As investors become more cautious they are likely to look further afield for products
Over the past two decades Islamic finance has become an increasing focus of the global investment community. Indeed, a recent estimate puts the value of the Islamic finance industry at $1trn worth of assets and predicts that it will grow by 10% to 15% per annum. Although still mainly focused on the Middle East and Asia, it is now expanding beyond these markets into Europe and the US.
Islamic asset allocation in the current environment
The reasons for this market growth can, in part, be attributed to the financial turmoil of the last couple of years and the cautious shift in global investor sentiment from wealth creation to wealth preservation. This changing philosophy has been reflected in the way in which investors are managing risk by investing in a greater range of products and asset classes.
For investors in the Middle East however, many of whom will only invest in Islamic products, there is a mounting sense of frustration regarding the limited number of regional opportunities in which they can invest. Consequently, many of these investors are looking to Europe for alternative investment opportunities.
In parallel with this demand, the European market for Islamic finance has rapidly developed. London in particular has positioned itself as a leading hub for Islamic finance and there are now four banks in the UK which are dedicated to the provision of Islamic investment finance, while a number of conventional banks have opened Islamic ‘windows’ over the last ten years.
During the recent past, these institutions have created a variety of Shariah-compliant financial products to deliver liquidity and yield within the context of a stable and tightly regulated framework. Islamic money market, fixed income and equity funds, as well as bespoke investment vehicles and large-scale commercial and retail property investment opportunities are now available to Islamic investors worldwide.
This ability to deliver choice has become imperative as Middle Eastern investors increasingly divide their portfolio into core and satellite investments, with a growing tendency to switch between defensive and enterprising core investments at short notice. Despite these changing attitudes to allocation however, investors continue to look for assets with relatively secured returns.
Perhaps as a result of this sentiment, Middle Eastern investors’ demand for property and property investment funds has increased. These act as a proxy for conventional fixed income as they are high grade investments with a stable income stream.
According to international law firm Trowers & Hamlins LLP, the proportion of international investment in the UK commercial property market from the Middle East has trebled over the last five years and that Gulf investors committed nearly £3bn to the UK commercial property market in the two years following the credit crunch.
These findings bear out recent high-profile activity, including the acquisition of Harrods by Qatar Holding, as well as the purchase by Barwa of a $370m office and retail development on Oxford Street. In addition, there is mounting interest in the acquisition of properties within London’s ‘golden postcode’ by investors from the Middle East, who consider transactions in this area to be relatively low risk and to have the ability to deliver reasonable returns.
The need for diversification and the banking crisis have also created demand for good quality, low risk Shariah-compliant assets, which include sukuk (an Islamic bond), ijara (the leasing of assets), Islamic money market and fixed income funds. These products can provide investors with a reliable income stream, while maintaining a strong focus on liquidity and capital preservation.
While the market has been affected by the economic turmoil and also by recent events in Dubai, the Islamic bond market is recovering.
This trend has been illustrated by sukuk issuances by well-rated international companies such as Nomura. As conventional banks drastically reduce their corporate lending, organisations are looking for alternative sources of funding and are attracted to the liquidity in Islamic finance.
In addition, the success of sukuk, such as that issued by General Electric, which was significantly oversubscribed, is a critical development in the evolution of the market.
Legislation hurdles have meant that, to date, there have been no UK sukuk issued in London. However, the Finance Act 2009 has paved the way for issuance of Alternative Finance Bonds using the sale and leaseback structure of real estate assets. This development brings the opportunity to issue a UK sukuk a step closer.
Over the next 12 months we expect investors to continue to demonstrate a cautious approach with regard to their asset allocation. They will lean more towards fixed income and cash rather than equity investments, with liquidity remaining an overriding consideration. No investor wishes to be a forced seller of illiquid assets.
To achieve this holistic approach to risk management, there is an increasing requirement for investors to look further afield for products which offer a secure and steady yield. For investors in the Middle East searching for liquidity combined with a range of investment opportunities, Europe is becoming an increasingly attractive proposition.
Nigel Denison is head of Markets at BLME
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