CASE STUDY

Global Shariah Equity

Financial institution | Summer 2020

Engagement at a glance

A financial institution in South East Asia was seeking to restructure its equity portfolio to improve diversification and resilience, which included re-orienting the portfolio from domestic to international stocks. As part of this project, the investor sought to appoint 2-4 global developed market Shariah equity managers for mandates of USD 150-200 million each, with the goal of consistently delivering a 7-9% p.a. ‘return on investment’ (ROI, via realised gains and dividend income).

Client-specific Concerns

The search for global developed market Shariah equity managers was just one part of a comprehensive project to overhaul the institution’s equity exposures. A detailed equity portfolio review conducted by bfinance identified ways in which the investor could meet its objectives and resulted in searches for Shariah strategies within several sectors: global developed market equities, global emerging markets and global low volatility.

The investor had an ROI objective for mandates, which is not mainstream in the West but is relatively standard in the home market. This was accompanied by a focus on capital preservation in declining markets, with the investor seeking a smoother performance profile and a focus on total return. While it was essential to have a Shariah-compliant strategy, prior experience with Shariah investing was not considered necessary for prospective managers. Given that the investor had limited experience with international equities, the managers’ ability and willingness to offer ‘knowledge transfer’ was also of great importance as the client seeks to develop internal expertise.

Outcome

  • Maximising the universe of viable strategies was essential, given the relatively unconventional ROI metric and other requirements on return profile, size, track record, Shariah-compliance, and knowledge transfer. Through an open-architecture RFP and manager engagement/education, 52 suitable strategies were analysed at long-list stage – far more than would have been obtainable “off the shelf”.

  • Focus on index-agnostic managers. The investor had dual objectives of ROI plus positive total returns over a market cycle. The most suitable managers for this purpose are more index-agnostic in their investment approach and aim to produce a performance outcome that is more ‘absolute’ than benchmark-relative in nature. ROI-type objectives are unfamiliar to many equity managers, necessitating some engagement and education. The investor ultimately appointed managers that did not have direct previous experience of managing to an ROI objective.

  • Shariah-compliant investors should not limit themselves to “Shariah” or “Islamic” strategies in global equities. Discretionary global equity managers with a quality focus and/or a sustainability/ESG focus have reasonably close natural alignment with Shariah investment principles: many have little-to-no financials; most have little exposure to industries such as alcohol, tobacco, gaming and weapons. While Shariah compliance requires the exclusion of more than 20% of the MSCI ACWI index, a considerable number of active equity managers require little-to-no customisation to their standard portfolios in order to be suitable.

  • Knowledge transfer is increasingly mainstream. Knowledge transfer requirements proved to be challenging for some managers, particularly those at the smaller end of the spectrum, but did not prove to be unduly limiting: an increasingly large group of firms are keen to build long-term strategic relationships with their clients. Indeed, educational support is seen by many managers as a good way of helping clients understand their investment approach as well as developing trust. Common examples of support offered included: internships, secondments, in-house training, conferences and provision of research.

Our specialist says

  • This Shariah equity search really illustrated the benefits of open-architecture manager selection in enabling investors to access managers who would not otherwise have been on their radar as prospective partners. This investor ended up appointing several managers that did not have direct experience of investing with an ROI objective or managing to Shariah requirements but whose investment approaches, once fully understood, were well-suited to the client’s needs.

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