There may be $270 billion in Islamic endowments in Saudi Arabia alone, much of which is over-exposed to real estate. But Thomas Woods, of Safa Investment Services, says more of this money should be invested in sharia-compliant funds.
Islamic endowments, or awqaf, are an essential method of alleviating poverty in the Muslim world and a potential cornerstone of the Islamic finance industry. In the past, awqaf, which date back to the time of Prophet Muhammad, typically endowed buildings or plots of land for charitable purposes.
Today, awqaf (the singular is waqf) have large sums of money at their disposal and should, in theory, look to serve their beneficiaries, the poor and infirm, in the most efficient way possible. This suggests modern portfolio theory should be exercised to ensure endowments serve their beneficiaries to their full capacity, with diversification and progressive asset allocation to ensure the highest returns possible.
Awqaf in the Muslim world must continue to be client-facing while ensuring they invest in a broader range of sharia-compliant assets to gain the appropriate balance of risk and return.
It is likely that awqaf in Saudi Arabia are far too heavily concentrated in real estate.
This lack of asset diversification is not consistent with modern portfolio theory and may be overly risky. It is probable that awqaf are not achieving the same risk-adjusted returns that a diversified portfolio would achieve.
Arab investors have commonly favoured property as an asset class, but because of the lack of liquidity this asset class represents, it generally receives a far lower weighting in diversified global portfolios than in those of awqaf.
Awqaf managers have the opportunity to access the growing Islamic mutual funds industry if they wish to exercise diversification. It is estimated that the awqaf industry in Saudi Arabia is worth around a trillion Saudi riyals ($270 billion), perhaps more. If these endowments were to invest in Islamic mutual funds across currencies, fund domiciles and asset classes, the natural re-alignment with contemporary asset management could only benefit the endowments’ beneficiaries.
As mentioned, in Saudi Arabia, awqaf managers tend to invest donors’ cash in real estate, because of the supposed safety and consistent returns that this asset class offers. However, aside from diversification of property type and duration of lease, this strategy does not allow investors to spread their risk. Over-exposure to one asset type is risky and does not serve to sustain returns for the beneficiaries of awqaf. Mutual funds, whether they comprise mixed asset classes, equities, fixed income, money market or alternatives, can provide diversification.
The continued growth of the Islamic finance industry is encouraging, as are the increasing number of Islamic mutual funds available to investors. A growing global Muslim community, coupled with increasing per capita income of the Gulf Cooperation Council (GCC) states which, with the exception of Bahrain, were relatively untroubled by the Arab Spring, has led to growing consumer confidence in Islamic funds.
Although limited in number, in comparison with conventional funds, the strength of emerging markets in the Far East in addition to the relative insulation that the GCC enjoys from the eurozone debt crisis makes Islamic funds an attractive prospect for investors.
However, although the market capitalisation of the Saudi stock market, the Tadawul, is the largest of the GCC states, the market remains closed to external investors. This means European sharia-compliant equity funds cannot buy equities listed on the Tadawul All Share Index unless they have a local booking agent – that is, a registered office in Saudi Arabia to invest directly in Saudi-listed companies.
An abundance of poorly managed capital present in the awqaf industry offers a significant opportunity for European fund managers. Awqaf represent large pools of cash that fund managers could target to increase assets under management. If European fund managers marketed their funds to awqaf, providing endowment managers with diversification in their investments, they could create a large market within the Islamic funds space.
The largest endowments in the West, such as those of Harvard and Yale universities, have dedicated investment professionals managing their portfolios. This is, sadly, not the case for many Islamic endowments in the Mena region, particularly those of Saudi Arabia. Religious scholars are highly influential in the investment process.
If Saudi awqaf were to invest in Islamic mutual funds to diversify, the source of the fatwa, or religious edict, provided by the fund’s dedicated board of sharia scholars would be important. It is likely that a Saudi waqf would want specifically to invest in a mutual fund with a fatwa provided by a Saudi sharia scholar, or from the GCC at the very least.
In the past, reform of waqf management was often met with resistance from community leaders, thus mismanagement was common, often resulting in below average returns for the poor. If this mindset were to change, and if sharia-compliance and modern portfolio theory could work to improve the lives of beneficiaries, there is an opportunity for Western funds to gain access to these pools of capital.
Underdeveloped investment techniques exercised by awqaf managers, perhaps due to an inability or a lack of desire to stray from the traditional approach to investing in real estate means they may not be achieving the highest possible returns for their beneficiaries. This should be the fundamental objective for any type of fund or endowment, whether Islamic or conventional.
Thomas Woods works for Safa Investment Services in Riyadh, Saudi Arabia, and is a graduate of the Master’s programme in Islamic Finance at Durham University
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