Assets is sharia-compliant investments total around $65 billion, according to financial services research firm Cerulli Associates, which is a figure thatÆs more modest than the hundreds of billions of dollars often cited by regulators and industry players.

In a report on sharia investing, Boston-based Cerulli notes that 53% of the assets, or $35 billion, is held in mutual funds. Specifically, $33.6 billion is managed by local fund managers, while $1.4 billion is managed by foreign fund managers.

The rest is held through foreign manager mandates (21% or $21 billion) and local manager mandates (16% or $10.4 billion).

The report covers the key Gulf states, Malaysia, large Muslim centres such as Pakistan and Indonesia, offshore centres such as the Cayman Islands, and non-Muslim markets such as South Africa and the United States.

Cerulli considers only slightly more than 500 products to be sharia-compliant mutual funds, held mainly by fund managers based on the ground in Islamic countries (although multinationals do have significant holdings in Saudi Arabian asset managers). Few foreign fund managers have launched ranges of Islamic funds and the exceptions include HSBC Amanah, DWS Noor (part of Deutsche), and BNP Paribas.

International fund managers considering entering or expanding in the area of sharia investing face several key issues, according to Cerulli.

First, the market for sharia product is so far mainly retail, mass affluent, and in some places high-net-worth, driven primarily by religious considerations, although performance is also important. As such, retail distribution is a major factor, and managers must contend with the closed architecture prevalent in many countries. Many fund managers are either a part of a bank or are legally separate from a bank but remain closely linked. Banks dominate sharia mutual fund distribution and Islamic banks, in particular, are expected to play an increasingly important role as they grow in scale and reach.

Second, equity products dominate in terms of asset size, and in most cases, these are local or regional products. Money market or trade finance products are also popular, especially in the Middle East, particularly Saudi Arabia. International fund managers have the potential to add value relative to local houses by offering global equity and global-themed products, especially as there is no shortage of sharia-compliant stocks in the world, Cerulli says.

Third, there is little evidence of institutions seeking sharia-compliant investments, and this is particularly the case with sovereign wealth funds (SWFs), Cerulli says. The SWFsÆ frequent ventures into American and European investment banks illustrate that sharia compliance is not an over-riding concern for them, although it is generally said that many such funds are willing to listen to sharia-compliant ideas if there is a clear performance and risk-diversification benefit to doing so, Cerulli says.

Fourth, standards of sharia compliance across various asset classes and investment products are not uniform across the world or even necessarily in a single market, Cerulli says. In most countries, players have to rely on their own appointed sharia advisory councils (although a national council is in place in Malaysia), but given the high costs involved, most managers will want a good indication of demand before doing so.

Potentially balancing out these costs are the cross-sell opportunities prevalent within the Islamic banking industry. The deposits in the fast-growing Islamic banking sector are set to reach $1 trillion by 2010, and while these banks have yet to make a concerted effort to move these into managed investments, it seems to be only a question of time, especially as sharia mutual funds grow in range and accessibility, Cerulli says.

The most influential market in sharia asset management is Saudi Arabia, which accounts for almost half of the Islamic mutual funds in the world by assets. Saudi Arabia is the only country where sharia funds represent the majority of the industry, whether measured by number of funds or by assets. Two asset classes dominate: local equities, and money market or trade finance products. The largest sharia fund in the world, from NCB Capital under its AlAhli brand, fits into the latter category, Cerulli says.

Several foreign banks, notably HSBC, Credit Agricole, BNP Paribas, and ABN Amro (which is in the process of being merged with Royal Bank of Scotland), have significant stakes in Saudi Arabian banks, which in turn control some of the largest asset managers in the country. Goldman Sachs also has a stake in NCB Capital, the investment banking and asset management arm of National Commercial Bank. While the role of the foreign parties in product origination varies from bank to bank, Cerulli says, this is arguably the place where foreign houses have the greatest engagement in sharia product.

In Asia, Malaysia is the most important market for sharia fund management and is generally considered to be the most sophisticated environment for Islamic finance in the world. Malaysia is home to more Islamic funds than anywhere else in the world, Cerulli says, although it lags behind Saudi Arabia considerably in asset terms. Malaysia is also striking for its Malaysian International Islamic Financial Centre (MIFC) initiative, which seeks to open the doors to foreign asset managers and has so far licensed five foreign-majority-owned Islamic asset managers in the hope that they will bring in offshore assets (chiefly from the Gulf) for management through Malaysia. The seed capital for these funds will be provided by the countryÆs main pension fund, the Employees Provident Fund.

Cerulli notes that many other Middle Eastern markets have significant sharia fund management industries. Bahrain remains a regional hub for this area, and over 100 sharia funds are registered there, although in practice the funds themselves are often from elsewhere, notably Kuwait. Kuwait itself and the UAE have growing sharia fund-management industries. In Egypt, a market with a much larger Muslim population than the Gulf nations combined, there are relatively few sharia funds. Other countries of interest include Pakistan and Indonesia, two of the largest-population Muslim countries in the world. Both of these have been relatively late entrants to Islamic finance, but Pakistan in particular is now actively trying to encourage development of the sector, while IndonesiaÆs issuance of a sovereign sukuk (Islamic bonds) last year was a significant statement of intent for the future.

Several developed-world countries also host active sharia asset-management industries, usually to service their own minority Muslim populations, Cerulli notes. The United States and South Africa are examples of this trend, but the United Kingdom is not, despite LondonÆs efforts to make itself a global hub for Islamic transactions.

While Cerulli believes the size of the overall sharia market has been overstated, that is not to say it does not believe it has potential.

Cerulli projects a 12% compound annual growth in sharia assets in the next five years once the current volatility subsides. Underpinning growth are the strong demographics of Muslim countries, the increasing wealth and sophistication of the retail client base, a greater interest among that client base in investing along the lines of religious principles, and the fact that Pakistan and Indonesia are now embarking upon more coherent strategies to boost Islamic finance, the firm says.

It will take some time before foreign managers engage in this area en masse, however, Cerulli says.

Plus, the impact the global financial crisis will have on Islamic asset management remains to be seen. On one hand, the credit crunch has been an opportunity for Islamic finance û the banks could not invest in many of the securities that caused Western banks to come unstuck (no Islamic bank has collapsed, although the behaviour of Gulf real estate in the near future may test that) and the funds, in turn, could not invest in the Western banks. Generally, Islamic funds have at the very least kept pace with conventional equivalents. But, then again, Gulf and Asian stock markets have been among the worst hit by market volatility and in Saudi Arabia in particular there is a tendency to flee for the exits and redeem funds when times are hard, rather than riding out falls in the market.