Research

Shariah Compliant Asset Management: Overcoming Distribution Challenges

 

Conventional asset management has seen impressive growth over the last few decades and funds have become a well-established financial product. However, Shariah compliant asset management remains a niche within conventional asset management. Why is Islamic asset management, Pierre Oberlé asks, still small and how can it further develop?

There is strong growth potential in the Islamic asset management sector but growth has so far been limited and the average size of Shariah compliant investment funds remains smaller than conventional funds. Distribution challenges seem to be a key explanation of the issues the sector is facing. When looking at the Islamic funds launched over the last decade, there are two scenarios as follows.

On the one hand, several large international asset managers have launched Shariah compliant investment funds in the last 10 years. Some have been successful but many did not meet the success they hoped for because they lacked distribution channels in the Middle East and Southeast Asia where they hoped to collect most of the assets.

On the other hand, smaller-sized local asset managers, mostly in the Middle East and Southeast Asia, have launched funds in their home jurisdictions that they sell to local investors. Their growth potential is limited by the size of the population of their home country because these products are hard to sell beyond their national borders.

A major trend in the asset management world in these last 20 years was the emergence of a new business model: the cross-border distribution of funds. Asset management groups are using one country as a hub to sell their funds to investors in as many countries as possible across the globe, instead of setting up local funds in each of the different countries in which they want to target investors. Luxembourg has become the main international distribution hub with funds sold to investors in 70 countries across the globe. The emergence of this cross-border distribution business model was enabled by one European Directive called Undertakings for Collective Investment in Transferable Securities (UCITS) in 1985. It had an objective to create a harmonised legal framework for investment funds across Europe, to define an equivalent level of investor protection and to facilitate cross-border sale of funds by creating a fund distribution passport which means that a fund domiciled in one European country could very easily be sold to investors in all the other countries of the European Union. Over the years, UCITS has become a very well-recognised brand around the world and, UCITS funds are now the preferred way to reach investors globally.

The UCITS structure is well suited to the principles underlying Islamic finance: since UCITS funds are primarily for retail investors, the main concern is safety, and funds have rigorous investment policies that accommodate the prohibition of Gharar (uncertainty). However, only a limited number of Shariah compliant funds have adopted this structure. Indeed, even though UCITS is the most appropriate structure for Islamic fund promoters targeting retail or institutional investors in different countries, other structures may be more appropriate, depending upon the promoter’s investment strategy and targeted investor base. Indeed, most Shariah compliant funds have a limited targeted investor base or an investment strategy, such as real estate for example, that does not fit into the UCITS requirements. They have therefore chosen other structures which do not benefit from the passport and the global reach offered by UCITS.

This is about to change. Indeed, the European Commission has been putting in place since 2011 a new framework called Alternative Investment Fund Managers Directive (AIFMD) which covers, in a nutshell, everything that did not fit into UCITS (e.g. real estate, private equity and hedge funds). One key component is that these funds will also benefit from a passport for distribution to institutional investors. It is hoped that AIFMD will follow the same path as UCITS and that it will also become a recognised brand around the world. This would be a great tool to solve the distribution problems that non-UCITS Islamic funds are facing.

Another encouraging element is that several MENA and Southeast Asian asset managers have reached a certain size and want to expand internationally. They are considering launching UCITS funds since it can help them extend their investor base and penetrate new markets.

I am confident that Shariah compliant asset management groups will in the future be able to position themselves in the cross-border distribution business and grow further in this way.

 

Pierre Oberlé is the senior business development manager at ALFI (Association of the Luxembourg Fund Industry). This article first appeared in Islamic Finance News (18 February 2015, Volume 12, Issue 7, Page 26). For more information, please visit www.islamicfinancenews.com.