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Opalesque Islamic Finance Intelligence

Industry Snapshot: A Study of Islamic Mutual Funds Mobasher Zein Kazmi

Thursday, September 02, 2010

The writer completed his MBA (Investment Management) from Concordia University and is a CFA Level 3 candidate. He was recently awarded the Islamic Finance Qualification (IFQ) designation. Mobasher has had four articles published in the Journal of Strategic Studies, Bahrain Center for Studies and Research. The first three dealt exclusively with Islamic finance topics namely: Sukuk (see reference link), Islamic Hedge Funds (see reference link) and the impact of the current financial crisis on Islamic banks (see reference link). The last paper dealt with the rise of sovereign wealth funds.

The introduction of Islamic mutual funds in recent years has been an important component in the growth and development of Sharia compliant financial products. The industry itself is undergoing consolidation following a tumultuous period of global economic uncertainty and market reversal. Under such circumstances a critical examination is needed to evaluate whether such Sharia compliant funds have been offering superior risk-adjusted returns. Furthermore fund managers need to consider formulating investment strategies that will lead to sustainable competitive advantage over conventional fund structures and help attract capital on a long-term basis.

Mutual funds are open ended investment schemes tradable on an ongoing basis and redeemable at the respective Net Asset Value (NAV). Sharia compliant funds are identically structured although managers use specific screens in security selection restricting the investment universe to assets that are interest free and of halal origin. A rethink of the investment processes coupled with a serious re-branding of Islamic mutual funds within the context of socially responsible investing should be adopted so that Sharia funds can be positioned within the mainstream of international capital markets. Islamic financial institutions should redirect their energies to strengthening their fund offerings underlining its ethical and social underpinnings to investors. Indeed Islamic private equity and other exotic alternative investments operating within the realm of Islamic finance have proven to be relatively ineffective in generating the desired return among serious investors.

The Market

The Islamic Funds & Investor Report of 2010, published by Ernst & Young's Islamic Financial Services Group, has projected funds under management to be an estimated $52.3 billion in 2009 (predominantly based on the data from the Eurekahedge Islamic funds database); a fraction of the $22 trillion global asset management industry [i] and a minor component of the estimated $ 1 trillion Islamic finance industry. The number of new fund offerings per annum also shrank from the high of 173 in 2007 to 29 in 2009.[ii] The only encouraging sign is the overall growth in the pool of investable assets that has risen to $480 billion[iii] underscoring the depth of investment opportunities available to the average retail investor.

Exhibit1: New Islamic Fund Launches

Source: Thomson Reuters-Lipper

Fund managers should seek to build on the enlarged market of Sharia compliant assets through superior analysis and asset selection. It will help overcome current fund limitations of scale and profitability while providing investors with a greater range of funds to choose from thereby restoring an element of trust and confidence in the market. The Islamic mutual fund segment has shown remarkable resilience with 37 new fund launches so far in 2010 following the disappointing lows of 2009.

Exhibit 2: Islamic Fund Asset Growth

Note: Net Asset Values based in $ Millions
Source: Thomson Reuters/Lipper

The last three years have been inordinately challenging for the Islamic industry. The momentum generated in 2007-08 with new fund launches was severely undermined with weak fund performance and a shrinking asset base. While the overall trend has been upward temporary market reversals have tempered asset growth. According to statistics provided by Reuters-Lipper the total NAV of funds stood at an estimated $ 35 billion in June 2010 with an average fund size of $ 68 million based on data provided by fund managers.[iv] Interestingly, the five largest Sharia compliant funds are all based in Saudi Arabia with established investment histories and distinct concentration in trade finance assets.

Exhibit 3: The Largest Islamic Funds



Asset Type

Geographic Focus



Date of Launch

Fund Management Company

Total Net Asset Value ($) in Millions

Al-Ahli Saudi Riyal Trade


Saudi Arabia

Saudi Arabia



NCB Capital CJSC


Al-Ahli Diversified Saudi Riyal Trade

Trade Finance

Saudi Arabia

Saudi Arabia



NCB Capital CJSC


Al-Ahli International Trade

Trade Finance


Saudi Arabia



NCB Capital CJSC


Al-Rajhi Commodity Mudarabah SAR

Trade Finance

Saudi Arabia

Saudi Arabia



Al-Rajhi Capital Co


Al-Sunbula SAR International Trade Finance Fund

Trade Finance

Saudi Arabia

Saudi Arabia



Samba Cap & Invest Mgmt


Source: Thomson Reuters/Lipper

A review of the market in 2009 showed inherent weaknesses among Islamic mutual funds particularly in terms of liquidity, transparency and volume.[v] These findings were reinforced in a major academic study of Islamic mutual fund performance where researchers using the three-level Carhart model found that two fifths of Islamic equity fund portfolios significantly underperformed international equity benchmarks.[vi] Researchers were able to reasonably conclude that Islamic investors from Muslim countries do not sacrifice financial returns by investing actively in line with their religious principles. Furthermore, Sharia compliant funds domiciled in Muslim countries outperformed relevant benchmarks, whereas Islamic funds originating in the West lagged behind.[vii]

Performance attribution analysis identified investment style as the principal causal factor where western Islamic funds exhibited a bias towards small cap growth stocks. Investment styles from funds based in the Arab/Islamic world showed no discernable tilt either in terms of market capitalization and/or value growth stock selection. In addition, Islamic funds were shown to be indifferent between momentum and contrarian investment strategies.[viii]


Islamic mutual funds by their very nature are low-risk investment vehicles. Funds managers are restricted to invest in assets with minor debt components. Furthermore, funds are disallowed from undertaking leverage and consequently are protected when severe market downturns occur. The gradual introduction of Islamic funds in North America and Europe and commercialization by conventional banks provides opportunities for non-Muslims to invest their assets in a Sharia compliant manner. [ix] This increased commercialization has led to a decrease in transaction costs for Islamic funds and enabled managers to seek discounts on their security trades.[x]







Dow Jones Islamic Market Titans 100 Index



01/01/10 to 26/07/10


MSCI World Islamic Index


01/01/10 to 20/08/10


Standard & Poor's 500 Sharia Index



01/01/10 to 17/08/10


Eurekahedge Islamic Index


01/01/10 to 23/08/10


Return indicators from major international Islamic benchmarks display resilience in the face of troubling economic conditions. With the global financial architecture undergoing an uncertain transformation fund managers must exhibit prudence in asset selection. This is particularly acute given the discernable limitations of dedicated delivery channels in emerging markets where the breadth and depth of various fund offerings has yet to become part of the financial planning tools available to the average investor. In similar vein fund managers operating in developed markets are equally constrained as Islamic funds remain sidelined to the sphere of socially responsible investing. Overcoming fund raising constraints necessitates aggressive rebranding and streamlining of distribution channels to ensure selection of Islamic funds as the investment of choice while helping managers build scale.

Current trends in new Islamic fund launches indicate a concerted push towards the coverage of emerging markets. Saudi Arabia and Pakistan together accounted for one third of total new geographic mandates. Further analysis reveals smaller and less-known fund sponsors such as Kuveyt Turk of Turkey, Amundi Asset Management of Luxembourg and Element Investment Managers of South Africa, to name a few, entering the market competing alongside more established operations such as NCB Capital of Saudi Arabia and CIMB Asset Management of Malaysia. The most aggressive player on the Islamic funds scene has been Emirates Funds Managers that launched 2 sukuk Funds and 3 money market funds all with a global geographic focus targeted for investors in multiple jurisdictions.[xi] Considering its first Islamic fund launch was in 2005 Emirates Funds Managers' trailblazing approach should offer encouragement to newer outfits seeking market entry.

In 2010, portfolio mandates ranged broadly across acceptable asset classes with varied levels of diversification. A clear and discernable tilt towards equities and money market instruments can be identified with new fund offerings. Interestingly, not a single open ended private equity fund was introduced displaying investor nervousness in the market for these alternative investment asset classes.[xii] Sukuk funds have also staged a modest comeback as standalone funds and as components of balanced funds.

It is expected that as the emerging markets in the Arab/Islamic world evolve Islamic mutual fund managers will face similar portfolio value enhancement challenges as their conventional counterparts without the harmful side-effects of assuming additional risk. The potential to develop balanced funds and/or fixed income (Sukuk) funds remains strong as market corrections subside and investors switch from private equity and/or real estate funds to mainstream Islamic funds.


The ongoing global financial crisis has provided an excellent opportunity for fund managers to showcase the superiority and robustness of Islamic mutual funds in terms over their conventional counterparts. Current economic conditions necessitate fund sponsors to stick to traditional asset classes especially equities and bonds. Ideally, balanced funds with an emerging markets focus should provide the perfect blend in generating interest among investors. Sharia compliant commodity funds also remain under-utilized and remain an enticing prospect for fund sponsors. Reducing existing market constraints in terms of tradability, size and reliability will be fundamental in branching beyond the core money market instruments and trade finance portfolios. As the industry grows Islamic mutual funds should capitalize on scale and offer today's investor with sustainable long-term risk adjusted growth that is relatively insulated from the reversals in major international capital markets and preserves the real values of portfolios.

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