Asset allocation is a very important component of financial planning. It deals with the way the asset of a client are being placed in various forms of investments so that his financial goal are met. The last decade has seen increasing demand for shariah compliant asset management from institutional and private clients, partly driven by the rapid rise in the region’s wealth, but also by the increasing number and breadth of asset classes now available for Islamic investors.
The paper is, basically, a survey of Asset allocation issues in Islamic Funds Management, where the bulk of the paper focuses on asset allocation issues and Shariah compliant fund management. 2. Difinition a. Islamic Fund Management Fund Management - The management of the cashflow of a financial institution. The funds manager ensures that the maturity schedules of the deposits coincide with the demand for loans.
To do this, the manager looks at both the liabilities and the assets which influence the banks ability to issue credit. A fund manager must also pay close attention to cost and risk in order to really capitalize on the cash flow opportunities. A financial institution runs on the ability to offer credit to customers. Ensuring the proper liquidity of the funds is a crucial aspect of the fund managers position. Funds management can also refer to the management of fund assets.
Islamic Fund Management - Fund management that complies with shariah requirements. b. Asset allocation Asset allocation - An investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon. The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time. 3. Shariah Compliant Fund Management
Funds offer major advantage for investors who wish to have shariah compliant asset holdings as a shariah board is usually accountable for the criteria governing the portfolio selection and in the case of equities, the actual stock included. Muslim investors who purchase stock directly through a broker or invest in other types of assets such as commercial property can have no guarantee that their money is being utilised for halal purposes, unless they had the resources to engage personal shariah advisors to monitor all their investments.
Few, other than high net worth investors, could contemplate such an approach, and in practice it is ruled out, not only on grounds of cost, but because it would delay investment decisions, and undermine potential gains in financial markets where timing is crucial for success. In contrast, fund managers can operate within known parameters that are established by the shariah boards of the institutions in which they are employed. Unfortunately, none of the major specialised fund management providers offer shariah compliant funds, most at present being offered by Islamic banks or conventional banks providing shariah compliant products.
In these cases, it is the shariah boards of the banks that have the responsibility to audit the funds offered, their remit being to approve new product offerings and monitor the operation of existing funds, especially their purchase of equities and other financial assets. This requires different skills and experience however to those needed to audit Islamic banking activities. The task of shariah auditing consists in the authentication of the Islamic products to ensure they are compatible with the traditional contracts used in fiqh jurisprudence.
The Shari'ah basis of Investment funds is not just avoiding alcohol and pork products. Rather, it addresses the very essence of modern corporate finance where capital structure of corporations is examined and standards for equity investment based on both Shari'ah and financial facts are developed. From the above we can understand that conventional fund management and Islamic fund management differ in some ways, eventually both have the same traditional financial goals of capital preservation and capital growth. 4.
Islamic Asset Allocation Many financial experts say that asset allocation is an important factor in determining returns for an investment portfolio. Asset allocation is based on the principle that different assets perform differently in different market and economic conditions. A fundamental justification for asset allocation is the notion that different asset classes offer returns that are not perfectly correlated, hence diversification reduces the overall risk in terms of the variability of returns for a given level of expected return.
This is a description of a simple Islamic asset allocation model, which is how BLME suggest investors to choose between the following four different asset classes: Fixed Income which includes cash, money market instruments, sukuk and some structured fixed income products; Equity which includes listed equities, tracker funds (often referred to as "passive management"), and professionally managed stock selections (often referred to as "active management"); Property which includes individual properties or property portfolios funded with cash, not debt, but which excludes equity investments in listed property companies which fall within equity risk (above); and Alternative Assets which mainly comprise private equity funds, but also include some structured products, agriculture and energy, as well as esoteric asset classes like art. 5. Asset classes and strategies
There are many types of assets that may or may not be included in an asset allocation strategy in Islamic Fund, as in Islamic Funds asset must be Shariah compliant, and the asset is : Cash and cash equivalents. Fixed interest securities such as Bonds short-term, intermediate, long-term or convertible security. Stocks: value, dividend, growth * Commodities: precious metals, broad basket, agriculture, energy, others. * Insurance products ( Takaful- Retakaful product )
There are several types of asset allocation strategies based on investment goals, risk tolerance, time frames and diversification: strategic, tactical, and Insured. Strategic Asset Allocation — In this asset allocation approach, a long term policy asset mix is decided upon and adopted, although does not ean minor adjustment are not made in the short term Tactical Asset Allocation — method in which an investor takes a more active management approach constantly adjusting the asset class mix, attempting to derive incremental returns from changes in capital market conditions.
Insured Asset Allocation — is a reactive asset strategy, known as a constant proportion strategy because the strategy calls for shifts in asset mix as investor wealth and net worth changes have already set in monitor. 6. Sharia compliance of asset classes Shariah compliant asset construction would appear to be different from conventional portfolios due to the nature of the investing. Islamic law identifies business activities as haram when they generate profits in unacceptable ways. Haram business activity include the manufacture or marketing any of this products: alcohol, gambling, riba, pork or pornography, gharar.
Islamic legal scholars use several conventions to determine when a business activity is a core source of revenue when is not. The 5 percent rule says that a core business is one that accounts for more than 5 percent of a company revenue, or gross income. A somewhat less stringent rules sets the standard for a core business at 10 percent. This reasoning applies to the prohibition on riba as well. In Islamic law, riba defined as excess, either in quantity or term, in the counter values whatever is exchanged-currency, commodities, goods. 7 Asset Allocation Issue a. Asset allocation in Shariah compliant portfolio Shariah compliant portfolio construction would appear to be different from conventional portfolios due to the nature of the investing.
Though they may differ in some ways, eventually both have the same traditional financial goals of capital preservation and capital growth. Diversification of specific risk assumes that there are sufficient asset types and sub asset types in the investable universe. Protection against market risk requires products that dampen volatility and limit down? side risk. Portfolio construction is based partly on understanding of how the asset classes performed across various economic cycles, as well how they correlated during market. It is also based on a reasonable expectation of how the asset classes will perform in the future given current knowledge. b. Challenges in Shariah portfolio construction * Limited Prodct Range: where product is available, the trade is crowded.
Innovation is introduced by global conventional banks, which may sometimes not meet strict application of the Shairah law. * Risk management: Lack of sophisticated and effective risk practices, especially in understanding the behavior of asset classes during market stresses. * Operational Inefficiency: systems to monitor performance and analyze portfolios, cost of Shariah board approvals and audits; etc. * Lack of universal Shariah standards: limits the investment universe, causes volatility in the portfolio, lack of hedging in a Shariah compliant form; lack of universally accepted benchmarks. * Innovation: Investment Product innovation has been slow to develop. Mostly focused on structured product or deposit. * Liquidity: Lack of liquidity in secondary markets.