Insights into Islamic Investment Management from a Charterholder in Jordan
To gather insights into Islamic investment management from experienced CFA charterholders from different countries, we will be conducting a series of interviews. In the second interview of this series, we discuss Islamic investment management with Qutaiba Al-Hawamdeh, CFA.
Al-Hawamdeh is the head of asset management for AB Invest (part of the Arab Bank Group). He is based in Amman, Jordan, and focuses on the Middle East and North Africa (MENA) region. Al-Hawamdeh earned his CFA charter in 2005. In addition, he holds an MS in international securities, investment, and banking from Henley Business School at the University of Reading, and he earned his MBA from the University of Southampton. He has more than 15 years of work experience, with five of those years in Islamic and Shariah-compliant investment management.
CFA Institute: How has the market for Islamic investment management grown relative to that of conventional investment management?
Qutaiba: Despite its size and relatively high growth rates, Islamic investment management is still a fragmented sector at the country, regional, and global levels. Having said that, Malaysia, which has been a powerhouse in terms of consolidating the industry, will be facing more competition in the future as new Islamic financial hubs are being planned (such as Dubai) and as more sovereigns in the developed and emerging economies rectify their regulatory frameworks to become more accommodative for Shariah-compliant financial services and stakeholders. At the moment, most of the growth in terms of AUM and products is happening in the Sukuks asset class at the wholesale and institutional levels. Islamic finance is actually deeper in terms of scope, diversity of investment vehicles, and range of investors. My view is that market participants and stakeholders will continue to shape towards fulfilling the need for a more established Islamic finance mainstream.
How do fees charged on Islamic funds compare with conventional counterparts?
Given the frontier nature of the capital market in the MENA region in general and the market’s relatively smaller size compared to the developed markets, the fee structures, whether applied to Islamic or conventional investment mandates, are somewhat higher on a relative basis due to the lack of consolidation and commoditization in the industry. Islamic funds in particular may not necessarily charge a directly higher percentage in terms of management fees for example, but the overall direct operational expenses of the funds are usually higher than their conventional counterparts. This is mainly due to the addition of service providers (like the Shariah scholars board, for example) and the inclusion of additional auditing services (such as compliance with AAOIFI standards, for example). This is not to mention the reduction of returns attributable to purification procedures. In addition to that, Islamic funds may face indirect hidden costs. Given the smaller investable universe, and the arising concentration risks, the risk-return tradeoff may become less optimal in the context of the portfolio. Other opportunity costs include the longer time needed to diligently determine that the investable assets are Shariah compliant. This cost rises with lower levels of voluntary and legally imposed transparency and disclosures requirements.
Describe the screening process employed in your market? What are the effects on the investable universe and portfolio turnover?
There are usually two screening stages before arriving to an investable universe. Once the opportunity set is identified, buy-side research begins to determine selections in the portfolio/fund. (Even at this stage, some securities with potential may get excluded due to asset/geographic/sector maximum limits and market liquidity/size constrains.)
The first stage in the screening process is the “qualitative” filter. In many cases, this is a usually a straightforward procedure where companies whose core business is Sharia prohibited activities are screened out. So, for example, conventional banking and insurance, alcohol/pork manufacturers/distributors, to name a few, are eliminated. This results in a tighter pool to screen further on a quantitative basis.
The second stage is the “quantitative” filter. This is actually the sticky part in the screening process. In some cases for example, companies’ disclosures and transparency levels may not be adequate to determine if the operations are slightly or significantly tainted with prohibited activities. The analyst here is torn between assuming the best or the worst when a line at the income statement is phrased “other revenues” for example. My view is that analysts should do the maximum effort in terms of diligent research to determine the degree of Shariah compliance for investments under consideration. The fund/portfolio clients who demand Shariah-compliant investments are targeting a spiritual fulfillment at the expense of the anticipated returns. This is usually a prioritized objective.
The resulting pool after both criteria are applied is a function of the size of the market and its stage of development. For example, in the MENA region, applying the qualitative criteria reduces the markets’ capitalization by around 50% as conventional banks dominate the market.
Different index providers may have differing Shariah criteria due to different scholarly boards and for commercial reasons, at both screening levels. In addition, indexes may also be unrestricted or have different constraints in terms of allocations, not to mention that the criteria applied are somewhat mechanistic/rigid. This may result in a moving benchmark error for indexed funds, whereas for active strategies, the index/benchmark is indicative at best. With respect to the automatic application of quantitative criteria, a company which is compliant in qualitative and quantitative terms may become incompliant and dropped out of the index if the market crashes (resulting in breaches to the ratio of debt/market capitalization), or if it undergoes a capital increase (resulting in a breach to the cash/assets ratio). For indexed funds, this becomes problematic as the fund manager will have to “buy high and sell low” in the first instance, and increase portfolio turnover in the second instance. In both situations, increasing the overall indirect and direct expenses on the fund.
What is needed to consolidate the industry is not only more harmonious and centralized Shariah criteria, taking into consideration portfolio optimality in terms of risk/return, but also a more open two-way continuous dialogue with Shariah standard-setting bodies to make the investment process less rigid and more portfolio friendly. This should go hand in hand with a higher level of transparency and disclosure requirements at the level of the market.
How have Islamic investments performed in your market?
It is very difficult to judge performance on both relative and absolute bases for many reasons. At the relative level, index providers may have different Shariah criteria, geographic/asset/sector/single security restrictions amongst themselves, as well as when compared to funds with different domiciles. At the absolute performance level, many of the markets are dominated by conventional/Shariah-prohibited securities that may cause the overall market to move in either direction, thereby causing volatility for the Shariah-compliant portion of the market. Market structures in terms of foreign ownership limits or restricting investments of certain securities to locals may also cause distortions to performance comparisons.
What have been some of the recent innovations in Islamic investment management in your market?
Most of the new products in the MENA region have been in the Sukuks asset class at the corporate and sovereign levels. There has also been talks about establishing a mega Islamic bank. As new accommodative regulatory frameworks are put in place, and the equity markets expand organically, I believe that the next big development in the foreseeable future would be Shariah-compliant real estate investment trusts (REITs).
What are the major challenges and opportunities for Islamic investment management in your market? How do you see its future prospects?
The challenges facing the industry are diverse and interconnected. Notwithstanding the time needed, they are not insurmountable. Special securities and tax regulations at the sovereign and corporate levels need to be in place. Many countries in the region have actually drafted or adopted new laws in this respect in order to attract capital or to finance long-term infrastructure projects. It will definitely take time to test new regulations to determine their practical effectiveness and to update them accordingly. The demand for Shariah-compliant investment vehicles has not only reached a critical mass, but is actually continuing to grow at double digit rates annually. The markets’ paradigm in terms of investment solutions, solutions providers, and qualified personnel is shifting towards satisfying this need, however at a slower pace. At the moment, most of the growth in terms of Shariah-compliant exposures is happening at the wholesale level. I expect this to continue to grow at significant rates for the foreseeable future. However, I expect stronger growth rates for a longer horizon at the retail level which remains underpenetrated by any standard.
If you are interested in Islamic investment management, please consider joining the CFA Institute Islamic Investment Management subgroup on LinkedIn. If you are an experienced professional investor working in Islamic Investment Management and you would like to share your insights with us, please contact the manager of the Islamic Investment Management group on LinkedIn.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.