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Opalesque Islamic Finance Intelligence

Fund Manager Interview: Saeid Hamedanchi, President & CEO, Florentez Investment Management

Tuesday, October 27, 2009

"Florentez Investment Management (ShariahShares ETF), based in Irvine, California, is a newly established Exchange Traded Funds (ETF) sponsor that will be offering complete line of Shariah compliant ETFs on the New York Stock Exchange upon obtaining approval from the US Securities and Exchange Commission (US Regulator). Florentez Investment Management was founded by Saeid Hamedanchi, CFA and James Altenbach, CFA."

Q1.Regarding the product range you are developing, it seems indexation products have not been widely developed in the Islamic finance space. What is your take on this?

This is absolutely correct. Indexation and passively managed mutual funds and ETF have not been widely developed in the Islamic Finance arena. There are several reasons for that:

  • The fees charged by industry participants are substantially higher in actively managed products rather than Indexing. Actively managed mutual funds have higher expense ratio than their passively managed counterparts in both conventional and Islamic Finance markets. The typical Shariah compliant mutual fund in GCC charges total expense ratio of 1.5%-2%. Shariah compliant ETFs are typical charging between 0.50% - 0.70% globally.
  • Lack of education of the investing public on passively managed products. Investors need to be educated by the industry about the benefits of passively managed product. Passive managers in the US spent a lot of money and effort to educate the retail and institutional investors on the benefit of Indexing strategy.

However studies have consistently shown that Index funds outperform active managers on regular basis due to lower total expense ratio. Lower fees lead to greater returns for investors in an extended time period. In fact most Active Shariah mutual funds underperform FTSE All World Shariah index and other similar indexes on consistent basis due to higher fees charged by the managers.

Q2. Why has the industry been slow in taking up these products? Is this a case of a business-as-usual approach that delays product development or precludes product innovation?

The Islamic Finance industry is accustomed to actively managed products where high fees can be charged from the investors. The typical Shariah compliant mutual fund charges expense ratio of at least over 1.5% per year. Unfortunately most active managers underperform the index funds due to factors cited above. There are currently very few Shariah compliant passive ETF or mutual fund products available worldwide.

Q3. Can you describe your product pipeline, how do these fit in the current universe of Islamic investment products?

We are planning to offer complete family of Shariah Compliant Equity ETFs covering both developed and emerging markets. These products will be passively managed with low total expense ratio. We will be using world class index providers to create our products. (i.e: FTSE Shariah Global Indexes Series). In addition, we are partnering with world class service providers to manage our products.

We will also be offering non equity Shariah compliant ETF that would be very unique in the near future. We are also in the process of developing commodity ETFs that would be Shariah compliant. By offering these products, our investor base will have ability to do a complete asset allocation strategy according to their investment criteria and constraints. We believe this will be well received by our investors.

Q4. What other products are you planning to develop under your umbrella? What is the investor appetite for actively managed solutions, and how would you incorporate these into your offering?

We are planning to focus on Indexation as we are a firm believer that Index products provide better return to investors due to lower management fee and trading expenses over an extended time period than actively managed products. As discussed earlier, very few managers outperform the index over an extended period. In fact, the managers that outperformed in the past do not necessarily outperform in the future. This is the biggest challenge in identifying the best managers who will outperform in the future.

Q5. You have undertaken extensive market research on Shariah Compliant ETF industry, in your view what are the key drivers of growth for ETFs and specifically for Shariah compliant ETFs?

There are three areas the investors benefit greatly by using the ETF structure versus the traditional mutual funds structure.

  • Lower Expenses: Exchange Traded Funds are offering the lowest expense ratio’s compared to Index and active mutual funds. Shariah ETF are charging between 0.50-0.75% where as the mutual funds are charging between 1.5-2.00% per annum.
  • Greater Transparency: ETF sponsors are required to disclose their holdings on daily basis to market participants where as the mutual funds disclose their holdings on a semiannual basis. In today’s market, Investors value transparency especially after the events of 2008.
  • Speedy Execution: ETFs offer speedy execution during the market hours where as mutual funds can only be redeemed or purchased at the close of the trading day. ETF investors are able to purchase the ETF early in the day and redeem later in the day.

These three drivers have fueled the growth of the ETF industry. In fact, ETF industry has had a very rapid growth since its inception in 1993. Today, assets under management exceed $900 Billion globally. Shariah compliant ETF are the newest addition to the ETF family of products. The first Shariah compliant ETF was introduced in 2006 on Istanbul Stock Exchange and there are still very few Shariah compliant ETFs around the globe. We believe the above benefits will apply to Shariah compliant ETF as the investors will be seeking lower expenses, greater transparency and speedy execution.

The other benefit of ETF is to equitize cash for active managers. If an active manager has excess cash, he can invest in Shariah compliant ETF until he decides what securities to purchase. By using this strategy, the active manager will minimize cash drag in the rising markets. In addition, Shariah ETF can be effectively employed as an asset allocation tool to gain exposure to various regions, sectors and market capitalizations.

Q6. Considering the competitive landscape, and increasing interest of ETF investments, how do you plan to position yourselves in the market and what are your differentiating factors?

We are planning to be a low cost provider of Investment Management products in the Islamic Finance Arena. In the ETF industry, we can be a niche player who focuses exclusively on Islamic Finance products. Other players just offer Shariah compliant window in addition to their other products (i.e: Deutsche X-tracker).

By having this objective, we will be offering quality Shariah compliant ETF and will have better understanding and expertise in the space.

Q7. What regions and investor segments do you intend to target first? What particular challenges do you see in efficiently accessing these?

We are planning to target GCC and South East Asian countries initially as these are the largest markets in the world for Islamic Finance. We will initially reach out to Institutional Investors as well as high net worth investors to introduce our ETF. One of the particular challenges in the GCC & Southeast Asia has been the lack of knowledge by investors regarding ETF and their application. We will need to invest in educating all investors on the various applications of ETF such as Asset Allocation, using it to minimize cash drag and other applications.

Exchange Traded Fund products are being used extensively by both institutional investors as well as retail investors in the USA. In fact the split is around 50/50. However even in Europe, ETF are mostly used by Institutional investors (90%) and only 10% employed by retail investors. In Asia except Japan, ETF are in their very early stages of development in the conventional arena.

Q8. Marketing and distribution are often underestimated by fund managers, what strategies are you considering for disseminating your products?

We will be partnering with world class financial institutions who are interested in distributing our products in the various regions. We will be working with these financial institutions to help their marketing teams understand our products in greater detail and be able to provide them as solutions to their client’s investment needs and requirements.

We are interested in joint ventures with financial institutions who are interested in developing ETF based on the various regions of the world to be distributed in the US market. We are particularly interested in regions with strong fundamentals such as GCC, South East Asia. . Furthermore, we are interested in cross listing our ETF in various exchanges.

Q9. Innovation has become a bad word lately; does this present a challenge when the industry is trying to develop fresh new solutions for investors?

ETF industry has seen rapid growth due to its ability to innovate constantly create new and exciting products. Inverse, Ultra Short and Highly leveraged ETF were recently introduced by ProShares and Direxion in the US. These products have witnessed very rapid growth due to their innovative ability to solve investors needs and requirements.

We must realize that the Islamic Finance is very young industry. The first Islamic Banks were crested in 1970’s. There are many products that can be created in Islamic Financial Arena that are available in the conventional Finance space. We believe that the Islamic Finance industry needs to continuously innovate to meet the needs and requirements of its investor base. We believe Index based ETF provide cost effective way for investors to invest in Shariah compliant portfolios.



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