Islamic laws highlight government fund restrictions

Malaysia’s $130 billion Employees Provident Fund plans to expand its global Islamic bond program by about 50 per cent this year in a move which highlights some of the challenges faced by fiduciary investors at many of the world’s government-controlled funds.

Islamic funds, more properly called Sukuk (the singular is Sakk) and sometimes referred to as Shari’ah bond funds because they are designed to comply with the Muslim law against usury, represent a small-but-growing part of the global bond universe. Put simply, they make payments from capital rather than paying interest.

Sukuk clearly get most or all of their support from investors in Muslim countries and the managers, including big Western bond houses, of Muslim clients’ money. PIMCO, the world’s largest bond manager, for instance, has a global Shari’ah fund.

Under Malaysian government direction, the country’s biggest pension fund will increase the sukuk in particular to allow it to invest more in Asian bonds. It currently has about 68 per cent of assets in bonds and property and 90 per cent of the total fund is invested domestically.

While the improved diversification from more international investments is a positive, the existence of these sorts of vehicles raises wider issues of fiduciary responsibility and limitations often imposed by governments and other institutions.

Without getting into a religious debate, especially since governments of all persuasions impose various restrictions on their funds, the fiduciary aim of providing the highest possible risk-adjusted return over a given timeframe will be compromised when the investment universe is more limited.

The yield from Malaysia’s sukuk was about 2.8 per cent last year, according to Bloomberg figures, which is not the sort of return you’d want from an emerging market. Other sukuk, such as Indonesia’s, yield much more, although on admittedly lower Standard & Poor’s ratings.

And even the global Shari’ah funds which are in other denominations, including the dollar, are heavily skewed towards emerging markets, particularly the Middle East, which is not helpful for diversification.

While it could be said that restrictions such as those imposed by ethical or ESG-themed funds may have a similar effect, they are usually proposed on the basis of “sustainable” returns and invariably claim to not “cost” the investor anything in foregone returns due to the tilt.

The important thing is that the ultimate beneficiaries of the fund know the limitations and possible costs which are being imposed on the fiduciaries and are prepared to wear it.

Information on the whole sukuk market is scant but a report sponsored by the Islamic Financial Services Board and the Islamic Development Bank in 2007 estimated it to total between $700 billion and $1 trillion at the time, with an expected growth rate of 10-15 per cent per annum. This included more than 250 Shari’ah-compliant mutual funds.

Malaysia actually boasts the oldest Islamic financial institution developed in modern times, Tabung Haji, which was founded in the early 1960s after scholars came up with a business model for an Islamic bank to comply with religious law.