic market for basic infrastructure capital, the evolution of Islamic funds will allow for better liquidity and performance as well as reduced costs."
"Currently Islamic funds have limitations in the type of sectors or investments they can make due to the lack of assets to invest in," said Naza. "Many times Islamic funds invest in fairly illiquid investments to enhance returns. Furthermore, we do not see that there is much liquidity in Islamic funds so performance can be unduly represented if an investor is comparing net asset value. As more Islamic products and assets become available in the market and new emerging economies tap the Islamic market for basic infrastructure capital, the evolution of Islamic funds will allow for better liquidity and performance as well as reduced costs."
According to Malim, the only thing an Islamic fund can guarantee is Shari'ah compliance. "The characteristic of an Islamic fund will be dependent upon the underlying asset or industry segment the fund invests into," he said. "Comparing apple to apple, for example, if one were to select a fund manager who manages an equity fund investing into the same universe but split into Islamic and conventional portions than, all things set-aside, both funds should perform the same excepting any unsystematic risk associated with the underlying conventional or Islamic script.
"Hence, the Islamic fund should only assure the investor that a separate body consisting of Shari'ah scholars will review and guide the process which does not guarantee superior performance. This is a simplistic view; however, as the products get more sophisticated, Islamic funds may be barred to structuring any highly speculative or leveraged transaction which may not be allowed by the Shari'ah board, and as such may have a positive or negative effect on the performance of the fund. This means that Shari'ah does not allow the investors to take certain unspecified risks or open-ended risks where the underlying event is purely speculative or non Shari'ah-compliant in nature. In such a situation, an investor's capital is better preserved with an Islamic fund's structure than with a conventional one; however, lower risk also means lowerrelative returns."
CAN'T AFFORD TO BE CHOOSEY
It seems the Islamic investor won't fare financially better or worse for choosing an Islamic fund; the problem is there are far fewer to choose from. With Islamic assets standing at only 0.5 per cent of conventional assets, there remains a large surplus of Islamic money lying dormant through lack of Islamic investment vehicles.
"You're talking about a relatively limited universe," said Kronfol. "Right now, the fact of the matter is the Shari'ah-compliant investor doesn't have the same amount of choice. Certain asset classes, such as commodities and fixed income, are especially lacking - investors have much more choice in real estate and equities. Plugging these gaps is particularly important to really give Shari'ah-compliant investors a choice. We at Franklin Templeton recently launched a global Sukuk fund to plug this space, and we continue to look at other funds that we think will fill these important folds that currently exist."
"Though the international Islamic finance industry has had some success on innovation, there is still room for more diversification in product development, geographic reach and asset class diversification," said Hasan S. AlJabri, Chief Executive Officer of SEDCO Capital. "Islamic investors have traditionally found it difficult to access the same investment opportunities as conventional investors. This lack of asset class diversity in Shari'ah-compliant investment products represents both a challenge and an opportunity. The significant increase in cross-border Islamic investment activities, coupled with Islamic investors' increasing recognition of the importance of diversification in their investment portfolio, calls for the Islamic funds and investments industry to tap into new asset classes and develop new funds for better diversification and portfolio management."
Although our sample of funds indicate that the cost of compliance is negligible, it seems investors will have to pay for conforming to their beliefs by compromising on choice and diversity - something that may cost them dearly in the future.
0 Comments:
Post a Comment