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A window into South African Shari’ah unit trusts

12 June 2012 Imraan Jakoet, Investment Analyst at Glacier by Sanlam
Imraan Jakoet, Investment Analyst at Glacier by Sanlam

Imraan Jakoet, Investment Analyst at Glacier by Sanlam

Shari’ah investing can simply be defined as investment in compliance with Islamic law. Glacier Research recently met with the Shari’ah fund managers available on the Glacier platform to gain a better understanding of how Shari’ah unit trust funds are mana

Shari’ah unit trusts are aimed at providing ordinary Muslim investors with the opportunity to invest in savings vehicles which invest in a way which is in accordance with their religion. These funds may also appeal to any investor who is looking for funds with social responsible investing characteristics and for those who simply buy into the philosophy of Shari’ah investing. For a number of years the domestic Shari’ah funds available in South Africa have been limited to the general equity sector but the industry has since seen the emergence of Regulation 28 compliant Balanced funds.

Investable universe

The Shari’ah investable universe, due to a number of exclusions of sectors such alcohol, tobacco, etc., is a unique proposition for a South African investor and has a number of characteristics which one should take cognisance of when evaluating fund returns. One of the key characteristics of the JSE Shari’ah index is its large weighting to the companies Anglo American and BHP Billiton, which has ranged between 35 – 50% of the index over time. This makes it difficult for these funds to track the index. In light of this, most managers have taken an agnostic stance to the index and have derived a custom benchmark or have benchmarked themselves relative to peers (either Shari’ah or the general equity category). Another trait of the index is that the entire financials sector is excluded from the South African investable universe due to their broad use of interest, which is impermissible under Shari’ah law.

Shari’ah funds follow a long-only approach as derivatives may not be used. Risk management is therefore even more important in this category of funds. This factor, in addition to the reduced investment universe, may impact the managers’ ability to manage risk in these portfolios when compared to conventional unit trust funds.

Many of these funds that were able to hold offshore assets have included this exposure and most with domestic mandates only indicated that they are intending to include foreign to their universe. This is good news for local Shari’ah investors as it opens the funds up to a larger range of opportunities and a much broader universe of sukuk (Islamic bonds). The range of sukuk available in South Africa is currently quite limited and it is likely that it will be increased in future.

Shari’ah advisory boards and the investable universe

Although the JSE maintains a Shari’ah index we found that all the asset managers still do their own investment screening and that the investable universe is determined under the guidance of the Shari’ah advisory boards. Advisory boards are comprised of Islamic scholars who specialise in the interpretation of Shari’ah law specifically relevant to the financial services industry. These scholars – referred to as Muftis – are typically leaders in their field of study either locally or abroad and bring a wealth of experience in guiding the portfolio managers.

The interpretation of Shari’ah law may differ between the different boards and investors may find that one fund may be allowed to invest in a particular share while another may not due to the difference of opinion between their respective advisory boards. Examples of this were found in respect of property and sukuk. In terms of property, most advisory boards have advised against the use of property with the exception of Element Investment Management. The view of most advisory boards with respect to listed property is that the revenue from the underlying tenants is too difficult to determine and this uncertainty has caused the boards to vote against the inclusion. With regards to sukuk, we found that Old Mutual was the only balanced fund manager whose advisory board voted against its use; the fund instead uses equity conduits as an alternative in their balanced fund.

AAOIFI

AAOIFI, which stands for the Accounting and Auditing Organisation for Islamic Financial Institutions, is a global body which sets global Shari’ah standards for the financial services industry. The FSB and South African Shari’ah scholars have adopted their guidelines in evaluating the investable universe. The AAOIFI financial ratios (set for a company to qualify for the investable universe) requires that debt to total assets is less than 30%, cash and interest bearing items to total assets is less than 30%, accounts receivable and cash to total assets is less than 70% and that interest income is less than 5% of the total revenue.

Non-permissible income

The removal of non-permissible income is also something which is unique to the Shari’ah category of funds and requires that the percentage of earnings from non-permissible sources be “purified” before entering the fund. Examples of non-permissible income include revenue that a company derives from interest and pork products. This portion is usually removed from the dividends paid and may serve as a slight detraction from the funds’ performance. Investors however have the comfort in knowing that this portion is distributed to numerous charities across South Africa and globally. All the managers assured us that none of the proceeds are used elsewhere in the business or for advertising purposes.

Shari’ah funds comprise a small percentage of the South African unit trust universe but they certainly have the ability to grow significantly over time. As Muslim investors now have a larger universe of managers from which to choose - compared to 10 years ago - it is important that they determine which managers are best suited to their needs from a style, performance and process perspective.

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