27four Investment Managers
26th August 2015
The huge potential in Islamic Finance
Responsible investing is becoming a major theme across the global industry. And one of the most significant areas within this sphere is faith-based investing.
Speaking at the Money Expo 2015 at the Sandton Convention Centre, investment analyst at 27Four Investment Managers Nadir Thokan said that the Islamic Finance industry is still in the early stages of growth, but the potential is significant.
“The conventional financial services industry is more than 400 years old,” Thokan said. “But Islamic finance only dates back 40 years.”
While there has been substantial innovation over that time, the market remains relatively small.
“Currently the global market for Islamic finance is $1.5 trillion and its growing at 30% per annum,” Thokan said. “But penetration levels are still very low. Twenty-six percent of the world’s population is Muslim, but just 1% of banking assets globally are Shari’ah compliant. Given the huge pools of wealth in the Muslim world, this is poised for massive increases over the next few years.”
Thokan believes that the biggest potential for growth is in asset management, which still makes up a very small part of the Islamic finance industry as a whole.
“Of the $1.5 trillion in Shari’ah compliant assets, only $64 billion sits in fund management,” he said. “Only $25 billion of that is in equity mandates. But this is a multi-trillion dollar industry in the conventional asset management space.”
He argued that as penetration of products increases and as more people take a greater interest in Shari’ah compliant finance, this will also be a platform for very attractive returns moving forward. As flows into these products increase, returns will move upward.
In particular, he highlighted the global Sukuk market as one in which 27Four sees huge potential.
In simple terms, Sukuk can be described as a Shari’ah compliant bond product. With a bond, an issuer will receive capital from a pool of investors and in return will pay them an interest coupon over a set period and return their capital to them at the end of it.
Sukuk works in a similar way, but it is structured differently in that it gives ownership in a particular product. It therefore does not pay interest, but rather a share of the issuer’s earnings.
“With a conventional bond you take very little risk because unless the company goes bankrupt you are guaranteed the interest and your money back at the end of the term,” Thokan explained. “With Sukuk, however, you participate in profit and loss of that company. Typically what we’ve seen happening though is that it finances fairly low risk projects where cash flows are reasonably certain.”
Thokan said that there is huge potential in this market as it is tapping into a huge source of potential funding that is looking for good rates of return.
“In the Sukuk market there has always been more demand than supply,” he said. “So people have been willing to pay up. And as the industry grows and more people realise the benefits of issuing Sukuk we are likely to see the depth and liquidity of the market increasing.”
A significant benefit of Sukuk is that it shows very low correlation to other asset classes, including global bonds. It is therefore a great tool for diversification, making it appealing not only to investors looking for Shari’ah compliant products, but any investor looking for alternative sources of return.
The market is already showing signs of expanding out of its traditional base, with increasing numbers of issuers coming from outside of Asia and oil-producing nations. Recently Sukuk has been issued by the likes of investment bank Goldman Sachs, multinational conglomerate General Electric, and the German state of Saxony-Anhalt.
“We are going to continue to see rapid rates of growth because it is an attractive avenue for issuers to look at in terms of diversifying their funding base,” Thokan said. “And as the market gets bigger it will attract larger pools of money, bigger issuers and more attractive returns.”
Author: Patrick Cairns