CHAPTER 10

Shariah-Compliant UCITS Funds

Satisfying the Appetite of International Investors

He it is who hath made the earth subservient unto you, so walk in the paths thereof and eat of His providence.

(Al Mulk: 15)7

INTRODUCTION

Although Turkey introduced Islamic finance 30 years ago at the same time as Malaysia, Turkey has only been active since 2009 at the national level in offering Islamic solutions. The Malaysian International Islamic Finance Centre (MIFC) organized a road show in Istanbul in September 2011. As a panel speaker, I was asked by a senior-looking gentleman who was a participant, “I am interested to invest my excess money in Islamic equities outside Turkey. But such offshore Islamic funds are not available in Turkey. How do I progress?” This is an apt and timely question. I explained that he could invest in Islamic Equity Undertakings for Collective Investment in Transferable Securities (UCITS) compliant funds, which were already available on global funds platform like Luxembourg and Ireland. I encouraged him to do a web search for the various global investment management companies that offer global strategies for Islamic UCITS funds approved by global fund platforms. He could then refer to respective prospectuses available online from these investment management companies. Each prospectus includes the names of the fund administrators (e.g., Bank New York Mellon). As an investor, I encouraged him to take guidance from the fund administrator for subscription/purchase on the Islamic UCITS equity funds.

This is an example of the emergence of a new investment trend. International investors are exploring alternative assets and investment processes that are socially and financially ethical, that are managed transparently, and that are robustly regulated. These investors are also searching for investment products to diversify their portfolios internationally and across multiple asset classes. However, the availability of such products and solutions is in short supply, and they are not easily tracked or widely offered internationally.

The current supply of existing domestic-centric ethical mutual and unit trust funds, in the format of existing Shariah-compliant investment funds, is not appealing to international investors due to the following:

SOLUTION AT YOUR DOORSTEP

Investment solutions that can mitigate the above concerns do exist, albeit on small scale, in the form of Shariah-compliant UCITS funds. The UCITS fund structure was initially designed as a European regulatory “passport” in order to sell funds across the European Union,1 and its acceptability has now expanded to other regions around the world, including Latin America and Asia. These types of funds are available in regulated offshore fund platforms like Ireland (Dublin) and Luxembourg.

Global UCITS fund platforms are structured to appeal to international investors, given the robust risk framework and strict governance. The UCITS structure is flexible enough that it can be offered in multiple asset classes and multiple currencies to a broader investor base. As such, it can more easily build scale internationally. Such platforms are popular in the conventional space, and Islamic asset managers would do well to take full advantage of these platforms to structure international Shariah products.

PROVIDING EASE OF TRANSACTION TO INTERNATIONAL INVESTORS

An outcome of the global financial shocks over the last five years is a shift in the nature of investors’ demands. The priority now is to access investment products and solutions that are less volatile, with comparable risk-adjusted returns. After the Arab Spring in North Africa and some parts of Middle East, we believe there has also been a flight security from these countries to the United Arab Emirates (Dubai, Abu Dhabi, and Saudi). As such, the Islamic UCITS will be a timely offering to these liquid markets in the United Arab Emirates and Saudi.

Global UCITS fund platforms are traditionally structured to meet the demands of international investors in the conventional space. However, the UCITS structure is flexible enough to be reviewed to meet the requirement of Shariah screening processes. This way the Islamic investment funds can also be built in a scalable manner to service the integrated world.

Sourcing a UCITS fund from a global fund platform (say, Ireland), is an efficient way. Optimizing offerings from such a platform is certainly an apt strategy. Ireland, for example, has made some important strides in facilitating Islamic financial instrument transactions.

Under the Finance Bill Act of 2010, which took effect January 1, 2010, the Irish Ministry of Finance introduced some significant amendments to facilitate Islamic finance transactions in Ireland, especially in the area of Sukuk.2

Due to the common European standard, UCITS funds are regarded globally as very well regulated funds that have robust risk management procedures and a strong emphasis on investor protection.

BRINGING SHARIAH INVESTMENT TO A GLOBAL AUDIENCE

Acknowledging the increasing need to provide cross-border solutions, CIMB-Principal Islamic Asset Management (CIMB-Principal Islamic) established a UCITS funds platform in Ireland in December 2011, the first Malaysian-based Islamic asset manager to do so. CIMB-Principal Islamic has launched three Shariah UCITS funds—Islamic Global Emerging Markets Fund, Islamic Asia Pacific ex-Japan Fund, and Islamic ASEAN Equity Fund for international distribution.3 These three capabilities were identified based on market research, which revealed the growing investor demand for these investment strategies, which are not widely available on a UCITS fund platform today.

As a case in point, CIMB-Principal Islamic is offering its Shariah-compliant funds in seven jurisdictions. The identified markets in Europe are the United Kingdom, Switzerland, and Germany. The United Kingdom is the Islamic finance industry leader in Europe with a sizable Muslim population, while Switzerland is synonymous with its private bank industry. In Germany there are about 4 million Muslim from Turkish descent who are consciously seeking to include Islamic investment funds into their investment agenda. In the Middle East, the funds will be available in Saudi Arabia, the United Arab Emirates, and Bahrain. Saudi Arabia currently has the largest Islamic fund assets under management (AUM) in the world at USD19.9 billion.4

Available Globally but Limited Selection

Although Shariah-compliant UCITS funds are available globally, there are only a total of 26 Islamic UCITS in both Luxembourg and Ireland.5 Shariah-compliant UCITS funds were first made available to international investors on global fund platforms like Ireland and Luxembourg in 2000. However, the majority of the available funds were launched from 2008 onward.

It is interesting to note that Shariah-compliant UCITS funds that currently exist on these global fund platforms were established by conventional global asset managers from non-Islamic countries: the United States, Germany, the United Kingdom, France, Australia, and Switzerland. These conventional global asset managers are the obvious initiators that investors are comfortable with. With their proven track records, some spanning 50 years, these asset managers have the confidence of their investors in the conventional mutual fund space. It therefore makes a lot of sense that this trust, and hence additional investment, is extended to newer products like their Shariah investment offerings. We can find such Shariah-compliant UCITS funds by these managers mainly in Ireland and Luxembourg, where they have had a full complement of conventional UCITS funds available for many years.

For investors looking to invest specifically in Shariah-compliant equities on the UCITS fund platform, the widest selection is in global equity UCITS funds. For investors keen to invest in global Sukuk, there is only one available fund in Luxembourg; however, this fund is not UCITS-compliant.

The breakdown of these fund strategies in Luxembourg and Ireland are shown in Table 10.1.

Table 10.1 Funds in Luxembourg and Ireland

Investors should not be unduly concerned about the low fund size averaging USD20 million. We believe many of these funds were constructed to serve as an incubator strategy by the fund houses to build a sufficient track record of three to five years to showcase their investment management ability. In 2013, we expect the size of these funds will grow exponentially as they cross the five-year mark, granting confidence to investors that are currently tracking the performance.

Malaysia Encouraging Its Licensed Islamic Asset Managers to Offer UCITS

To reinforce the importance of those cross-border offerings, the Malaysia International Islamic Financial Centre (MIFC) is encouraging its 17 Islamic asset management houses to internationalize their product offerings and enhance the visibility of its Islamic funds among global investors by establishing and incubating their own Shariah UCITS funds as well. Investors are therefore encouraged to be on the lookout for Shariah UCITS funds by MIFC-licensed asset managers going forward.

Recognizing of the potential scalability of Shariah-compliant UCITS funds, this initiative is taken seriously by MIFC, to the extent that a memorandum of understanding (MoU) between the Securities Commission Malaysia (SC) and the Central Bank of Ireland was signed in November 2011. The MoU provides an arrangement for the two regulators to exchange information and cooperate in the area of regulation and supervision of authorized entities offering collective investment schemes. The SC also signed a similar MoU with Commission de Surveillance du Secteur Financier (CSSF) of Luxembourg in January 2012.

Shariah Investing Is Resilient in Bull and Bear Markets

Through a global fund platform, institutional and retail investors can track Shariah funds transparently via international investment research providers like Bloomberg, Thomson Reuters, and Morningstar. An internationally visible track record would definitively help debunk the myth that Shariah-compliant investments underperform the conventional investments. Over various time periods, Shariah-compliant funds have broadly matched, or in some instances even displayed comparable performance with, conventional funds even through adverse global economic conditions. On a global basis over the six years ending December 2011, the Dow Jones Islamic Market World Index outperformed its conventional counterpart the Dow Jones Global Index by a cumulative outperformance of 16.54 percent. For Asia Pacific ex-Japan, the Dow Jones Islamic Market Asia Pacific ex-Japan Index outperformed the conventional Dow Jones Asia Pacific ex-Japan Index by a cumulative outperformance of 8.30 percent during the same period.6 Without an international shop window for Shariah-compliant funds to showcase their outperformance to investors, this common misconception persists.

UCITS: An Ideal Platform

Investors of Shariah-compliant UCITS funds will be reassured by a regulatory framework that is clear, straightforward and easily understood. They can also take comfort that fund managers supervised under this regulatory framework must adhere to investor protection, transparency, and disclosure requirements. It offers investors industry best practices that will it acceptable globally, and introduces a more defined and prescriptive governance and risk management regime.

A UCITS fund is able to accommodate investors of all stripes within a single fund. Therefore, whether investors are retail, high net worth, or institutional, they will enjoy different fee levels and be subject to different requirements. In addition, such a fund can be available in multiple international currencies, making it more convenient for investors. Having different investors in one fund also results in a larger asset under management. This will reduce the total expense ratio of the fund (total expense ratio = total cost/total NAV), for onward benefit to each of their international investors.

NOTES

1. Dillon Eustace, A Guide to UCITS in Ireland (Dublin: Dillon Eustace, November 8, 2011). www.dilloneustace.ie/download/1/DE%20UCITS%20Brochure%20FA%20Web.pdf.

2. PricewaterhouseCoopers, “Ireland’s New Finance Bill Enhances Its Attractiveness for Islamic Funds” (2010). http://download.pwc.com/ie/pubs/new_finance_bill_enhances_its_attractiveness_for_islamic_funds.pdf.

3. CIMB Group Press release, “CIMB-Principal Islamic Asset Management establishes three Islamic funds to attract global investors,” CIMB Group (January 16, 2012). www.cimb.com/index.php?ch=g2_mc&pg=g2_mc_news&ac=421&tpt=4.

4. Ernst & Young Islamic Funds and Investments Report 2011: Achieving Growth in Challenging Times.

5. Islamic Finance News, “The Takaful and re-Takaful Industry” Islamic Finance News Supplements (RedMoney Publication, May 2012). www.islamicfinancenews.com/2012_supplement/2012takaful/Takaful.pdf

6. Bloomberg, LP, “DJIM vs. W1DOW & P2DOW vs. DJIP2,” December 30, 2005–December 30, 2011.

7. The verse calls for open-ended business structures in business and trade across jurisdictions, where there are no limits to boundaries. Carrying our business and acquiring property can be done by everyone, from everywhere, with anyone. There is no restriction on race, religion, location, or time as along the financial transactions are Shariah compliant.

General Reading

“The Next Frontier,” Smart Investor 264 (April 2012): 15–17.