With a fifth of the world’s seven billion people now followers of Islam, the demand for financial services complying with the faith’s requirements is growing by the day. However, the penetration of Islamic financing remains very small, with only a fraction of the US$80 trillion (QR291 trillion) global funds under management complying with Shari’ah law.
There is a vast and growing pool of investable wealth in the global Muslim community. According to a recent report by Ernst & Young, the addressable universe for Islamic fund managers exceeds US$500 billion (QR1.8 trillion), and still growing by at least 10 to 15 percent annually. In the Middle East, in particular, high growth achieved by many of the region’s economies have raised the level of individual disposable income, stimulating the demand for personal investment vehicles as part of wealth creation and management, and estate planning. Ernst & Young reports that in the Gulf Cooperative Council (GCC) states alone, liquid wealth with Shari’ah-sensitive investors (investors who only want Shari’ah compliant products) will add more than US$70 billion (QR254 billion) to this pool by 2013. Yet Muslims in these and other countries remain underserved.
Islamic financing is undergoing significant change. Last year, the Islamic funds industry grew to US$58 billion (QR211 billion), representing 7.6 percent growth, and 23 new funds were launched. The Islamic fund universe comprises about 100 fund managers, and favoured asset classes remain equities property, commodities, Sukuk and some alternatives. For Sukuk assets in particular, 2010 was a record year, with a total of US$50 billion (QR182 billion) in new offerings.
A driver of change is coming from investors themselves, with a quarter of Muslims now restricting their investment activities solely to Shari’ah compliant products, and a further 33 percent saying they would also invest in these vehicles provided the return matched or exceeded conventional investment funds. This has been a particularly important point for Muslim investors, as historically the lack of knowledge about and availability of Shari’ah products meant that these investors often did not enjoy the same returns as they would have, had they invested in conventional products.
Shari’ah compliant investing is a concept that has not often been well understood, however the magnitude of this market has encouraged financial institutions and private equity funds around the world to begin offering structures that meet Islamic requirements. Muslims are increasingly able to access financing and investment products that are in keeping with their faith, and on similar terms and costs to investors who choose conventional products. There are a number of key elements to Shari’ah investing. Financial institutions that offer these products do not need to be owned by Muslims, but their products must adhere to the restrictions. Islam forbids investing in any industry or asset that is involved in gambling, pornography, weapons, alcohol and tobacco. In the case of our new business, 90 North Real Estate Partners LLP (90 North), which is a Shari’ah compliant investment advisory firm focusing on real estate, we carefully screen the tenants of any of the properties in which we invest, as earning interest is also prohibited in Islam and so property deals are financed using Islamic structures, which an increasing range of financing institutions now understand and embrace.
While property is an obvious candidate for Shari’ah compliant investing, many industries lend themselves to this model. Real estate, however, is a major growth area in the Gulf and wider Middle East, and 90 North has identified its significant potential. The Founder Partners have a wealth of experience, having concluded over GBP1 billion (QR5.7 billion) in Shari’ah compliant transactions in the past decade.
The new company will partner with Gulf-based financial institutions, sharing fees generated by its properties under management throughout their life-cycle. Although the company was only recently established, it is close to closing its first transaction. 90 North’s value proposition is to offer attractive United Kingdom (UK) real estate assets, and the first investment opportunity product that is being marketed is in the student accommodation sector – now very familiar to some GCC investors. The asset will be structured to allow investors to make a regular cash return from rental income estimated at approximately eight percent per annum over a three-year lifespan. This is significantly more than the return one would achieve on cash deposits, one which is resistant to market fluctuations, and of course there is the additional prospect of capital value gains as the properties are asset managed, and cash flow and value increases. We believe that Gulf investors will be convinced of the potential to invest in secure and attractive UK real estate via Shari’ah compliant vehicles.
Britain is familiar territory for Muslims in the Middle East. For example, in 2010, one quarter of Kuwaiti nationals visited the UK, and spent on average GBP3000 (QR 10,920) per head, representing a GBP750 million (QR4 trillion) bonus to the British economy. The value of investment from GCC nationals in the UK is many multiples of that amount, given the attractions of the UK’s long established property system and law, a strong legal system that offers redress and transparency, and a currency that is not part of the eurozone and has thus escaped most of the volatility currently occurring in Europe.
Gulf investors are also attracted to the long, stable ‘triple net’ leases available on property investments, let to well-known global brands. These various factors, combined with the goodwill towards the UK that we have personally experienced, has resulted in strong inflows into Shari’ah compliant financial services in Britain, especially as the breadth and depth of products expand to cater for this market.
The success of Shari’ah finance companies and future growth in the industry rests on a few key factors. Track record is essential, and 90 North has brought together broad and deep experience of Shari’ah finance and acting for Middle Eastern investors to produce attractive risk adjusted returns.
According to Ernst & Young, another important factor is the fee structure. Off-market or private equity funds have to achieve a specific hurdle rate or profit for the investors before the fund managers can charge a profit fee. In typical Shari’ah funds, that hurdle rate starts at eight percent per annum (pa) – in other words, any profit earned over and above six percent pa is subject to the fund manager’s profit fee, and is usually applied in the case of riskier ventures that require a significant hand-on involvement and value add from the fund manager. The upper end of the scale is 15 percent, where the fund manager only gets a cut after the investors have achieved a profit of 15 percent or more. This is normal in safer investments where little management input is required. At 90 North, our hurdle profit fees vary between eight percent and 10 percent depending on the characteristics of the transaction.
As Shari’ah compliant investing becomes part of the mainstream financial services environment, investors in the Middle East and elsewhere will benefit from a growth in the spectrum of products and services. The opportunities are almost unlimited at this nascent stage of the industry’s development.