Investing was for several centuries limited to two securities, stocks and bonds. Stocks as we know them first appeared in Amsterdam in 1602. Bonds also made their debut on the world stage in 1602. Both were issued by the Dutch East India Company. Throughout the 20th century stocks and bonds were essentially the only investable asset classes. But, financial market innovation was soon going to transform the world of asset management. (yes, the Dutch East India Company was the first to issue both stocks and bonds in 1602. I have a research paper proving that). But in fact, government securities appeared even earlier. Please check the 3 extracts below. EXTRACT 1. Fernanad Braudel (French historian of the 20th century, who revolutionized the study of his discipline by considering the effects of such outside disciplines as economics, geography etc. on global history) suggests that in Cairo in the 11th century Muslim and Jewish merchants had already set up every form of trade association and had knowledge of every method of credit and payment, disproving the belief that these were invented later by Italians. In 12th century France the courratiers de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers. In late 13th century Bruges commodity traders gathered inside the house of a man called Van der Beurse, and in 1309 they became the &quot;Brugse Beurse&quot;, instituionalizing what had been, until then, an informal meeting. The idea quickly spread around Flanders and neighboring counties and &quot;Beurzen&quot; soon opened in Ghent and Amserdam. In the middle of the 13th century Venetian bankers began to trade in government securities. In 1351 the Venetian government outlawed spreading rumors intended to lower the price of government funds. Bankers in Pisa, Verona, Genoa and Florence also began trading in government securities during the 14th century. This was only possible because these were independent city states not ruled by a duke but a council of influential citizens. The Dutch later started joint stock companies, which let shareholders invest in business ventures and get a share of their profits - or losses. In 1602, the Dutch East India Company issued the first shares on the Amsterdam Stock Exchange. It was the first company to issue stocks and bonds. The Amsterdam Stock Exchange (or Amsterdam Beurs) is also said to have been the first stock exchange to introduce continuous trade in the early 17th century. The Dutch &quot;pioneered short selling, option trading, debt-equity swaps, merchant banking, unit trusts and other speculative instruments, much as we know them&quot; (Murray Sayle, &quot;Japan Goes Dutch&quot;, London Review of Books XXIII.7, April 5, 2001). There are now stock markets in virtually every developed and most developing economies, with the world's biggest markets being in the United States, Canada, China (Hongkong), India, UK, Germany, France and Japan. EXTRACT 2 (from the work &quot;Devil Take the Hindmost&quot; by Edward Chancellor) It was shortly after the establishment of the Dutch East India Company in 1602 when equities began trading on a regular basis. Trading took place at the Amsterdam Bourse, an open aired venue, which was created as a commodity exchange in 1530 and rebuilt in 1608. Commodity exchanges themselves were a relatively recent invention, existing in only a handful of cities. Rather than being a bazaar where goods were traded intermittently, exchanges had the advantage of being a regularly meeting market, which enabled traders to become more specialized and engage in more complicated transactions. As early as the middle of the sixteenth century, people in Amsterdam speculated in grain and, somewhat later, in herring, spices, whale-oil, and even tulips. The Amsterdam Bourse in particular was the place where this kind of business was carried on. This institution as an open-air market in Warmoestreet, later moved for a while to the ‘New Bridge,’ which crosses the Damrak, then flourished in the ‘church square’ near the Oude Kerk until the Amsterdam merchants built their own exchange building in 1611. They created contracts for the future delivery of commodities that were “sometimes even years in advance”. The Bourse was large enough to hold 500 people and was the site of trading of over 300 commodities. Upon issuance of shares in the East India Company in 1602 it was only natural for equities to be traded there as well, with the stockbrokers occupying a section at the edge of the Bourse. According to Bloom, “Marranos from the Spanish Netherlands brought with them a knowledge of exchange technique in the realm of produce which in Amsterdam they employed in money and securities.” Garber remarks that by the 1630s “the Netherlands was a highly commercialized country with well-developed and innovative financial markets and a large population of sophisticated traders.” Amsterdam did have a brokers guild, whose members swore not to trade on their own account, but large numbers of unlicensed brokers conducted business in their midst. The count of all licensed brokers was 300–500 and the number of unlicensed ones was probably twice that. In the mid-eighteenth century there were 100 stockbrokers, which likely is just over the amount in latter half of the seventeenth century. EXTRACT 3. During Roman times, the empire contracted out many of its services to private groups called publicani. Shares in publicani were called &quot;socii&quot; (for large cooperatives) and &quot;particulae&quot; which were analogous to today's Over-The-Counter shares of small companies. Though the records available for this time are sketchy, there is some evidence that a speculation in these shares became increasingly widespread and that perhaps the first ever speculative bubble in &quot;stocks&quot; occurred. The first company to issue shares of stock after the Dark Ages was the Dutch East India Company in 1602. The innovation of joint ownership made a great deal of Europe's economic growth possible following the Middle Ages. The technique of pooling capital to finance the building of ships, for example, made the Netherlands a maritime superpower. Before adoption of the joint-stock corporation, an expensive venture such as the building of a merchant ship could be undertaken only by governments or by very wealthy individuals or families. Economic Historians find the Dutch stock market of the 1600 particularly interesting: there is clear documentation of the use of stock futures, stock options, short selling, the use of credit to purchase shares, a speculative bubble that crashed in 1695, and a change in fashion that unfolded and reverted in time with the market (in this case it was headdresses instead of hemlines). Dr. Edward Stringham also noted that the uses of practices such as short selling continued to occur during this time despite the government passing laws against it. This is unusual because it shows individual parties fulfilling contracts that were not legally enforceable and where the parties involved could incur a loss. Stringham argues that this shows that contracts can be created and enforced without state sanction or, in this case, in spite of laws to the contrary.
Source: US SEC The first mutual fund Massachusetts Investors Trust was founded on March 21, 1924, and, after one year, had 200 shareholders and $392,000 in assets. The entire industry, which included a few closed-end funds, represented less than $10 million in 1924. The fund immediately familiarized the investment world with the concept of pooled assets, asset diversification, and professional management, all in one security for all to purchase.
Source: US SEC The stock market crash of 1929 slowed the growth of mutual funds. In response to the stock market crash, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws require that a fund be registered with the Securities and Exchange Commission (SEC) and provide prospective investors with a prospectus that contains required disclosures about the fund, the securities themselves, and fund manager. The SEC helped draft the Investment Company Act of 1940, which sets forth the guidelines with which all SEC-registered funds today must comply. With renewed confidence in the stock market, mutual funds began to blossom. By the end of the 1960s, there were approximately 270 funds with $48 billion in assets. The first retail index fund, the First Index Investment Trust, was formed in 1976 and headed by John Bogle, who conceptualized many of the key tenets of the industry in his 1951 senior thesis at Princeton University. It is now called the Vanguard 500 Index Fund and is one of the largest mutual funds ever with in excess of $100 billion in assets. One of the largest contributors of mutual fund growth was individual retirement account (IRA) provisions added to the Internal Revenue Code in 1975, allowing individuals (including those already in corporate pension plans) to contribute $2,000 a year. Mutual funds are now popular in employer-sponsored defined contribution retirement plans, IRAs and Roth IRAs. As of April 2006, there are 8,606 mutual funds that belong to the Investment Company Institute (ICI), the national association of investment companies in the United States, with combined assets of $9.207 trillion.
The first bond fund appeared in 1930s (You kill me, but there are no exact dates, I searched all the internet). Traditionally, total market value of all bonds has been 2 or 3 times stocks, with bonds being the favored investment asset by the institutional investment community. Bond funds allowed investors of all kinds—both retail and institutional—to achieve diversification and professional management in any style and kind of bond investing. Today there are over 2000 bond funds in the world. They now cover every imaginable style and asset class within the bond universe: - Corporate bonds - Treasury bonds - Emerging-market bonds - High-yield bonds - Convertible bonds - Mortgage-backed bonds - Asset-backed bonds
And, of course, these bonds have been stripped, separated, and otherwise shred into pieces to create a gigantic universe of hybrid securities: Treasury zeros, mortgage strips, interest swaps, and the never-ending line of collateralized debt obligations, where seemingly there are no limits to the creativity and imagination of financial professionals seeking yet another way to create a unique investment product that fits some niche in professional portfolio allocation.
Financial market innovation serves only one type of client: the asset manager. He or she is charged with responsibly managing a client’s assets. He or she must seek those securities that achieve rational objectives according to Modern Portfolio Theory. Each step of financial market innovation gets us closer to achieving with scientific precision our locus on the Efficient Frontier. Clients deserve no less. Asset managers have no choice but to constantly seek the highest order of efficiency in investing client funds. This is the core responsibility of our industry.
Look at the situation before Sanad. It is best if we start with a review of what Modern Portfolio Theory is all about. Commonly we will all agree that after nearly 6 decades of research, statistical evaluation and professional practice a common form of investing has evolved. This type of investing is applicable to all clients of all nationalities, religious affiliation and geographic location. There is no alternative, there are no substitutes. The one and only form of investing client wealth—whether institutional or individual—is through selecting securities among specific asset categories and assembling them in various ratios. We have today: - Deposits - Bonds - Equities - Alternative Investments A typical Balanced strategy portfolio today may have 5% in deposits, 45% in bonds, 35% in equities, and 15% in alternative investments. Income and Growth strategies would be identical, but with different weightings to achieve lower or higher levels of volatility, risk and reward. Again, I repeat, there is no substitute for this simple allocation. No one anywhere has proven a more efficient allocation of assets. The more than 34 years of studies in attribution analysis, pioneered in 1973 by Frank Russell & Associates and repeated many times since, has proven that asset allocation is the number one contributor of success or failure in asset management. It is no use trying to convince me of alternative methods of investing for any client, anywhere. There are no alternatives. Again, everything boils down to deposits, bonds, equities and alternative investments. Recently we’ve seen the enormous popularity of private equity and real estate. But, we can easily see these two asset classes are simply components of alternative investments. They are not new, and they are not substitutes for traditional allocations. Private equity and real estate must always be invested in prudent amounts, equal to the client’s overall risk and reward profile. Overloading on either can and will prove fatal over time. We’ve also recently seen enormous popularity in structured products. There are even conferences now trying to convince the investment classes that structured products are some form of “new” asset class. This is preposterous. Simply look at the most professionally managed money on the planet: the Harvard University endowment or the State of California Employees Retirement Fund. Does either own structured products? Sorry, not one penny. Until I observe the adoption of structured products by the most sophisticated money managers on earth, they will remain a simple gimmick. There is no place for structured products in modern allocations.
Now, imagine this same responsibility applied to Islamic client accounts. Unfortunately, as we have all too clearly seen, the professional discipline of our industry crumbles. Otherwise rational, trained and professional bankers hide from this responsibility. They come up with a dozen excuses why they do not serve their client’s true interest. Islamic asset management did not exist until we created the Sanad Sukuk Fund. The fund is revolutionary. For the first time in history we have an asset that finally permits us to invest a Muslim’s money according to Modern Portfolio Theory. We achieve with Sanad something that was until today impossible to achieve.
For years this conundrum frustrated me to no end. Many of my clients from Riyadh and Jeddah would ask, “Mr. Sandwick, I want professional portfolio investing but with Sharia compliance.” I always responded the same: “Sorry, we will give you ethical investing, but true Islamic investing is impossible.” The biggest gap was, of course, the lack of any meaningful way to allocate investments into Islamic bonds, or Sukuk. Trading sizes were limited to $5 million or more, supply was short, and the overall definition of Sukuk was seemingly changing. We got excited when Malaysia issued the first Sukuk back in 2000, but realized soon after their fatwa was unacceptable. Plus, structuring was an issue. One fixed-income analyst at SHUAA told me at the roadshow in Dubai that the Sukuk was simply a “ bond dressed in a dishdasha. ”
In choosing Islamic securities we seek the same things we seek in selecting traditional assets: liquidity, transparency, the ability to clear and settle the security in our client accounts, and otherwise a risk-adjusted return probability with high levels of confidence. This is precisely where the Islamic asset management community breaks down. What we see is some of the most highly unprofessional behavior among people who should know better. You know what we get? We get a car that’s been assembled in a village in Bangladesh, using whatever parts are available. Look, a door from a Ferrari. A bumper from a Nissan. A hood from a Chevrolet. Wheels from a Mercedes. The entire mess is an un-drivable, almost unrecognizable piece of random garbage. I regret to tell you that this is what Islamic asset management is all about today. Amazingly no one at any major money center bank, nor any important regional bank, has looked at this sorry situation rationally and developed a truly professional alternative. That is, no one until we did it late last year.
Inertia is our enemy. W have witnessed some appalling behavior among otherwise learned men. Some of the most egregious examples are right here in the Gulf. Heads of Islamic bank asset management departments have said: - We don’t want your Sukuk fund. The yield is too low. Our bank only wants LIBOR + 3.00% fixed-income assets (meaning junk?) - We don’t want your Sukuk fund. Our clients are naïve. They only want private equity and real estate (what is the meaning of “financial advisor”?) - We don’t want your Sukuk fund. Our treasury is already too big. We can simply buy Sukuk ourselves (meaning a static portfolio, always fully allocated?) In other words, while we know our fund is revolutionary, and while we know it is going to be huge, we have hit pockets of resistance that were unimagined when we created Sanad. There are simply too many professionals unwilling to adopt Modern Portfolio Theory in the Islamic space. They simply want to be like water flowing downhill, taking the path of least resistance. But, we have the satisfaction of a slowly increasing fund size, an increasing recognition in the professional community that we’ve achieved something amazing, and the knowledge that we were the first. In closing, I’m proud to have been part of the team that assembled and brought to market the world’s first Sukuk fund. It was sorely needed, and still is the only fund of its kind. Now we can truly say Islamic asset management is a reality, not a dream.
But, fortunately things began to improve. By the spring of 2006 they had improved dramatically. Trading volumes, which had hit about $70 million in 2005, were already at that level by June 2006. Total Sukuk issuance passed $15 billion. New Sukuk trading desks were being announced. The pipeline of new Sukuk looked large indeed. It was during the summer of 2006, after meticulous research and testing of the concept, that we finally pulled the trigger. I committed half a million dollars to the development of the world’s first Sukuk fund. By December 2006 we were ready. A team of highly professional specialists, each responsible for one part or another of the construction of the world’s first Sukuk fund, had assembled what would in my opinion revolutionize the world of Islamic asset management. While our fund was launched in late 2006 it really didn’t go to market until this year. Now we are heavily in the sales cycle, showing the fund to any and all who understand the product. It has proved frustrating in many quarters, in particular among institutional investors who never quite grasped the meaning of Modern Portfolio Theory. Among the enlightened the fund has proved much more successful.
The asset allocation process is meant to create a rational plan for achieving a client’s specific investment goals. Again, this process is the same for individual and institutional clients. And, importantly, the allocation process has no affiliation to religion. It is the same for Muslims and Christians, Jews and Hindus. It is a science, not an art. Only when we arrive at the final step in the allocation process—security selection—do religious matters arise. Here and only here does the professional management of money need to pay attention to religious concerns. Security selection for Islamic portfolios too really has no fundamental difference with security selection for non Muslims. We as asset managers must choose securities that will have a high probability of achieving our investment objectives. We do not lower our standards, we do not change the rules, simply because an asset is Islamic or not.
SANAD SUKUK FUND
SANAD SUKUK FUND a case study for a revolutionary new investment product John A. Sandwick Managing Director Encore Management S.A. Geneva, Switzerland Sukuk World 2007 – The International Islamic Finance Forum 24 – 27 June 2007 Abu Dhabi, United Arab Emirates
How investing began <ul><li>Stock and bond debut at the Amsterdam Bourse in 1602 ( the Dutch East India Company ) </li></ul>Until the mid-20th century stocks and bonds were essentially the only investable asset classes. Then financial market innovation transformed the world of asset management
The birth of the first mutual find <ul><li>New York Stock Exchange as a birthplace of the first mutual fund in 1924 </li></ul>The first mutual fund was Massachusetts Investors Trust , founded 21 March 1924 . A fter one year it had 200 shareholders and $392,000 in assets
Explosive growth of mutual funds in the United States <ul><li>The U.S. stock market crash of 1929: slow-down in the growth of mutual funds </li></ul><ul><li>Securities Act of 1933 and the Securities Exchange Act of 1934, creation of the Securities Exchange Commission: registration requirements </li></ul><ul><li>First bond fund appears, 1930 </li></ul><ul><li>1950s-1960s: Renewed confidence and growth of the stock market. John Bogle creates Vanguard 500 Index Fund, 1976 </li></ul><ul><li>1970s-1980s: IRAs and Roth IRAs as contributors to the mutual fund growth </li></ul>As of April 2006 there are 8,606 mutual funds that belong to the Investment Company Institute, with combined assets of $9.207 trillion
Bond funds multiply…. Bond funds allowed investors of all kinds - both retail and institutional - to achieve diversification and professional management in any style and kind of bond investing <ul><li>:::: Today more than 2,000 </li></ul><ul><ul><li>bond funds </li></ul></ul>:::: Bond universe is huge: - Corporate bonds - Treasury bonds - Emerging-market bonds - High-yield bonds - Convertible bonds - Mortgage-backed bonds - Asset-backed bonds
Human creativity in creating complex securities <ul><li>:::: For the last 25 years bonds have been stripped, separated, and otherwise shred into pieces to create an enormous universe of hybrid securities: treasury zeros, mortgage strips, interest swaps, and the never-ending line of collateralized debt obligations </li></ul>Financial professionals are in constant search for yet another way to create a unique investment product that fits some niche in professional portfolio allocation
The universe of Islamic funds Today Islamic funds are predominantly concentrated on equities. There is so far only one sukuk fund in the market – Sanad Sukuk Fund
The universe of Islamic funds: lack of fixed income (sukuk) funds Ernst & Young: “The supply of Islamic funds is concentrated on equities with substantial gaps across other asset classes”
Asset managers drive financial market innovation <ul><li>Asset manager’s aim is to seek a combination of securities that achieve rational objectives according to Modern Portfolio Theory </li></ul>Asset managers have no choice but to constantly seek the highest order of efficiency in investing client funds
Asset allocation in traditional portfolios <ul><li>Cash allows for opportunistic purchases </li></ul><ul><li>Bonds provide stable, guaranteed returns </li></ul><ul><li>Stocks provide extra yield, but with added volatility </li></ul><ul><li>Alternative Investments provide uncorrelated returns </li></ul>Traditional Balanced Investment Strategy 15% A.I. 35% Stocks 45% Bonds 5% Cash ALLOCATION ASSET
Asset allocation in Islamic portfolios <ul><li>Cash allows for opportunistic purchases </li></ul><ul><li>Bonds provide stable, guaranteed returns </li></ul><ul><li>Stocks provide extra yield, but with added volatility </li></ul><ul><li>Alternative Investments provide uncorrelated returns </li></ul>Islamic Balanced Investment Strategy 15% A.I. 35% Stocks 45% Sukuk 5% Murabaha ALLOCATION ASSET
Islamic asset management and Modern Portfolio Theory <ul><li>A common form of investing has evolved after nearly 6 decades of research, statistical evaluation and professional practice </li></ul><ul><li>MPT’s applies to everyone regardless of nationality, religious affiliation, or geographic location </li></ul><ul><li>There is no difference between asset allocation for Muslims, Christians, Jews, or Hindus except when one arrives at the final step: security selection </li></ul>Income, Balanced and Growth strategies: identical, but with different weightings to achieve lower or higher levels of volatility, risk and reward
Islamic asset management before the Sanad Sukuk Fund <ul><li>Murabaha and equity funds well enough represented in the Islamic space </li></ul><ul><li>Alternative investments are few, but can work around this with structured or specialized products </li></ul><ul><li>Fixed income is the sole major block for true Islamic Asset Management </li></ul>Islamic asset management did not exist until the creation of the Sanad Sukuk Fund 15% A.I. 35% Stocks Nothing available! Empty! 5% Murabaha ALLOCATION ASSET
Islamic bonds as Achilles’ heel in asset allocation process <ul><li>True professional Islamic asset management is impossible without products to fill all asset categories </li></ul><ul><li>Biggest gap: lack of meaningful way to allocate investments into Islamic bonds (sukuk) </li></ul><ul><li>Problems have been large minimum trading size, short supply in the Sukuk market, structuring and fatwa problems (sukuk as simply a “bond dressed in a dishdasha”) </li></ul><ul><li>Result was extreme frustration for professional managers </li></ul>The most challenging opportunity for asset managers is the growing desire for sharia-compliant assets in the Muslim world
Main barriers to sukuk investing Despite growth in sukuk issuances, there are still major barriers to investing
Solution for Islamic asset management 15% A.I. 35% Stocks 45% Sanad Sukuk Fund 5% Murabaha ALLOCATION ASSET
Choosing Islamic securities <ul><li>Avoiding complications and following the same criteria as for traditional securities: </li></ul><ul><ul><li>Liquidity </li></ul></ul><ul><ul><li>Transparency </li></ul></ul><ul><ul><li>Clearing & settlement </li></ul></ul><ul><ul><li>Risk-adjusted return probability </li></ul></ul><ul><ul><li>High levels of confidence </li></ul></ul>
The key benefits of investing in Islamic bond (sukuk) instruments <ul><li>Sukuk are priced competitively in line with conventional bond issues </li></ul><ul><li>Sukuk are sharia-compliant investments </li></ul><ul><li>Sukuk are rated by international ratings agencies </li></ul><ul><li>Sukuk are listed on established international exchanges </li></ul><ul><li>Sukuk are tradable </li></ul><ul><li>Sukuk perfectly fulfil need for fixed-income allocations </li></ul>The most challenging opportunity for asset managers is the growing desire for sharia-compliant assets in the Muslim world
Reef and rocks in Islamic asset management The yield is too low. Our bank only wants LIBOR + 3.00% fixed-income assets Our clients are naïve. They only want private equity and real estate Our treasury is already too big. We can simply buy Sukuk ourselves Common answers from potential sukuk fund buyers (Islamic bank asset management departments): meaning junk? what is the meaning of “financial advisor”? meaning a static portfolio, always fully allocated?
A breakthrough in the Islamic bond (sukuk) market <ul><li>Rise in sukuk issuance in 2006, passing $15 billion </li></ul><ul><li>Launch of the world’s </li></ul><ul><li>first diversified sukuk fund </li></ul><ul><li>(Sanad Sukuk Fund) </li></ul><ul><li>in late 2006 </li></ul><ul><li>Marketing begins 2007 </li></ul>Following a rapid growth in sukuk issuance, we created Sanad Sukuk Fund, which in our opinion revolutionizes the world of Islamic asset management
Growing opportunities in the Islamic bond (sukuk) market <ul><li>More issuers are seeking to enter the sukuk market </li></ul><ul><ul><ul><li>- Sovereigns </li></ul></ul></ul><ul><ul><ul><li>- Corporates </li></ul></ul></ul><ul><ul><ul><li>- Asset-backed and single asset </li></ul></ul></ul><ul><li>Sukuk funds are being created for retail distribution </li></ul><ul><li>Sukuk fund concept is becoming more popular </li></ul><ul><li>Interest increasing from: </li></ul><ul><ul><ul><li>- Central banks </li></ul></ul></ul><ul><ul><ul><li>- State & private pension funds </li></ul></ul></ul><ul><ul><ul><li>- National investment companies </li></ul></ul></ul><ul><ul><ul><li>- Insurance & takaful companies </li></ul></ul></ul>While Sanad is the first sukuk fund, the world will see many more in the coming years
Asset allocation for Islamic portfolios <ul><li>The asset allocation process: a rational plan for achieving a specific investment goal </li></ul><ul><li>Religious aspects of allocation: “it is a science, not an art” (the basic principles are the same for Muslims, Christians and Jews) </li></ul><ul><li>Selection of securities: “God matters” </li></ul>When we choose securities that will have a high probability of achieving investment objectives, we don’t change the rules for Islam
Asset allocation for Muslims & Non-Muslims Test & re-test the selections, adjust according to changing markets & changing client profile Profile client’s income, capital gain and risk needs Select securities in each asset category according to defined rules Map out allocation to meet those needs
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