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Portfolio > Mutual Funds

Profiting from Morality

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Brian Payne, vice president of investments at Wells Fargo Advisors in Dallas, has had a close association with the Muslim community in the Dallas/Forth Worth area for about five years. His interest in the community, coupled with the realization that Muslims who want to invest per the guidelines of Islamic finance are not being served, have led him to become a specialist in Islamic finance.

Now, Islamic or Shariah-compliant investing has become a prime area of focus for Payne, and about 75% of his new business comes from the Muslim community.

“Any particular group that needs to adhere to specific investment guidelines can pose a challenge to a financial advisor,” he says, “but in a positive way, because putting together a quality portfolio within the boundaries that a client needs to stick to is also extremely interesting and really defines the role of any financial advisor who can rise up to the challenge.”

Payne believes that the Muslim community in the United States presents a great business opportunity for financial advisors. Muslims represent about 0.8% of the population, according to a study conducted earlier this year by the Pew Research Center, but that figure is slated to double over the next two decades to 1.7%.

“This community is well-educated and relatively affluent, but many Muslims in America do not know how to go about investing Islamically even if they want to,” Payne says. “They do not know about how to set up a Shariah-compliant portfolio, even though they know they want to invest as per those guidelines, and they are not sure whom to turn to for advice.”

For most Muslim Americans, financial planning and investing are relatively new domains, says Mohamad Nasir, general manager at Allied Asset Advisors in Oakbrook, Ill., whose Iman Fund is one of the few mutual funds in the United States with a strict Islamic investing mandate.

“There was a time when Muslims would prefer to keep their money in cash, but now, people want their money to grow,” Nasir says. “While Muslims want to invest in Shariah-compliant finance, many don’t even know that that’s possible here in the [United States] and that there are investment vehicles that allow for it. Financial advisors can do a great deal in bringing the word out to people who, like everyone else, need to save for their children’s education, their retirement and so on.”

Although the United States is still some ways behind Europe in terms of providing the framework for Islamic finance and investments to become more mainstream (and of course, the interest level in promoting it ebbs and flows with the political climate in the country), the Muslim demographic is an important one, says Fawad Butt, managing partner at Zeus Capital Advisers in Chicago, a firm providing consultancy and advisory services in Islamic finance. Muslims in America—mainly South Asians and Arabs—are, on average, in their 30s, he says. They are for the most part highly educated and relatively affluent, and even though second- and third-generation Muslims in the United States may be as “American as the next person,” tradition and religion are still important. The ability of this community to consume financial products suited to them in the coming decades is extremely high.

The Nuts and Bolts of Islamic Finance

Islamic finance as it stands today first came into being about three decades ago to cater to the needs of the global Islamic population for whom conventional financial products were not fully acceptable.

Based first and foremost upon the idea of the religious sanctity of financial products, Islamic investments have, through the years, shown themselves to be both sustainable and ethical, says Sunil Kumar, head of risk management for the Middle East at FRS Global in Dubai, and they’ve proven to be more resilient to market shocks than their conventional counterparts.

“Islamic finance is asset-based and this is the key to its resilience,” Kumar says. “The limited interplay of Islamic financial products across major global markets proved to be an advantage during the financial crisis, and Islamic finance prohibits gambling and excessive speculation, which makes trades more rational and real. Credit derivative swaps and other similar products that have been blamed as being the major sources of the financial crisis were also absent from Islamic finance and helped protect it.”

In a nutshell, halal investing, or investing according to the Shariah principles of Islamic finance—guidelines that are set by Shariah boards—requires avoiding investments in liquor, pornography, pork products, gambling, banks and insurance companies, and any business where interest, or “riba,” is the primary driver of income. Bonds and other interest-bearing instruments are a no-no, as are derivatives, and defense is also a forbidden sector.

Today, worldwide Shariah assets total an estimated $900 billion to $1 trillion, according to a report released in September by consulting and research firm Cerulli Associates. That’s three times the size of China’s mutual fund asset base, and the market is projected to expand to between $4 trillion and $5 trillion by 2015, Cerulli says.

Most global financial markets offer specific indexes covering Islamic companies, and many large funds have some exposure to Islamic products. The Dow Jones Islamic Market Index family includes thousands of broad-market, blue-chip, fixed-income, and strategy and thematic indexes that have passed rules-based screens for Shariah compliance. The indexes are the most visible and widely used set of Shariah-compliant benchmarks in the world.

In the United States, there is a growing demand from the Muslim population for investment vehicles that can meet Shariah-compliant guidelines, but there’s also a need for products like Islamically compliant mortgages and small business loans—products whose structuring and origination are also growing in certain parts of the country through community banks that specialize in them, says Butt.

“People tend to start with the basics, but the demand from the local consumer base here in the [United States] is certainly increasing, so we are seeing a greater interest in Shariah-compliant investment vehicles,” he says.

But Islamic investing is also gaining greater traction and popularity among non-Muslims, Butt says, simply because it meets the risk appetite of many people who have been burned one too many times by the financial market collapses of the past few years. Above all, the complete absence of investments in financials has been and continues to be a huge plus point in favor of Islamic investing, he says, and it has encouraged more people to want to learn how this investment universe works.

Islamic Investing: Adherence to Principles and the Long-Term Value Play

For people who are looking for value, including non-Muslims, allocating a portion of their assets to vehicles like Saturna Capital’s Amana Funds makes for a good bet.

“Some of the guidelines for Shariah-compliant investing have to do with the debt structure of companies, so for investors looking for the leanest, meanest companies that they can find, companies that have good cash flow and a low debt structure, Islamic funds like the Amana Funds are very attractive from a value perspective alone,” Payne says.

According to Nicholas Kaiser, director and chairman of Saturna Capital, the Amana Funds’ success has come primarily from advisors and clients who are not Muslim. While the three Amana mutual funds meet the guidelines for Shariah-compliant investing, “most people see us as core, stable funds that they can hold for long periods of time,” Kaiser says.

Kaiser is the pioneer of the Islamic mutual fund in the United States. In 1984, the North American Islamic Trust (NAIT) approached him with the idea of creating investment products for the underserved Muslim community in North America, and in 1986, Saturna launched the Amana Income Fund. It was followed by the Amana Growth Fund in 1994 and the Amana Developing World Fund, which was launched in 2009.

While each of the funds invests according to Islamic principles and Kaiser and Monem Salam, deputy portfolio manager and head of Islamic investing, screen companies for compliance with these guidelines, their long-term goals are geared toward value and growth.

“We’re looking for companies that we believe have potential in the long run,” Kaiser says. “We are value managers who hold companies for between five and seven years, and this increases the efficiency of our funds as we don’t have to time the market in terms of buying and selling. I believe this is attractive to many people.”

In order to be successful in Islamic investing, it’s important for a fund to compete in both the Islamic and conventional spaces, Salam says. Like all other investors, Muslim investors are also looking for good returns, he says, and the Amana Funds give them both the Islamic screen that they require, as well as the long-term value proposition.

While the Iman Fund—launched in 2000 by Allied Asset Advisors, a subsidiary of NAIT—seeks capital growth through adherence to Islamic principles (it doesn’t invest in any of the prohibited sectors), the fund is actually stricter than the Dow Jones Islamic Index upon which it’s based.

“We take a stricter interpretation of what’s allowed only because there are people who demand that,” Nasir says. “Our target market is really those people who care more about not earning money they’re not supposed to earn, as opposed to performance.”

As such, the Iman Fund is fully invested—it doesn’t hold any cash and its managers are constantly monitoring the fund’s holdings to make sure that they are still Shariah-compliant.

“If we buy a stock today that meets our debt ratio of 10% and the debt ratio goes up next month, we will get out of the stock,” Nasir says. “We feel we need to monitor our holdings constantly and, within a reasonable time, get out of them if they don’t meet our investment principles.”

Nevertheless, the Iman Fund is invested in more than 100 Shariah-compliant companies in a range of industries. That variety alone, combined with the rigorous, active management, makes for an attractive investment opportunity even for non-Muslims, Nasir says.

For many people who have equity funds as their core holdings, Islamic funds offer a good diversification option because the criteria by which stocks are selected means that these names don’t often overlap with holdings in other funds, says Jeff (Jaafer) Gareau, a financial advisor at No Interest Investments in Toronto.

“Based on the diversification option and their performance, these funds can be attractive to many people, not just Muslims,” he says.

Advisors and Islamic Investing

While Payne has guided many of his Muslim clients to the Amana Funds, and he values the packaged option that they offer them, he also likes to screen stocks himself to round out his clients’ portfolios with individually selected investments that meet the principles of Shariah investing.

“It isn’t that hard, actually, to find investment opportunities, and the main point that needs to be made is just because something is Shariah-compliant doesn’t mean that it’s a good investment,” he says. “It’s an advisor’s duty to make clients aware of that.”

For Payne, everything revolves around the filtering process: “If you take the list of eligible investments that are out there and then you tailor them down to a client’s risk appetite, there are thousands of stocks to choose from,” he says.

But this may be easier said than done, cautions Gareau, and may not hold ground for very strict Muslims as it could unintentionally result in the selection of stocks that fall outside the guidelines of Shariah. A stock can be Islamic one day and then the next, no longer fit the bill, he says, because the company could sell a bond, causing its debt ratios to change.

Gareau gives the example of Nortel Networks in Canada, which was Shariah-compliant until its price fell to $12 and its debt ratios went out of the permitted range. Even a company like General Motors, which ticks off all the boxes for Shariah compliance, may not pass the grade for some because its financing arm, GMAC, derives a large portion of its income through interest.

“Names that become penny stocks are also prone to speculation and those are definitely not allowed,” Gareau says. “This is why it’s very difficult to do due diligence on your own if you’re going to get Islamic investing right, and best to go with a mutual fund that is constantly monitoring its holdings.”

However, there is just a sprinkling of Islamic mutual funds available in North America. While the interest level is growing both from the client base as well as from the provider side, it will take some time before the number increases, Butt says. Funds like Amana have been successful because they have branded themselves to attract Muslim Americans, but they have also made an effort to appeal to a broader audience through the value investing that is their focus, he says, and this is probably the most logical way for the industry to evolve.

According to Payne, many Muslims do not even know that there are funds like Amana and Iman in the U.S. marketplace, so a first step in moving the world of Islamic investing forward is for advisors to educate their clients on these options.

 “Many advisors think that simply because someone is Muslim, they know how to build a Shariah-compliant portfolio. Even when I first started, I made the assumption that the client knew the boundaries and how to interpret the guidelines,” he says. “That’s not the case and, in addition, investing in the securities market is relatively new to many Muslims. They are comfortable with opening up new businesses, where success and failure is in their own hands, but turning over the reins to an investment manager is still a new concept. Our job as advisors is to educate people, to let them know that it’s fine to finance a new business, but that investing additional funds into financial markets is not such a bad thing and provides a diversifier for overall investment.”

The basis for that education, of course, is trust, and cultivating the trust of a Muslim client is paramount. Without that trust in place, then even the most knowledgeable financial advisor, one who knows all there is to know about Islamic finance and investing, cannot succeed, says Gareau.

“To be an advisor to this community, you need to educate yourself, walk the talk and be committed,” he says, “because no one is interested in a flash-in-the-pan approach.”


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