According to State Street, the Islamic finance market has grown at more than 20 per cent a year since 2003, but interest has accelerated particular in the last year as the more conventional financial industry faltered.
Islamic banking caters to investors who want to avoid paying or earning interest, viewed as unacceptable under Islamic law. Islamic banks are not involved in the buying and selling of debt under Sharia law, unlike most conventional European and US banks.
In addition, because it allows for further diversification of risks, Islamic finance may attract an increasingly global group of investors – including non-Muslims – and rather than being defined as a separate sphere it may be helpful to view it as just another asset class.
While the selection of products at large Islamic financial institutions remains relatively narrow, some newly created sharia-compliant instruments are beginning to rival those of conventional banks. The principles of Sharia, the moral and legal code that governs the industry’s development, impacts the underlying structure of its products and services, and ultimately serves as one its biggest selling points to investors.
At its core, Sharia specifies that money has no intrinsic value of its own and should be used as a tool for measuring the value of assets. On the deposit side, these instruments include profit sharing investment accounts (PSIAs), which give depositors the right to share in Islamic banks’ profits and losses. In addition, several money market, equity, real estate, private equity and infrastructure funds are now being offered.
According to State Street’s Islamic finance report, the total assets under management by Islamic financial institutions now exceeds $600bn. The number of Islamic mutual funds has increased from 102 in 2000 to an estimated 706 and, State Street suggests, could reach 902 this year.
The Sukuk market (bonds) reached $47bn in 2007, up 70 per cent from 2006, and whilst the market dipped in 2008 State Street expects it to grow strongly again. However, according to data available on Trustnet Middle East, many Sharia funds have struggled to perform over the last twelve months.
Only 66 of the 359 global Sharia funds listed on Trustnet Middle East have achieved positive returns over the last 12 months, and the bottom ten funds have returns ranging from -56.4 per cent to -64.4 per cent. Five of the top ten are fixed interest funds, while nine of the bottom ten are equity funds.
Performance of top ten global Sharia funds over the last 12 months
| Fund | 1 yr % |
| RHB Islamic Bond | 8.6 |
| AmanahRaya Islamic Equity | 8.2 |
| AMB Dana Arif | 6.8 |
| Emirates Real Estate Acc | 6.2 |
| Public Islamic Bond | 5.3 |
| First Investment Al-Muthanna Islamic Money Market | 4.8 |
| MAAKL As-Saad | 4.3 |
| Public Islamic Select Bond | 4.3 |
| Samba Real Estate | 4.3 |
| CBK Tijari Islamic Money Market | 4.2 |
Source: Trustnet Middle East
Performance of top ten global Sharia funds over the last 12 months
| Fund | 1 yr% |
| Arab Bank IIAB Islamic Mena | -56.4 |
| HSBC Amanah GCC ex-Saudi Segregated Portfolio Ret | -57.3 |
| Albilad Al-Seef KWD | -57.7 |
| GIC Gulf Islamic Equity | -58.1 |
| Global Al Durra Islamic | -58.4 |
| Daman Islamic | -58.8 |
| SAIB Gulf Industrial Companies | -59.3 |
| Gulf Invest Intl Alhuda | -59.8 |
| TAIB GCC Islamic Index | -60.7 |
| Albilad Akar SAR | -64.4 |
Source: Trustnet Middle East
Islamic financial institutions are expanding into non-Muslim countries with the UK in particular expanding its Islamic financial basis. London recently became the only non-Muslim competitor to join the major financial hubs to handle Islamic transactions.
These had previously been dominated by Dubai, Kuala Lumpur and Manama, In addition countries such as Jordan, Tunisia and Sudan increasingly see Islamic finance as fostering economic development.
Trustnet Middle East lists seven UK-domiciled global Sharia funds: only two have a one-year track record:
Performance of UK-domiciled global Shariah funds over last twelve months
| Fund | 1 yr % |
| Stan Life HSBC Life Amanah Pn S3 | -10.9 |
| FP HSBC Amanah Global Equity Idx Pn | -9.3 |
Source: Trustnet Middle East
A key issue that needs to be addressed is the growing need to address differences in jurisprudence and legal methodology across geographical region, in particular for financial products and services for which there is no precedent or clear ruling from the classic texts. However, Malaysia in particular has played a key role in developing Islamic finance, driving forward attempts towards standardisation.
According to Trustnet Middle East, 139 global Sharia funds are domiciled in Malaysia. The top ten Malaysia-domiciled global Sharia funds have all delivered positive returns over the last 12 months.
Performance of Malaysia-domiciled global Sharia funds over last 12 months
| Fund | 1 yr% |
| RHB Islamic Bond | 8.6 |
| AmanahRaya Islamic Equity | 8.2 |
| AMB Dana Arif | 6.8 |
| Public Islamic Bond | 5.3 |
| MAAKL As-Saad | 4.3 |
| Public Islamic Select Bond | 4.3 |
| Public PB Islamic Bond | 3.7 |
| PRU Shariah FX | 3.7 |
| HLG Islamic Income Management | 3.3 |
| CIMB Islamic Structured Growth | 3.1 |
Source: Trustnet Middle East
The market has traditionally been targeted at retail investors but State Street believes that increasingly institutional investors will be looking to invest in Islamic funds. Rod Ringrow, State Street's MENA senior executive officer, believes that Luxembourg-domiciled UCITS III regulated funds based on Islamic finance will become a growing trend.
Trustnet Middle East lists five Luxembourg-domiciled global Sharia funds with a one year track record, performance ranges from -14 per cent to -42.1 per cent.
Performance of Luxembourg-domiciled global Sharia funds over last twelve months
Source: Trustnet Middle East
Ringrow acknowledges that there have previously been barriers to entry for investors, citing in particular Saudi Arabia. "I think the Saudi market is the one that has been the most troublesome for non-Saudis to get into. They have now changed so that other non-GCC residents can gain access into Saudi Arabia," he said.
According to Trustnet Middle East, 116 global Sharia funds are domiciled in Saudi Arabia, and only 27 have delivered positive returns over the past year.
Performance of Saudi Arabia-domiciled global Sharia funds over last 12 months
Source: Trustnet Middle East
Ringrow believes that institutional investors are currently waiting for the right time to invest in the Gulf. He said: "It is interesting because from our point of view eighteen months ago we were seeing the first sign of institutional investors looking at the Gulf as an area for investment. That then dried up in the wake of what has happened but I think they will come back.
"The trouble is a lot of the local bourses are very retail-driven and liquidity is relatively small and in some case there are only twenty or thirty stocks trading on the exchange. What we haven’t seen yet are the investments made by some of the large exchanges, such as the New York Stock Exchange into the Doha securities market and how that is going to change and develop. If that works correctly and does deepen the market then things should become much easier."
A key issue hindering possible growth is that demand for Sharia scholars has increased at a rapid rate leading to a worldwide shortage. "In fact, demand for Islamic finance products and services in the global market may be exceeding current availability," Ringrow said.
There are a number of challenges facing Islamic finance products. Firstly, management of market risks is often more difficult for Islamic banks than their conventional counterparts. This is because of the limited numbers of risk management tools and instruments such as derivatives that are generally forbidden under Sharia law.
Also funding and liquidity risk is one of the most critical challenges facing Islamic financial institutions since only a small secondary market exists to enable them to manage liquidity.
Ringrow said: "Against a backdrop of a challenging global environment, Islamic finance is emerging as a competitive form of intermediation in the international financial system and it has a key role to play in restoring confidence in the markets. Opening the door to additional forms of investing, particularly ones that emphasise the sharing of risk and reward, will certainly help to facilitate this goal."
He added: "Islamic finance will attract an increasingly global group of investors in the years ahead, and we believe the industry as a whole will respond with new products that will offer greater variety and sophistication for a host of complex, cross-border transactions."
However, Ringrow believes that for Islamic finance to be fully embraced worldwide, the industry will need to expand business parameters and create new product offerings. "Specifically, it must increase its investment in research and development to yield new instruments, regulatory structures, best practice and higher standards of risk management to meet the needs of the international community," he said.
"Despite impending market recovery, there should be a continued trend towards risk-averse investments and intense scrutiny of investment practices across the board. This will give Islamic finance a boost for years to come," Ringrow concluded.