New launches fill a gap in the market

12 July 1996

ISLAMIC investment funds have mushroomed in the last few months. Some of the new funds have been launched by institutions from the Middle East and others by Western merchant banks. In its modern incarnation, Islamic banking is a young industry and there is still a shortage of investment products that conform to the basic rules of the Sharia, which ban charging or lending at interest. With the proliferation of new funds the search for an Islamic investment product is becoming easier and the investors may soon be spoilt for choice.

In the past, Islamic bankers have tended to put their clients' money into short-term, traded-related investments. As the industry has expanded, there is growing recognition of the need for a wider range of products. The new investment funds launched in the last few months will go part way to satisfying at least some of the perceived need. However, as this domain of Islamic banking activity expands, it will have to address some thorny religious issues.

There are several reasons why there has been a rash of recent fund launches. Sharia scholars appear to be taking a more flexible attitude to the question of what investments are permissible under Islamic law. Another reason is that the Islamic banking industry has become technically more sophisticated. Saleh Malaikah, head of Dallah Albaraka's financial division, says the industry is now ripe for expansion in the area of financial services.

'Most Islamic banks are pretty much conforming to one standard,' Malaikah says. 'On the liability side, a lot of products have been developed. The next stage, which we're starting to see now, is the services area.'

Others are more sceptical. 'There's a fair amount of 'Me Too'. What's been overblown is the likely appetite for equity investment,' one Western banker involved in Islamic finance, says. 'Sales of equities into the Middle East have not been large. In conventional banking, it's a cash and bond market.' This banker suspects that the funds that will do best are those launched by institutions with a large distribution network. Those that do not have such a network will need to distinguish themselves by boosting their appeal, either on the grounds of closer compliance with the Sharia, or by delivering a better return on investment.

Not all the products are new and there have been Islamic investment funds for over a decade, targeting a range of investments from real-estate and leasing to commodities and equities. Within this spectrum, certain markets have greater appeal than others for the devout investor.

The Kleinwort Benson/IICG commodity fund will target base metals, whose prices are moved more by fundamental factors and less by the Islamically unacceptable activity of speculation than some other commodities. 'The base metal market in particular is driven by cycles of supply and demand. We've found this has particular appeal for Islamic investors, says Stella Cox, who is in charge of Islamic banking at Kleinwort Benson.

Equity investment may be the area which poses the biggest challenges for the creators of Islamic funds because of Sharia stipulations on ethical investing and the prohibition on earning or charging interest. There is a consensus on what kind of companies are clearly unacceptable investments - such as those that make or sell alcohol, or are involved in gambling, weapons production or other undesirable activities. There are grey areas round the edges - some Muslim investors frown on airlines because they make money from selling alcohol on board their planes.

With the interest issue, the problem is simple - most companies either borrow or earn interest income. Dallah Albaraka's Malaikah says the views of Sharia scholars on borrowing can be divided into three broad schools.

No interest

The first and most restrictive holds that it is not permissible for Muslims to invest in the stock of a company that has any borrowings or interest income at all. The second view is that such investment is permissible if the income from it is 'purified' of interest. The third and most relaxed view is that it is the act of borrowing itself which is forbidden rather than any subsequent earnings by investors in the company.

Most Sharia scholars have held the first view, but Malaikah says that younger scholars are taking a more liberal view which is one of the reason for the recent growth in the number of investment funds. 'We'll see a lot of debate in the next year or two about what sets the standard for equity investment.' Dallah Albaraka is applying the middle view to its Al-Safwa fund, which will invest in companies with leverage of less than one per cent of capital and interest earnings of less than five per cent of income. The fund will calculate the amount of interest income in dividends, strip it out and donate it to charity. Not all Muslim investors will appreciate this approach, one Western banker involved in the industry, says. 'Some people will say you're going to go to hell with anything more than zero (leverage).' Assessing the standard can be a complicated and time-consuming business.

Malaikah says Dallah Albaraka selected suitable stocks by researching the performance over five years of about 19,000 companies in the developed economies. It ended up with 560 quoted, actively traded stocks which met the fund's criteria. 'The number will change from time to time depending on leverage and interest income.'

A MEED Subscription...

Subscribe or upgrade your current package to support your strategic planning with the MENA region’s best source of business information. Proceed to our online shop below to find out more about the features in each package.

Get Notifications