Islamic Funds & Investments Report 2011 Achieving Growth in Challenging Times pot

Islamic funds industry benefited from performing markets in 2010 but global economic uncertainty risks recovery in the future Islamic funds’ assets under management grew 7.6% to US$58 bi

Islamic Funds & Investments Report 2011

Achieving Growth in Challenging Times

Dear Finance & Investment Leader,

It is with great pleasure that we present to you the 5th annual edition of the Ernst & Young Islamic Funds and Investments Report (IFIR 2011), a ground-breaking original research project developed in collaboration with leading global professional services organization, Ernst & Young Given the recent growth and momentum achieved by the global Islamic funds and investments industry in the post-crisis

landscape, it is essential today more than ever that the strong foundations prepared for the industry are now utilized to build critical mass and international scale for the industry

The Ernst & Young Islamic Funds and Investments Report has over the past 5 years, established itself as critical reference resource for the key decision makers in the global Shari’ah compliant funds and investments industry Exclusively launched on-site at a special plenary session of the 7th Annual World Islamic Funds and Financial Markets Conference (WIFFMC 2011), IFIR 2011, with a principal focus on “achieving growth in challenging times”, will analyze the key trends shaping the industry and will map out future strategic directions that the industry leaders will have to adopt to probe the

emerging landscape of opportunities

We would like to express our sincere gratitude to Ernst & Young and their Islamic Financial Services Group for investing their considerable talent and resources in developing the Ernst & Young Islamic Funds and Investments Report.

We hope that the analysis in this year’s Report will provide practical, constructive and valuable insights which will be useful in your own strategic planning activities and will assist your organization in its quest for success as the global Islamic funds and investments industry enters the next phase of growth To know more on how your organization can play a part in this initiative in the future, please e-mail sophie@megaevents.net

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Islamic Funds and Investments 2011

Achieving growth in challenging times

The contents of the Islamic Funds and Investments Report 2011 are based on a combination of quantitative data and qualitative comments and hence provide a subjective assessment of the current market All quantitative comments are based on published information wherever possible Where published reliable data was not available, qualitative comments were made which may or may not reflect the true state of affairs Information has been assimilated from secondary

sources, including published country, industry and institutional information, and primary sources, in the form of interviews with industry executives

We are not expressing any assurance on the accuracy or completeness of the information obtained Although this report has been documented based on our understanding of Islamic financing activities to include only such activities that are deemed Shari’a compliant, no Shari’a opinion whatsoever has been taken on this report Hence, the contents of this report, in terms of the activities to be carried out, might not necessarily be consistent with Shari’a in all cases, and the opinion of a Shari’a scholar(s) should be taken before any further steps are made to implement suggestions made in the report.

Whilst every care has been taken in the preparation of this report, no responsibility is taken by Ernst & Young as to the accuracy or completeness of the data used or consequent conclusions based on that data, due to the respective

uncertainties associated with any assumptions that have been made No part of this document may be republished, distributed, retransmitted, cited or quoted to anyone without prior written permission from Ernst & Young

Disclaimer

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Executive Brief

Ernst & Young’s Islamic Funds and Investments Report 2011

Dear Investment Executive

Islamic funds industry grew to US$58 billion in 2010, achieving a 7.6% growth The Islamic fund universe comprises of some 100 fund managers Favored asset classes continue to be equities, commodities, Sukuk and alternatives For Sukuk assets specially, 2010 was a record year with US$50 billion of total issuance As the industry continues to realign itself, there were 23 new Islamic funds launched during the year while 46 funds were liquidated

The growth is a welcome trend given the industry’s flat performance in recent years It was primarily driven by market performance, and only marginally from new net money raised by fund managers The recovery was also tested by the evolving geo-political situation across MENA Secondly, there remain serious concerns on the increasing likelihood of sovereign debt crisis in Europe and a double dip recession in the US Both these factors will continue to influence

conventional and Islamic asset management industry going into 2012

The addressable universe for Islamic fund managers is in excess of US$500 billion, and still growing by at least 10-15% annually In the GCC, liquid wealth with Shari’a sensitive investors will add more than US$70b to this pool by 2013

Our award winning Islamic Financial Services team explored the emerging trends with leading Islamic fund managers and their ability to assist clients in managing this wealth It appears that the top three priorities for the industry are:

Trust in the brand and track record are important factors, and will favor established and larger players

businesses, takaful operators etc is central to future growth

strategy, operating model and most importantly the risk infrastructure, will help set the tone for sustainable growth Looking ahead, the challenging times are by no means over I hope you will find these market insights useful for your businesses

Ashar M Nazim

Islamic Financial Services Leader

Ernst & Young

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1 Islamic funds industry benefited from performing markets in 2010 but global

economic uncertainty risks recovery in the future

Islamic funds’ assets under management grew 7.6% to US$58 billion in 2010 but the

performance will be difficult to repeat this year

money into high risk equities will remain a challenge

Investors remain cautious about investing in plain vanilla equity funds; recent decline in market prices has increased flow into money market funds

3 Achieving scale is even more critical to ensure long term sustainability

Over 70% of fund managers fall below estimated break-even AuM level of US$100 million; big will get bigger as the going gets tougher to win investors’ trust

4 Global economic scenario, investors’ risk aversion and political aftermath of

the “Arab Spring” are the top three risks in Fund Managers’ minds

Leading fund managers rate the economic situation in Europe and the US as the single biggest concern on future market performance as no region or market will remain immune in case of a double dip recession

Key messages

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Source: National Mutual Funds Association, Ernst & Young analysis

Global Mutual Fund Industry

Note: The data is for 45 countries

Global mutual funds AuM reached US$25.6 trillion in 1Q2011, 35% higher than the low touched in 2008

Source: Eurekahedge, Zawya, Ernst & Young analysis

Global Islamic Fund Management Industry

Number of Funds

Estimated AuM

(US$b)

After three flat years, the global Islamic fund management industry expanded by

7.6% in 2010, reaching US$58 billion in AuM; 13% higher than 2008

Assets Under Management (LHS) Number of Funds (RHS)

This is largely due to market performance and only partially on account of new money flows; 23 new funds launched, 46 liquidated

Global Islamic Funds - Annual Launches and Liquidations

Source: Zawya, Eurekahedge, Ernst & Young analysis

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The over dependence on a few institutional investors (Institutional Funds make up two-thirds of the total new funds launched) is a key structural weakness in Islamic markets globally (except Malaysia)

Source: Eureka Hedge, Zawya, Ernst & Young analysis

Note: Retail funds are defined as funds that have a minimum initial subscription of US$2,000 or less

Breakup of Retail and Institutional Islamic Funds Launched

0102030405060708090100

%

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Shari’a sensitive investors tend to park money with banks rather than investing in

Islamic funds – which constitute only 5.6% of the US$1 trillion industry

Source: Central Banks’ Reports, Securities Commission Malaysia, DataMonitor, Eureka Hedge, Zawya, Ernst & Young analysis

Asset Under Management to Total Banking

Deposits AuM to Banking Deposits

Size of Fund Management Industry to Total Industry Size (2010)

Islamic Financial Services Industry

Text

► Other AuM includes off balance sheet direct investments managed by banks and investment companies and restricted profit sharing accounts

► Islamic funds represent only 5.6% of the total Islamic financial services industry

Total Industry US$ 939 b

Islamic Assets Managed US$321 billion 31%

Islamic Funds 5.6%

Estimated Islamic Finance Assets US$ 1,033 billion

Key messages

1 Islamic funds industry benefited from performing markets in 2010 but global

economic uncertainty risks recovery in the future

Islamic funds’ assets under management grew 7.6% to US$58 billion in 2010 but the performance will be difficult to repeat this year

2 Sukuk, commodities and capital protected funds did well in 2010; bringing new

money into high risk equities will remain a challenge

Investors remain cautious about investing in plain vanilla equity funds; recent decline in market prices has increased flow into money market funds

3 Achieving scale is even more critical to ensure long term sustainability

Over 70% of fund managers fall below estimated break-even AuM level of US$100 million; big will get bigger as the going gets tougher to win investors’ trust

4 Global economic scenario, investors’ risk aversion and political aftermath of

the “Arab Spring” are the top three risks in Fund Managers’ minds

Leading fund managers rate the economic situation in Europe and the US as the single biggest concern on future market performance as no region or market will remain immune in case of a double dip recession

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Key messages

1 Islamic funds industry benefited from performing markets in 2010 but global

economic uncertainty risks recovery in the future

Islamic funds’ assets under management grew 7.6% to US$58 billion in 2010 but the

performance will be difficult to repeat this year

2 Sukuk, commodities and capital protected funds did well in 2010; bringing new

money into high risk equities will remain a challenge

Investors remain cautious about investing in plain vanilla equity funds; recent decline in market prices has increased flow into money market funds

3 Achieving scale is even more critical to ensure long term sustainability

Over 70% of fund managers fall below estimated break-even AuM level of US$100 million; big will get bigger as the going gets tougher to win investors’ trust

4 Global economic scenario, investors’ risk aversion and political aftermath of

the “Arab Spring” are the top three risks in Fund Managers’ minds

Leading fund managers rate the economic situation in Europe and the US as the single biggest concern on future market performance as no region or market will remain immune in case of a double dip recession

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Equity funds performed in 2010 as markets recovered but the future is likely to be volatile mainly due to economic problems in Europe and the US

Islamic and Conventional Indices

Index return

Islamic Equity Funds - Average Returns

Top Quartile Return Weighted Average Return

-41.8

20.9

4.4

-50-40-30-20-100102030405060

%

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Assets Under Management of Islamic Funds by Categories (2010)

Source: Zawya, Eurekahedge, Ernst & Young analysis

*Note: Other includes alternative investments and feeder funds

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MENA Sukuk Size Rest of World Sukuk Size Number of Sukuk

2010 proved to be a record year for global Sukuk issues with over US$50 billion raised; Islamic fixed income funds continued to perform well

Source: IFIS, Zawya Sukuk Monitor, Eurekahedge, Ernst & Young analysis

Global Sukuk Issuance Islamic Fixed Income Funds - Average Returns

*Deals rumored/announced/delayed

%

Note: Data includes returns of 49 funds

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Global commodity prices continued to rise in 2010 albeit at a slower pace than in

2009; the surge in gold and silver prices accounts for more than 80% of the Islamic Commodity Funds’ performance

Source: Merrill Lynch, Bloomberg, Eurekahedge, Zawya, Ernst & Young analysis

Merrill Lynch Commodity Excess Return Index Islamic Commodity Funds - Average Returns

% Top Quartile Return Weighted Average Return

Note: Data includes returns of 13 funds

Money market funds lost some attraction as stability returned in 2010, but are likely

to perform well going forward despite a low profit rate environment due to renewed worries on global financial situation

Source: Bloomberg, Eurekahedge, Zawya, Ernst & Young analysis

USD 3 Month LIBOR Islamic Money Market Funds - Average Returns

%

Top Quartile Return Weighted Average Return

Note: Data includes returns of 28 funds

Property prices have stabilized in most markets or the sharp declines have been

arrested; investors continue to remain cautious about investing in real estate

Source: Bloomberg, Eurekahedge, Zawya, Ernst & Young analysis

Global REIT Index Islamic Real Estate Funds - Average Returns

% Top Quartile Return Weighted Average Return

Key messages

1 Islamic funds industry benefited from performing markets in 2010 but global

economic uncertainty risks recovery in the future

Islamic funds’ assets under management grew 7.6% to US$58 billion in 2010 but the

performance will be difficult to repeat this year

money into high risk equities will remain a challenge

Investors remain cautious about investing in plain vanilla equity funds; recent decline in market prices has increased flow into money market funds

3 Achieving scale is even more critical to ensure long term sustainability

Over 70% of fund managers fall below estimated break-even AuM level of US$100 million; big will get bigger as the going gets tougher to win investors’ trust

4 Global economic scenario, investors’ risk aversion and political aftermath of

the “Arab Spring” are the top three risks in Fund Managers’ minds

Leading fund managers rate the economic situation in Europe and the US as the single biggest concern on future market performance as no region or market will remain immune in case of a double dip recession

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Key messages

1 Islamic funds industry benefited from performing markets in 2010 but global

economic uncertainty risks recovery in the future

Islamic funds’ assets under management grew 7.6% to US$58 billion in 2010 but the

performance will be difficult to repeat this year

money into high risk equities will remain a challenge

Investors remain cautious about investing in plain vanilla equity funds; recent decline in market

prices has increased flow into money market funds

3 Achieving scale is even more critical to ensure long term sustainability

Over 70% of fund managers fall below estimated break-even AuM level of US$100 million; big

will get bigger as the going gets tougher to win investors’ trust

4 Global economic scenario, investors’ risk aversion and political aftermath of

the “Arab Spring” are the top three risks in Fund Managers’ minds

Leading fund managers rate the economic situation in Europe and the US as the single biggest

concern on future market performance as no region or market will remain immune in case of a

double dip recession

Scale remains a key issue for the Islamic fund industry worldwide; only 30% of Islamic fund managers have more than US$100 million in AuM and top 10 have ~80% market share

Number of Islamic Fund Managers by Assets Under Management (2010)

Source: Eurekahedge, Zawya, Ernst & Young analysis

Total AuM (US$m)

A comparison with conventional investment managers reflects the infancy stage of the Islamic funds industry; the top 25 conventional fund manager is 50 times the size

of the largest Islamic fund manager

Top 25 Global Asset Managers (2009)

Source: Towers Watson

MetLifeFranklin TempletonWells Fargo

AvivaGenerali Group

Northern Trust GlobalPrudential Financial

Legg MasonNatixisBank of AmericaHSBC Holdings

Goldman Sachs GroupUBS

Credit Agricole

Bank of New York MellonCapital Group

JPMorgan ChaseDeutsche Bank

BNP ParibasAXA Group

Vanguard Group

Fidelity InvestmentsAllianz Group

State Street GlobalBlackRock

AuM US$b

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A comparison with conventional investment managers reflects the infancy stage of

the Islamic funds industry; the top 25 conventional fund manager is 50 times the size

of the largest Islamic fund manager

Top 25 Global Asset Managers (2009)

Source: Towers Watson

MetLifeFranklin TempletonWells Fargo

AvivaGenerali Group

Northern Trust GlobalPrudential Financial

Legg MasonNatixis

Bank of AmericaHSBC Holdings

Goldman Sachs GroupUBS

Credit Agricole

Bank of New York MellonCapital Group

JPMorgan ChaseDeutsche Bank

BNP ParibasAXA Group

Vanguard Group

Fidelity InvestmentsAllianz Group

State Street GlobalBlackRock

AuM US$b

Source: Zawya, Eurekahedge, Ernst & Young analysis

Average Management Fee of Islamic Funds

A 30% compression in management fee since 2007 has added to Islamic fund managers’ worries in an already tough market; achieving an optimum AuM size and efficiency of operations are needed for survival

Based on the average asset management fee of 1%, AuM of at least US$100 million is required for a fund manager to break-even

Source: Industry interviews, Annual Reports, Ernst & Young analysis

Note: The methodology for the breakeven calculation is based on the average annual operational costs for listed equity mutual funds It is important to note that costs/AuM will

vary for more sophisticated asset classes

Break Even Management Fee for Selected AUM Levels

0255075100125150175200

4.0 3.5

3.0

2.5 2.0

1.5 1.0

0.5Assets Under Management (US$m)

Management fee (%)

Industry Average Management Fee

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Based on the average asset management fee of 1%, AuM of at least US$100 million is

required for a fund manager to break-even

Source: Industry interviews, Annual Reports, Ernst & Young analysis

Note: The methodology for the breakeven calculation is based on the average annual operational costs for listed equity mutual funds It is important to note that costs/AuM will

vary for more sophisticated asset classes

Break Even Management Fee for Selected AUM Levels

0255075100125150175200

4.0 3.5

3.0

2.5 2.0

1.5 1.0

0.5

Assets Under Management (US$m)

Management fee (%)

Industry Average Management Fee

Source: Pew Research Center, Ernst & Young analysis

~148m

Turkey

~74m Egypt