There are currently 1 607 unit trusts and exchange-traded funds registered in South Africa. According to analysis by Glacier, just 24 of those are Shari’ah-compliant.
The total assets under management in these funds come to around R22 billion, which is a little over 1% of the total market. While these funds do serve a niche population, these figures suggest they are still under-represented. Around 1.5% of South Africa’s population is Muslim. In the Western Cape, that figure is close to 7%.
Local asset managers are also showing a desire to innovate and offer new products in this space. Earlier this year, Kagiso Asset Management launched a Shari’ah-compliant multi-asset income fund, and Old Mutual plans to do the same in the coming months. These offerings have become possible as more Shari’ah-compliant fixed-income type instruments have come out in South Africa.
Discretionary fund manager (DFM) Glacier Invest has also put together three Shari’ah wrap funds that combine unit trusts from different managers into a single portfolio. The intention is to provide a solution for financial advisors who have clients that want Shari’ah-compliant investment solutions.
The Shari’ah universe
The defining characteristic of Shari’ah funds is that they must invest in accordance with Islamic law.
Apart from avoiding certain industries like alcohol and gambling, these funds are also restricted to investing in companies that show certain financial characteristics.
One of these: debt levels that do not exceed 30% of their total assets.
This means managers face a specific set of challenges. The most obvious is that they are limited to a much narrower investment universe. While there are 160 shares in the FTSE/JSE All Share Index (Alsi), there are only 74 in the FTSE/JSE Shari’ah All Share Index.
The latter is also highly concentrated in the resources sector. At the end of September, 71% of the index was basic materials stocks. More than half of that is just the two large diversified minders on the JSE – BHP Group and Anglo American. Together, they constitute 42% of the index.
As mining tends to be cyclical, this means Shari’ah funds in South Africa tend to follow a similar pattern. The result is that they can perform very differently to the overall market.
“The tracking error of Shari’ah funds to non-Shari’ah funds is about 6-7%,” points out Rayhaan Joosub, director and portfolio manager at Sentio Capital.
What adds to this discrepancy is that, for various reasons, the four multinational industrial stocks that dominate the Alsi – Naspers, Prosus, Richemont and British American Tobacco – are excluded from the Shari’ah index. Since the performance of those counters has an oversized impact on the general market, Shari’ah investments can display a significantly different return profile.
Shari’ah funds also exclude all the banks, insurers, highly leveraged property stocks and any retailers that rely heavily on credit sales.
This means it can be difficult for managers to get exposure to stocks that benefit from a strong rand environment.
A final challenge is that the concentration of Shari’ah products in mining and value stocks can create much higher volatility. Between January 2008 and June 2017, the annualised volatility of the Shari’ah index was 19.6%, versus 14.7% in the Alsi.
“A lot of the work you have to do as a Shari’ah fund manager is to try to manage this volatility for South African investors,” Joosub says.
Local Shari’ah managers need to find ways of dealing with these idiosyncrasies. One is to be far more willing to look at the mid and small cap sectors of the market, which can also create opportunities for outperformance.
“We are forced to be a lot more creative, and that ultimately benefits the investor,” says Saliegh Salaam, lead fund manager for Shari’ah products at the Old Mutual Customised Solutions boutique. “We search for opportunities in places where traditional managers who don’t have these restraints wouldn’t necessarily look.”
A second, vital, approach is to make full use of the allowable international exposure in local portfolios of 30%.
“Globally, you can invest in many different countries, many different sectors, many different industries,” Joosub points out. “The problems in South Africa are not a problem on a global basis.”
This makes global exposure a vital part of mitigating the risks in local portfolios, but it also offers a much broader opportunity set from which to deliver returns.
“The offshore universe is so ripe for stock picking, we have no excuse not to find opportunities for our clients,” says Jihad Jhaveri, head of process at Kagiso Asset Management.