The Islamic finance industry has traditionally served the needs of the Muslim population which accounts for a quarter of the world’s population. This niche market operates by a different investment philosophy as opposed to a traditional investment philosophy which the rest of the world is more familiar with. The key characteristic that differentiates Islamic funds from other conventional funds is that it provides services to its investors inside a Shariah-compliant framework, prohibiting transactions considered to be unethical under Islamic law, engaging in products that are compliant with Islamic guidelines and promoting greater social justice by sharing risk and reward. In recent years, Islamic finance has been catching on with traditional finance institutions as international banks have expanded into providing Islamic finance services. As the use of derivatives, options and futures are deemed to be speculative; Shariah-compliant products tend to exclude their use, thus making the structure of Islamic finance products different from those found in conventional finance. Though appearing to be esoteric, Islamic finance has been garnering the attention of the broader global investment community as attempts at harmonising the difference between conventional and Islamic finance offers both familiarity and stability to participants of Islamic finance.
The overall performance of Islamic funds is not isolated from the broader macroeconomic events as well as events inherent to GCC and Southeast Asian countries which are the two main regions serving the Islamic finance world. While the global economy remained sluggish for most of 2015, the slump in oil prices has had profound effects in GCC countries while political and economic turmoil engulfing Malaysia have also contributed to concerns over the country’s economy. Furthermore, the OPEC meeting in early December resulted in no consensus among member countries to agree on a production ceiling, as OPEC members are defending their current market share, with some member countries signalling a ramp-up in productions instead.
Across regional mandates, Asia Pacific mandated Islamic funds ended the year up 2.63% while other regional mandates languished. Middle East mandated Islamic funds performed the worst down 8.87%, while globally focused Islamic funds declined 1.60% despite benefits brought about by diversification. Across strategic mandates, money market Islamic funds ended the year on a positive note, up 1.79% followed by fixed income Islamic funds with 1.65%. Equity Islamic funds did not do too well during the year, down 2.63% - the worst performing strategy among all strategic mandates as exposure into GCC equity markets by some Middle East Islamic funds contributed to a drag in performance. Some of these funds which had reduced their holdings into materials, energy and consumer sectors did however manage to stem much of their losses. A number of Islamic funds have also increased their cash holdings in response to the sluggish macroeconomic environment, preferring to wait until the right buying opportunities appear in the market. In addition, the oil slump and ‘greenback pegging’ saw most GCC countries struggling to dig into their reserves to remedy fiscal deficits while weak Southeast Asian currencies have also left the local central banks flailing their arms to steer economic growth.
Figure 1 shows the industry growth of Islamic funds since 2007 with its assets under management (AUM) currently standing at US$80.92 billion overseen by a total number of 879 funds. Indeed, the ebb and flow of the industry is not isolated from global events though the conservative approach of Islamic finance investing has worked in the favour of the Islamic funds in some cases. The 2008 financial crisis which had its epicentre in speculative and highly-leveraged investments is one such instance where Islamic funds have managed to avoid the repercussions of the collapse of asset prices. The Eurekahedge Islamic Fund Index fell only 28.72% in 2008, compared to the MSCI World Index1 which plummeted 41.1%. Growth picked up again sharply in 2009, alongside rebounding equity markets as government stimulus measures kicked in to support the market, with total AUM climbing to US$66.36 billion. Similarly, the political turmoil that followed the Arab Spring demonstrations and the economic uncertainty caused by the Eurozone crisis in the 2011-2012 period proved to be just minor hiccups, with redemptions from jittery investors causing a dip in AUM but recovering in the subsequent months.
The performance of Islamic funds in 2015 reflected the sluggish global market environment with the sustained decrease in oil prices a recurrent theme throughout the year. GCC countries have had to dig deeper into their existing reserves in order to remedy fiscal deficits brought about by a substantial decline in oil prices. A challenging global macroeconomic environment also weighed in on performance with the Eurekahedge Islamic Fund Index ending the year down 1.41% in 2015, with three month losses in the period ending August alone coming in at 6.29%. Investor redemptions also took their toll on Islamic funds with net capital outflows for the year coming in at US$9.5 billion as capital was called down amidst an increasingly uncertain market outlook. However, should we see a recovery in oil prices later in 2016, some of this capital can be expected to flow back into Islamic funds as a rally in oil prices shores up underlying equity markets.
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