Overview

The Islamic funds under management are a USD 60 billion industry which is estimated to grow to at least USD 77 billion by the year 2019, while the underlying demand for Islamic funds is also forecasted to grow to USD 185 billion over the following years leading to major growth opportunities. However, without fundamental reform, the sector will not be able to live up to its fullest potential in the near- to mid-term in order to bridge the USD 108 billion gap in latent demand and supply. Despite experiencing multiple global and regional crises, the majority of investors and asset managers still believe that performance and efficiency during the past years stayed the same or surpassed expectations after which most asset managers were willing to increase their Islamic investment holdings. The GCC has emerged as the most preferred investment destination for investors and asset managers and Sukuk and equities were the most the preferred asset types in 2015 and 2016. Most asset managers also preferred a supportive Shariah framework within their markets. The key areas of opportunity available to the Islamic asset management industry include Islamic wealth management, private equity, crowd funding, sustainable investing and socially responsible investments.

Dubai

According to a report released by European Islamic Bank, Dubai's Islamic Finance sector is on track to seize a better opportunity with the overall size of the global Islamic asset management expected to rise from USD 60 billion to USD 185 billion. Despite the possibility of becoming a global hub for Islamic asset management, the sector has lagged behind in securing its core demographic. Although Dubai possesses huge international appeal, it possesses a very narrow product offering for investors and lacks diversification and quality. There is an increased demand by GCC investors for sophisticated Shariah-compliant savings, pensions, insurance policies and mutual funds and they desire to diversify their investments geographically as well as into a range of alternative and fixed-income products or asset-backed instruments.

Rasmala and Thomson Reuters have been spearheading developments in the Islamic Finance industry and are actively working with Dubai Islamic Economy Development Centre DIEDC to implement a comprehensive strategy to help Dubai achieve success. The main focus is on the advancement of the Islamic asset management industry which remains heavily under-penetrated and relatively unsophisticated compared to its conventional counterparts. Product innovation, diversification and customer choice are key considerations in improving the quality of Shariah-compliant funds. With the support of DIEDC and other government-related entities alongside a mandate to invest public monies, a move to allocate a marginally higher proportion of funds to Shariah-compliant assets will have a multiplier effect on Dubai’s Islamic asset management industry, potentially putting it on a pedestal. Throughout the Islamic asset management industry, parochial and passive management has led to an overemphasis on local assets with limited choice for the end customer.

Dubai has already achieved significant success in attracting global financial services providers through the Dubai International Financial Centre and has become a destination of choice for the financial community across the MENA region and with the relevant support, initiatives like the Dubai Islamic Economy Development Centre (DIEDC) can further build on its financial credentials to attract investment for pension funds with greater diversity and innovation.

Abu Dhabi

Islamic banks in Abu Dhabi compete on a border-free basis within the nation due to the federal nature of the UAE. Abu Dhabi Islamic Bank (ADIB), with total assets of USD 33.3 billion (DH 122.3 billion) at the end of 2016, is one of Abu Dhabi’s largest banks and has issued the world’s first Shariah-compliant hybrid perpetual Tier-1 Sukuk in 2012. In 2008, Al Hilal Bank joined the local market and was established with an authorised capital of USD 1.1 billion (DH 4 billion) by the Abu Dhabi Investment Council (ADIC). Following its second year of operation, the bank became profitable and held USD 5 billion in 2010 and grew to USD 10 billion in the next three years. By 2013, it had raised its capital base further with a debut Sukuk offering a dollar-denominated sale bringing in USD 500 million. These banks have helped increase the growth of the national Shariah-compliant banking sector, expanding at a compound annual growth rate (CAGR) of 13% between 2010 and 2014.

In 2014, Abu Dhabi’s Islamic banks were confirmed as being at the forefront of the global Sukuk development when ADIB and Al Hilal Bank issued their respective Sukuk. In terms of conventional lenders, National Bank of Abu Dhabi (NBAD) was ranked among the top 10 of Sukuk managers globally in 2016 with nine issuances of USD 1.4 billion combined.

The UAE is the third-largest domicile for funds in the GCC with nearly USD 1.2 billion of assets under management (AUM). In 2014, a total of 12 funds in the UAE were categorised as Islamic with AUM amounting to USD 331 million. Among local banks, NBAD is the most active in Shariah-compliant fund management. It invests across diverse sectors in public equity markets around the region and stood at an AUM of USD 9.5 million (DH 35 million) as of December 2016. The bank’s Sukuk Income Fund offers access to the popular Sukuk market.

ADIB provides structured products for sophisticated investors and has also opted to take an advisory role for mass market fund offerings. It offers 16 third-party Shariah-compliant funds operated by local and regional institutions in addition to access to Sukuk trading platforms for secondary market trading.

On the other hand, Al Hilal Bank has launched the Al Hilal GCC Equity Fund, the Global Sukuk Fund and the Global Balanced Fund. It has also established several strategic investment funds targeting longer-term investors in infrastructure, energy and natural resources.

Pension Funds: Structural Challenges and Issues

Islamic wealth requires a large boost in retirement savings and therefore, a lack of scale serves as a hindrance on the profitability of asset managers and attracting institutional investment to the UAE. Additionally, besides creating more pension funds, scale is achieved the establishment of pension funds as key investors across asset classes, especially fixed-income instruments backed by infrastructure assets.

Currently, UAE nationals do not get to select whether their pension is invested in Shariah-compliant or conventional outlets, as well as how and which asset classes to invest their pensions in.

Over half of the population in the UAE is under the age of 25 and throughout the next decade, the workforce will continue to expand, piling pressure on pension payouts as workers eventually retire. Healthcare will become a critical issue as life expectancies are increasing rapidly around the Muslim world and state pensions with small amounts of savings will become an obstacle on GCC government funds in the future. Consequentially, pension funds must seek higher yields and lower volatility from their investments and in the UAE, this could mean steering clear from locally invested, concentrated funds and moving into professionally-managed, geographically diversified and multi-asset funds. The alternative solution to remedy these funding potholes is either to raise contribution requirements or reduce the benefits.

GCC pension schemes are not sustainably funded due to skewed contribution rates, as nationals who are currently in retirement are paid for by current workforce contributions. With some of the highest payout ratios at 80%, this will not last given the current and future demographics of the region as it will consume reserves and government funds.

Several funds in the GCC remain concentrated for instance, in local real estate and regional stocks and therefore lack proactive management. Asset managers of larger funds continue to take over the Shariah-compliant space and their cautious nature tends to direct them to replicating the simplest product structures and mandates. This monotony leads to a lack of diversification despite the market demanding greater sophistication and innovation in product development. Islamic pension funds, generally managed by the larger players, continue to give a wide berth to investing in alternative assets, fixed income funds and other asset classes.

Conclusion

The Islamic pension fund industry has a long way to catch up globally. Pension funds worldwide have assets in excess of USD 27 trillion while Islamic pension funds only make up 0.001% cent of this figure, despite almost a quarter of the world's population being represented by Muslims. In Saudi Arabia, Malaysia, Indonesia and Bahrain, a small number of pension funds have included Shariah-compliant products in their investment portfolios although with limited impact and penetration levels. In the UAE, consumers have even less choice and access to asset diversification. Most GCC nationals lack the opportunity to choose whether their pension should be invested in conventional or Shariah-compliant avenues even though evidence suggests that the majority would choose the latter given similar cost, quality and performance.

During the last decade and since the inauguration of the Dubai International Financial Centre (DIFC), Dubai has established itself as a centre for financial excellence in the MENA region, as well as one of the world’s leading bases for innovation in the Islamic Finance industry through the structuring and arranging of several breakthrough transactions. Through the talent and resources of the DIFC coupled with the ambitions of the Dubai Islamic Economy Development Centre (DIEDC), Dubai is now poised to achieve the same success in the Islamic asset management space. However, in order to realise latent demand projections and raise the rank of Dubai in the Islamic asset management industry, it would be prudent to form a collaboration between leading local fund managers and the Dubai government to incentivise the creation of multi-asset class multi-geography funds to meet the long term savings requirements of the local population. It is also necessary for Dubai and the UAE’s state-owned savings institutes to create working groups to modify the way they interact with and appoint professional private sector asset managers to improve their performance. Lastly, by transferring 20% of investments in existing regional pension funds to Shariah-compliant funds, around USD 36 billion would be added to the global Islamic asset management industry, resulting in a hike of over half the existing AUMs. With a few tweaks, Dubai has the potential to capture the market and revolutionise the Islamic Finance industry once again.

Despite forecasted oil prices falling below its fiscal break-even points, the ability of Abu Dhabi’s government contributes to the expansion of the Islamic financial services sector, as well as its ability to draw on its foreign reserves to meet spending demands. One interesting possibility in the future is following through a renewed appetite for conventional bond issuances with sovereign Sukuk program. Furthermore, a larger number of GCC corporates may find the Sukuk market an efficient path to funding as regional finances increase against lowering oil prices.

References

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