SPECIAL COMMENT: Uneven Development of Islamic Asset Management

By John A. Sandwich, Islamic Wealth & Asset Management

This article first appeared in DJIM Newsletter and has been reprinted here with the kind permission of the author.

In recent months this author has frequented the asset management units at numerous banks, family offices, takaful insurers and asset managers in Saudi Arabia, Bahrain, the UAE, Qatar, and Malaysia, interviewing and questioning the status of Islamic asset management. The current state of affairs, unfortunately, is not good.

This is most puzzling. In my experience, and certainly in the experience of anyone involved in managing the wealth of Muslim clients, there has been a constant, repeated refrain from those individuals who are uncomfortable owning assets that are in violation of their spiritual principles. Nearly all of them, in particular at the moment of signing a discretionary management contract, look at the manager and ask, “Can you please make sure none of my investments are haram?”

“Haram” is the Arabic term for forbidden, meaning the item or activity is not supported by the principles of shari’ah. In the context of asset management this means bonds, hedge funds, structured products (or almost anything made from derivatives), and stocks in businesses that are involved in forbidden activities, such as selling money for interest (banks), alcohol, or weapons.

Without doubt most bankers—myself included—are or were guilty of disregarding this part of the client’s investment requirements, instead investing 50 percent or more of the client’s money into assets that are clearly haram. My own conscience was bothered by this practice, so in 2008 I began a systematic effort to not only understand what exactly is the professional practice we call asset management, but what could be done to deliver this service in a shari’ah-compliant fashion.

Not surprisingly, the practice of asset management can be easily distilled into four sequential steps. First, one creates a detailed profile of the client, whether it’s an individual or an institution. The client profile defines and clarifies the client’s investment objectives and risk preferences through quantitative and qualitative methods.

This applies to all clients, regardless of their sophistication. It is important to note that at the client profile stage there may be a need to educate less sophisticated clients on their actual rather than perceived needs. Unfortunately it appears many bankers forget this basic function. Instead of helping clients achieve balanced, diversified investing, the hallmark of good asset management, it appears many bankers simply practice what I called the “throw it and see what sticks” form of banking. Product-centric banking involves randomly offering investment products to clients and waiting until one of them is purchased, based mostly on emotional rather than professional criteria.

The second stage of asset management is selecting the investment strategy that best fits the client profile. There are only three strategies: low-, medium-, and high-risk investing. All other investment strategies are derived solely from these three. One cannot achieve any strategy at all if the banker-client interface is dominated by product sales, which could in fact damage the client interests if certain products—including high-commission derivative investments like structured products—were to overwhelm a client’s ownership of investment assets.

An investment strategy reflects the client profile by allocating assets according to an asset’s potential risk, which is measured by price volatility, liquidity, and creditworthiness, as well as the size, form, and substance of the underlying investment. A low-risk client will have predominantly lower-risk assets in his or her portfolio, and vice versa for higher-risk clients. So far this is all common sense, and in fact is the universally practiced business we call asset management.

Up to this point there is no element of spirituality; it is only the same degree of professional practice one would find in any other industry, such as dentistry or geology.

The third stage of asset management involves the actual selection of securities. This is where spirituality enters, and only here.

Conventional asset managers have the choice of over 3 million investible securities, a plethora of assets that are so abundant as to make the selection very difficult. But, for a Muslim client who cares whether his or her assets are haram, one must take care.

And, as an asset manager, you have to ask: “Can we achieve asset allocations that meet client profiles and at the same time meet professional standards?”

The short answer is yes, we can. This is what strikes me as most unique about Islamic asset management. If we find there are sufficient assets to construct professionally competent portfolios that meet client profiles, yet are fully shari’ah-compliant, then it is our professional responsibility to do so if this in fact is what the client wants.

Surveying the universe of banks and asset management companies that have Islamic asset management units, it’s clear that such a service barely exists in the world today. It doesn’t exist in any great number in Arabia, nor in Malaysia, the world’s two centers of Islamic banking. It certainly doesn’t meaningfully exist in London or Geneva, two great centers of global asset management.

Why this is so is a great mystery, as work done by this author has shown that the universe of shari’ah-compliant assets is not only viable, it is ready now for constructing globally diversified portfolios that meet both professional and shari’ah standards.

We have counted around 118 mutual funds that are both managed according to Islamic principles and have minimum liquidity, size, and track records to meet professional and regulatory standards.

Remember, most investing today is done on an all-funds basis, where allocations in each asset category are done via mutual funds, not directly investing in individual securities such as stocks.

In practice, say a private or institutional client settles $10 million (or $200,000 or $5 million) with an asset manager. The manager will achieve globally diversified portfolio allocations via the purchase of 12 to 15 mutual funds in the four classic asset categories: money market, fixed income, equities, and alternative investments.

The portfolio modeling we have done using the short list of professionally qualified funds with respectable shari’ah compliance has demonstrated that Islamic asset management is not only feasible, in some ways it may be superior to conventional investing.

What we have demonstrated is that a professionally assembled portfolio of shari’ah-compliant assets may have fewer declines during very difficult and falling markets, and equal or nearly equal returns in rising markets, compared to highly similar portfolios offered by major global asset managers.

Now we need to ask, if this service is so readily available, then why don’t major asset managers offer it to their Muslim clients?

This is why I have said the status quo is puzzling. There are no barriers today to professional Islamic asset management. There is, however, resistance among major asset management companies to adopt these simple practices, while in fact almost none of the inputs

are any different than in conventional asset management.

Our conclusions are clear enough. We await widespread adoption of professional practices in Islamic asset management. Yes, there are not nearly enough investment products available, with some clear and major gaps in some asset categories. But, there are sufficient assets to start this business, and to start it today.

This is, after all, what many Muslim clients want. Their spirituality is important to them, including the assets owned in their long-term savings portfolios. We as asset managers have a responsibility to deliver our professional best for those who require shari’ah compliant investing, and we can do so now.

Mr. Sandwick is an independent consultant seeking to assist banks, insurance companies, family offices, and others in the development and implementation of Islamic wealth and asset management solutions. He has created some of the first-ever global allocations that meet strict professional standards, yet at the same time also meeting universal shari’ah standards. Formerly Mr. Sandwick was a private banker in Geneva since 1993, first at Deutsche Bank (Suisse) S.A. and then Banque Leu S.A., a unit of Credit Suisse Private Banking. He was also the founder and managing director of the conventional asset manager Encore Management S.A. from 1999 to 2009. Mr. Sandwick’s frequently published works include the analytical and process foundations for Islamic asset management. Thom Polson assisted in the development of the financial models and portfolio allocations that resulted in this work.