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SA SHARI’AH FUNDS: LIMITATIONS TO BEAT
These funds must invest in accordance with Islamic law.
There are currently 1 607 unit trusts and exchange-traded funds registered in SA. According to Glacier, just 24 of those are Shari’ah-compliant.
The total assets under management in these funds come to about R22 billion – just over 1% of the total market. While these funds serve a niche population, these figures suggest they’re still under-represented. About 1.5% of South Africa’s population is Muslim.
Local asset managers are showing a desire to innovate 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 coming months.
Discretionary fund manager Glacier Invest has also put together three Shari’ah wrap funds that combine unit trusts from different managers into a single portfolio.
The Shari’ah universe
Shari’ah funds 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 is debt levels not exceeding 30% of total assets.
Managers face specific challenges. One, they’re limited to a much narrower investment universe. Of 160 shares in the FTSE/ JSE All Share Index (Alsi), only 74 are in the FTSE/JSE Shari’ah All Share Index.
The latter is also highly concentrated in the resources sector. At the end of last month, 71% of the index was basic materials stocks. More than half is the BHP Group and Anglo American, which together constitute 42% of the index.
As mining tends to be cyclical, Shari’ah funds in SA tend to follow a similar pattern. The result is 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%,” says Rayhaan Joosub, director and portfolio manager at Sentio Capital.
Exclusions
What adds to this discrepancy is that the four multinational industrial stocks that dominate the Alsi – Naspers, Prosus, Richemont and British American Tobacco – are excluded from the Shari’ah index.
Shari’ah funds also exclude all the banks, insurers, highly leveraged property stocks and any retailers that rely heavily on credit sales. Thus it can be difficult for managers to get exposure to stocks that benefit from a strong rand.
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 as a Shari’ah fund manager is to try to manage this volatility for SA investors,” Joosub says.
Shari’ah managers need to find ways of dealing with these idiosyncrasies. One is to look at the mid and small cap sectors, which can also create opportunities for outperformance. A second approach is to make full use of the allowable international exposure in local portfolios of 30%.