Malaysia's efforts to promote itself as a global Islamic investment hub are paying off.
The country has overtaken Saudi Arabia in terms of the number of locally domiciled sharia funds, and is second to the huge Middle East market in terms of sharia assets under management (AUM), based on data from financial services research firm Cerulli Associates.
As of November 2008, sharia funds domiciled and managed in Malaysia totalled 145, compared to just 131 in Saudi Arabia. These range from investments in money markets and sukuks (bonds) to regional and global equities.
Malaysia has, over the past few years, worked to establish itself as a centre for sharia fund manufacturing, in line with its efforts to promote itself as a global Islamic investment hub. Malaysia now possesses the most highly developed regulatory structure for Islamic finance in the world, according to Cerulli.
So far, Malaysia has attracted eight international sharia fund managers by offering a host of tax and other incentives.
However, in terms of sharia AUM, Saudi Arabia is still the clear winner worldwide. Sharia AUM in Malaysia has grown from $1.4 billion in 2003 to $4.6 billion in November 2008. That's nevertheless just a fraction of Saudi Arabia's $13.9 billion in sharia AUM. Malaysia's sharia AUM is also small compared with the estimated $40 billion in AUM of conventional funds managed onshore.
"Malaysian-domiciled sharia funds are still unable to compete with Saudi funds in terms of asset size," says Ken Yap, Singapore-based head of Asia-Pacific research at Cerulli.
To illustrate his point, Cerulli data shows that the AlAhli Saudi Riyal Trade Fund in Saudi Arabia is the world's largest sharia portfolio, with $3.6 billion in assets. In contrast, Malaysia's largest sharia portfolio -- Public Ittikal Fund -- has $421 million in assets.
"While the Malaysian sharia market has shown impressive growth, managers need to do more to build up assets in each of its sharia funds, rather than simply continuing to launch more funds," says Shiv Taneja, London-based managing director at Cerulli. "This means marketing sharia funds to high-net-worth individuals and institutions, and working with the banks, including Islamic banks, to improve sharia fund distribution to the public."
Saudi Arabia's obvious advantage over Malaysia, Cerulli's Yap notes, is the deep pockets of its institutional, high-net-worth and retail investors.
In Malaysia, the focus has been mostly on retail investors -- understandably so because they are an easy target for the asset management arms of banks, for example. Asset management companies with a conventional funds business in Malaysia are also setting up sharia units and they are targeting existing clients.
"The sharia funds in Malaysia are focused more towards the retail client base, which needs more variety and, thus, fund managers need to launch more funds. In Saudi Arabia, the funds are focused more towards the wholesale client base," says Trica Sum, a Singapore-based analyst at Cerulli.
Both Saudi Arabia and Malaysia are capable of attracting and managing offshore funds, but the Gulf state has done more to cultivate that market over the years.
Cerulli's Yap believes that in the near-term the potential for sharia AUM growth in Malaysia still rests with the retail market. Over the long-run, however, he says there is strong potential for growth in the offshore market of sharia firms in Malaysia, the demand from institutional investors and pension funds in Malaysia, and in new businesses from new Islamic fund management company license holders.
Malaysia's Securities Commission has awarded eight foreign Islamic fund management licenses to Aberdeen Islamic Asset Management, BNP Paribas Islamic Asset Management, Nomura Islamic Asset Management, Kuwait Finance House (Malaysia), DBS Asset Management, CIMB-Principal Asset Management, Global Investment House and Reliance Asset Management.
The Malaysia government allows 100% foreign ownership of Islamic fund management companies, in line with its bid to attract more key fund players to the country. The incentive is part of ongoing liberalisation measures in Malaysia's capital market as well as being aimed at complementing the broader Malaysian International Islamic Finance Centre (MIFC) initiatives of positioning the country as a hub.
Islamic fund management companies are allowed to invest all their assets overseas and will be given income tax exemption on fees received until 2016. They will also be able to tap into M$7 billion ($2.1 billion) in seed money from the Employees Provident Fund, the national pension fund for the private sector in Malaysia. Tax incentives are also being offered to existing stockbrokers that set up Islamic subsidiaries.
Cerulli estimates that global sharia fund assets totalled around $35 billion in October 2008 and had been growing at 23% over the past five years, well ahead of conventional mutual funds. Although this rate is expected to ease during the course of the global financial crisis, the firm believes Islamic finance has only started to take root in many Muslim nations and has plenty of room for expansion.