The new economic frontiers

A full review of Shariah investment and Takaful


Shariah-compliant investment and Takaful insurance have seen the interest in them pique as both markets display exceptional levels of growth. As with the space race of the 1960s the superpowers are scrambling to explore and capture market share as much of this emerging global market for themselves.

However much like the cold, dark recesses of space there is much left to discover and learn with innovation the key to discovering its secrets. The FWU group has long been a leader in the industry and is, to stretch a laboured metaphor even further, the NASA of the Islamic investment and Takaful world.

The Munich based company, while acknowledging and revelling in the industry’s successes, is warning that the full potential of the products and services still need to be fulfilled. By taking their lead and examining some of the innovations they have introduced a roadmap for the future of the industry can be developed.

The steady and consistent growth of Islamic financial services over the last six years can be attributed to a number of factors. Firstly Islamic financial products meet the increasing demand for socially responsible investment.

The Shariah law that governs them ensures that investment is not made in businesses related to, among others, gambling, alcohol and tobacco. It also enforces a ban on securities that receive revenue made from financial interest, referred to as Riba. As such there is a greater sense of transparency and accountability, which is of great importance for everyone living in the recent aftermath of the sub prime credit crisis.

However, a clear conscience and social responsibility alone are not the only reasons why traditional powerhouses such as Deutsche Bank, BNP Paribas and Goldman Sachs have entered the market. Due to the expansion of the range of products there are many more consumers turning to Islamic solutions, from inside and outside the Muslim world. The Dow Jones’ and MSCI’s global indicies for Islamic finance include about 40 to 45% of all stocks. There are now a wide range of products available including: hedge funds, private equity, Sukuk, Murabaha, real estate, commodities, leasing and trade finance.

According to McKinsey’s 2007 “World Islamic Banking Competitiveness Report”, Islamic finance has reached new heights-Islamic banking assets and assets under management are estimated around $750bn in 2006. The sector outside Iran has reached $400bn to $450bn and is on track to exceed $1trn by 2010. Islamic assets represent six percent of GCC investable assets of $2.4trn to $2.8trn.Saudi Arabia is by far the largest market in a sizeable and growing HNWI environment. The market continues to grow at an estimated rate of 15 percent annually and there is a further $200bn of assets housed in Islamic windows or divisions of conventional banks. According to McKinsey, Islamic products in Malaysia are growing faster than conventional products by a significant margin.

Takaful, the insurance product where a fixed rate can not be charged and the return is based solely upon the performance of the supplier’s portfolio, is an example that shows the entire Islamic market in microcosm. The Takaful market has been greatly aided by the growth in of commercial banking within the Muslim world and is reaping the rewards of a period of product innovation.

In both of the Mudharabah and the Wakalah models the Takaful product family now spans across general, life, health and pensions business line. Its growth can also be seen by the development of new distribution methods, Bancatakaful and in the growth of the secondary market Retakaful. Takaful has become a $1.77bn industry in Malaysia alone and is a prevalent force in the insurance market across Asia and the Middle East.

The introduction of compulsory health insurance for expatriates and motor third party liability in Saudi Arabia and compulsory health insurance for expatriates in the UAE has led to surge of Takaful in the Middle East. Additionally the introduction of a comprehensive Takaful regulatory framework by Securities Exchange Commission of Pakistan (SECP) and the establishment of Allianz Takaful in Bahrain as the company’s Takaful hub have also boosted the market.
Further development
But while this growth is impressive there is a lot of room for further development, Takaful has the potential to generate huge sums of money if it can expand upon its traditional power base within the Muslim community.

It is a market that is estimated as being potentially worth more than $20bn annually with Europe and North America considered capable of delivering half of it. Estimates have speculated that 20 percent of that pot of $20bn a year could be generated from non-Muslim customers.

The key factors and phrases are “potential” and “could be” because for all the optimism and excitement around the market more needs to be done in order to realise this potential.

While the Shariah regulations make Islamic products appealing they can also put some consumers off. Many non-Muslims perceive there to be an imbalance with religious considerations given more credence than financial ones. This perception can lead to a lot of policyholders to believing that the portfolio being created is vulnerable to religious crisis’s unconnected to financial matters.

In order to grow and win customers away from the traditional markets clearer profit sharing mechanics need to be established. This was the conclusion of a series of meetings held in 2006 between the Islamic Financial Services Board (IFSB) and the International Association of Insurance Supervisors (IAIS).

If these issues can be dealt with, the European and US markets represent a significant opportunity for Takaful suppliers. The UK has already established a Takaful company (British Islamic Insurance Holdings) to go alongside its other Islamic financial banking institutions (Islamic Bank of Britain and The European Islamic Investment Bank).

Commonly accepted

In a report on the future of the market by Fitch Ratings it is stated: “It is commonly accepted that if there is no suitable Shariah-compliant option then it is acceptable for Muslims to use conventional insurers. As Takaful firms become more established and accepted, it may well become less acceptable (both ethically and socially) for Muslims to use conventional insurers.

“This is certainly a potentially important factor in Muslim countries but also in some Western European countries such as France, Germany and the UK, which have significant Muslim communities. Currently, only a tiny proportion of these individuals use Takaful, but this could change in future.”

Constant innovation and adaptation is not only required but is vital across the entire Islamic Banking market globally. This is because, of the estimated $4 trillion that the Islamic market could be worth by Standard and Poor, currently only 10 percent of it is being utilised.

There is a trend for Islamic funds to be skewed towards smaller funds, an Ernst & Young report in 2007 revealed that half of all funds managed less than $50 million of assets. The report entitled “Islamic funds and investments” further revealed that geographically allocations remains based in the Asian Pacific or the Middle East and equities remain the dominant asset class.

There needs to be a shift towards “best of breed” solutions and the development of an Open Investment Architecture for Islamic investment. Concepts such as multi-manger solutions, where the investment in multiple funds helps to reduce risks through diversification or increased sub-advisory arrangements must be offered on a greater scale. Additionally ‘white label partnerships’, offering a distribution partner an established service under their brand, are an excellent way for Islamic services to develop.

The success of a ‘white label’ solution can be seen by the asset management subsidiary of FWU. This is a specialist quantitative equity manager that implements a fund selection and allocation model that is radically different to the buy and hold strategy of traditional investment. The philosophy behind the model is to get the best risk adjusted returns by selling for a profit in bull markets and reducing equity market exposure in bear markets.

The selection of funds is determined not by trying to predict the movements of markets but to react to it and attempt capitalise on the largest part of a trend. It attempts to react to market movements by following an investment that is on an upward trend and attempt to sell for even higher but as part of the model there is a willingness to sell at a loss when the trend falls.

There is a strict criteria employed for funds to be considered part of the model’s target universe. The prevailing factor is that it must be Shariah-compliant however the fund must also be managed by a reputed investment house and must also hold total net assets in excess of $20m. Additionally it must also have a minimum track record of two to three years and offer superior risk-adjusted returns.

Following the selection of funds the allocation is determined by each fund’s individual alpha or ‘relative strength’ (RA) rating. The funds are then ranked by their RA from best to worst with a greater weighting given to those with the better ranking. In this way the higher performing funds are overweighted while low performing funds are underweighted. This model has allowed FWU to continue offering competitive risk adjusted returns in what has been a recent recessionary economic environment.

The success of implementing a solution with Open Investment Architecture shows how Islamic investment services can outperform traditional investments and are a salutary lesson. The future looks to be bright for the Islamic Banking industry so long as an emphasis is kept on innovation, the sky is literally the limit.

For further information: