Al-Rajhi Balanced Fund - Case Study Example

Al-Rajhi Balanced Fund Critically analyse the performance of Islamic funds in your chosen country and test whether they outperform the market index of the chosen country. Suggest the reasons for under/outer performance of these funds on the basis of their risk and investment Introduction Islamic funds invest in funds complying with the Shariat laws. These funds have the inherent feature of hedging as they are permitted to invest only in companies with a low debt-equity ratio. Research has highlighted that Islamic equity funds perform better than their global counterpart when the return on the international equity market is negative. As per the Shariah law these Islamic mutual funds are prohibited to invest in certificate of deposit, conventional bonds, preferred stock, warrants and selected derivatives. The proportion of their investment is large in small stocks compared to the larges tocks as the latter has a high risk of generating revenue from the activities that are restricted as per the Shariah laws. Middle East has the highest concentration of such funds and equity is the most preferred asset class. Malaysia and Saudi Arabia account for 23 percent and 19 percent of Islamic funds respectively (Kuwait Awqaf Public Foundation, 2009). Analysis of some major Islamic funds Al-Rajhi Balanced Fund 1- This fund follows the fund-of-funds method in designing its fund structure. Its main aim is to derive capital growth out of the planned investment. It is basically a long term instrument with a nearly 75 percent of the investment in commodity funds and the remaining in the equity funds of Al Rajhi. The fund has the policy of investing primarily in commodity fund and upto a limit of 25 percent in equities. Risk- The risk profile of the fund is medium As investing in shares is very risky due to the volatility in the share markets along with the currency risks this fund maintains a diversified portfolio by investing in different countries and by investing in financially strong companies. In equities the fund is mainly focusing on India and China with just 1 percent in the local equity market. Figure-Allocation of assets Assets Allocation Commodity 75% India & China 6% Global Equity 5% European Equity 5% Global Small Cap 5% GCC Equity Fund 3% Local Share 1% Source: (Gulfbase-a, 2009) In the current year the price of the fund declined at the beginning but it started moving up from the month of March-April. The annual return on the fund is 8.80 percent whereas the return over the three year period is 10.44 percent. Figure- Price movements in the fund Source: (Gulfbase-a, 2009) Comparison of fund with the market index Beta measures the sensitivity of the portfolio returns with the market returns. A portfolio with a high beta is considered to be very risky. Similarly, a portfolio exhibiting a beta of less than one is a defensive portfolio and is considered to be less risky. The above mentioned fund has a beta of 0.09. This means that the fund has a low market risk. This is mainly due to the limited exposure of the fund to the equity markets. This fund has an equity component of nearly 25 percent which again is diversified in many countries including India, China and Europe. Moreover, the annual return of the fund is 8.80 percent as compared to the market return of 2.20 percent (Gulfbase-a, 2009) Figure: Fund Performance over the past five years The volatility of the fund as measured by standard deviation is 1.16 percent which is much less than the market volatility of 10.67 percent. For this reason when the returns in the equity markets declined upto 23 percent in October last year, the fall in the value of the fund was limited to 4.02 percent owing to the low beta and limited equity exposure. All these factors prove that the fund performance is superior to the market index i.e. the fund has outperformed the markets. Al Rajhi Children Fund- This fund is designed to take care of the savings need for the children. The investment in this fund is done based on the long term point of view. It is primarily investing in the commodity funds along with Al Rajhi equity. As this fund follows the fund-of-funds method it can generate good returns in the long term. It invests 15 percent in Al Rajhi commodity funds and the remaining is invested on a monthly basis in equity in Al Rajhi equity funds. It is a medium risk growth fund. Investment Pattern & Risk - As the fund invests a significant amount of money in the equity markets it is exposed to market risks and also to currency risk owing to its global equity portfolio. To counter this Fund management invests has adopted country diversification and invests only in financially strong companies. The fund invests in the European equity markets upto 15 percent and along with this it also invests in the global small cap and global equity markets to the extent of 18 percent and 15 percent respectively. Figure-Allocation of assets Assets Allocation GCC Equity Fund 23% Commodity 20% European Equity 19% Global Small Cap 18% Global Equity 15% Local Share 5% Source: (Gulfbase-b, 2009) The price of the fund has consistently moved up in the current year except for some minor slips as evident from the price graph. Figure- Price movements in the fund Source: (Gulfbase-b, 2009) Comparison of fund with the market index The beta of the fund is 0.31. This is less than one signifying that it is a defensive fund as reason its movement will not be proportionate to the market movements. The low beta makes it a less risky investment. Besides this the volatility in the fund returns is 4.40 percent which is far less than the fluctuations in the market. The annualized return of this fund over the past one year is 29.41 percent (Gulfbase-b, 2009). This is much higher than the market return of 2.20 percent over the five year period. One reason for this is the high return earned by the GCC equity funds with year-to-date performance of nearly 39 percent and this fund allocates the maximum percentage of 23 percent in the GCC equity (Gulfbase-c, 2009) Figure: Fund Performance over the past five years The price line of the fund has remained mostly positive as is evident from the above Price chart. On many occasions when the market fell very sharply the price of the fund did not witness the same amount of fall. This is mainly because of the diversified equity investment of the fund and also because of its low beta. The fund’s annual return of 29.41 percent is nearly thirteen times the market return of 2.20 percent. This shows that the fund has successfully beaten the market mainly because of its diversified investment pattern. Al-Rajhi Balanced Fund 2 This fund has been designed with the objective of generating capital growth by investing in aggressive avenues. Nearly 60 percent of the investment is done in Al Rajhi Equity funds with an investment of only 17 percent in Al Rajhi commodity. Being a medium risk growth fund it is suitable for long term investment. Investment Pattern & Risk- To mitigate the market risk and currency risk because of the high equity exposure the Fund management practices a diversified investment technique by investing in the various global markets including China, India and Europe. India and China together account for nearly 13 percent of the investment corpus. The fund allocates 18 percent of the assets in GCC Equity funds and Global Small Cap accounts for nearly 19 percent of the allocation. Figure-Allocation of assets Assets Allocation Global Small Cap 19% GCC Equity Fund 18% Commodity 17% Global Equity 17% India & China 13% European Equity 13% Local Share 3% Source: (Gulfbase-d, 2009). The price of the fund has moved up without a major fall from the end of the first quarter of 2009 as is evident from the figure. Its beta is 0.28 signifying a defensive investment and low risk. This has been achieved by the countrywide diversified investment technique of the fund spreading across Asia and Europe. Figure- Price movements in the fund Source: (Gulfbase-d, 2009). Comparison of fund with the market index The annualized return of the fund over the past one year is 29.54 percent which is much higher than the market return of 2.20 percent (Gulfbase-d, 2009). This has been achieved by the low risk as measured by the low beta keeping the volatility at 4.31 percent which is roughly half the volatility in the market return of 10.67 percent. Figure: Fund Performance over the past five years The price of the fund has followed a mixed trend of rise and fall with the highest fall occurring in November 2008 of 13 percent when the markets declined by nearly 21 percent. So the fund has been able to beat the market because whenever the markets declined, the fall in the fund was capped at nearly half the fall in the market because of the low beta of 0.28. Also, the annual return of the fund is 29 percent which is much higher than the market return of 2.20 percent. The fund management has been able to achieve this because of its investment technique of countrywide diversification and investment in GCC equity as the latter has managed to perform outstandingly in the last year. As a result of this the fund has outperformed the market index. AlManarah Medium Growth Portfolio- This fund is a medium and growth fund with a medium risk. The investment in the fund is done with a view of capital growth as well as preservation. For this the manager practices diversification of investment across various asset classes. It invests in ‘Sukuk’ (Islamic bonds) and other securities and certificates that are listed in the domestic or the international markets that are permitted by the Shariat law. As it is a medium growth portfolio the equity investment is limited to 55 percent. Investment Pattern and Risk- This fund strikes a balance between Sukuk and/ or Murabah trade which are considered to be less risky and equities which have a potential to generate high returns but with a high risk level. Nearly 31 percent of the assets are allocated towards equities with the Murabaha accounting for nearly 68 percent of the asset allocation. Figure-Allocation of assets Assets Allocation Murabaha 68.6% Equities 31.4% Source: (Gulfbase-e, 2009). The price of the fund started rising from the end of the first quarter of 2009. Although the 9 year return of the fund is negative at 1.70 percent, the fund has managed to give an annual return of 16.48 percent over the last one year (Gulfbase-e, 2009). Figure- Price movements in the fund Source: (Gulfbase-e, 2009). Comparison of fund with the market index The low covariance with the market of 15.01 percent has resulted in a low beta of 0.13. This means that the returns from the funds are relatively stable in comparison to the market. Volatility of the fund returns is also very low at 4.31 percent as compared to the market volatility of 10.67 percent. When the markets recorded the steepest fall of 23 percent last year the returns on the fund fell less than the markets. This is only because of the low beta and the minimal equity exposure of the fund. This is the reason while the markets have recorded a return of 2.20 percent the returns on the index jumped to 16.48 percent over the last year. So the diversified investment technique of the fund together with the high percentage of Murabaha exposure enabled the fund to post positive returns even in the current financial crisis. As a result of all these factors the fund was successful in outperforming the market. Figure: Fund Performance over the past five years The returns on the fund fell by nearly 14 percent in the month of October last year which is the highest fall since its inception. As evident from the figure the returns generated by the fund has been positive throughout except in the trading sessions of last year when the fund recorded its steepest fall but even then the fall in its return was much less than the decline in the market index. Almanarah High Growth Portfolio- This is a growth oriented high risk fund designed to give capital growth from the long term point of view. It invests in the ‘Sukuk’ (Islamic Bonds) along with securities and other certificates complying with the investment principles of Shariah. As it is a high growth fund it can invest upto 80 percent in the equities. Investment Pattern & Risk- As a result of the high equity investment the fund is a highly risk portfolio. But because of a significant amount of investment in Murabaha the fund has been able to give a better performance than the market index. The fund has allocated nearly 52 percent of its assets to the equities which is spread across various countries with Asia accounting for the highest allocation of 26 percent. Figure-Allocation of assets Assets Allocation Equities 52.4% Murabaha 47.6% Source: (Gulfbase-f, 2009). The price of the fund started rising from the current year as is visible from the price chart. However, the high equity component resulted in a negative return of 7.66 percent over the three year period. But, the performance improved in the current year posting an annualized return of 28 percent in the current year (Gulfbase-f, 2009). Figure- Price movements in the fund Source: (Gulfbase-f, 2009). Comparison of fund with the market index The beta of the fund is 0.20 which is less than one signifying less than proportionate fluctuations in the returns in comparison to the market index. The volatility in the returns is 4.17 percent which is less than compared to the variance in the market returns. As a result even when the markets fell by 23 percent in the last year the fall in the fund price was less than the market index. This is mainly because of the diversified nature of the fund and its low market beta due to which the portfolio’s return over the last one year is 28 percent whereas the return on the market index is merely 2.20 percent over the five year period. Figure: Fund Performance over the past five years In January 2008 when the markets fell by nearly 15 percent the returns of the fund declined by only 6.30 percent which is even less than the fall in the market index. This happened mainly because the fund has allocated nearly half its assets to the Murabaha which has a low risk. So, the fund has beaten the market index on account of its countrywide allocation of the assets as well as low variance in returns in comparison to the market index. Al-Rajhi Local Shares Fund- This fund invests in the stocks of Saudi Arabia and is a high risk growth fund. It has been designed for long term investment purpose. It is primarily investing in stocks that are allowed as per the Shariat laws and does not include banking stocks. Investment Pattern & Risk- As it is only investing in the domestic markets it is subject to high levels of risk. In order to minimize the risk the fund manager has invested in varying sectors like cement, telecommunication, services etc. by doing this the fund manager has been able to achieve diversification across various sectors. Figure-Allocation of assets Industries 73% Cement 9% Telecommunication 8% Services 8% Banking 2% Source: (Gulfbase-g, 2009). Comparison with the market- The beta of the fund is close to one at 0.95. This means that the fund moves almost in proportion to the markets. The volatility of the funds also matches the market variance at 9.80 percent. All this shows that the fund is highly risky. The beta of 0.95 indicates that the fund has a high covariance with the market. While the markets return is 2.20 percent over the last five years the fund has maintained a positive annual return of 27.58 percent (Gulfbase-g, 2009). This is mainly due to the sector wise diversification technique adopted by the fund manager. As the asset is allocated between cement, telecommunication and service industry all of which are not interrelated i.e. a news that is not favourable to one sector may be favourable to another sector thus compensating the loss that may arise from the fall of the affected sector. This explains the reason for the sharp difference in the returns between the fund and the index. Figure: Fund Performance over the past five years The returns from the fund are very volatile as is visible from the above figure. As the equity exposure is high the fund returns have been mixed with uptrend and downtrends. Even in the current year when the performance of most of the funds has picked up the fund’s return has been negative. In February last year when the markets declined by nearly 8 percent the fall in the fund was limited to -0.76 percent. This is only because of the industry wise diversification technique adopted by the manager. As a result of this technique the fund has outperformed the market in terms of returns. The cross investing of assets has helped the fund tremendously such that despite of the high volatility it has succeeded in beating the markets. Conclusion The analysis shows that the performance of the Islamic funds is better when compared with the market index. Most of the funds have maintained a low beta which explains the low risk component of the fund. The risk arising due to the exposure to equity has also been minimized to a great extent by investing in assets with a low risk such as Mubaraha. Besides this the country wise allocation of funds has resulted in an effective diversification thus protecting the fund from any county specific risk. Many funds have invested heavily in the Asian markets like China and India which have been less affected from the current financial turmoil than their western counterpart (Dooley, Hutchison, 2009). All these factors explain the superior performance of the funds in comparison to the index. References Kuwait Awqaf Public Foundation. 2009. Islamic funds growth stalls but investable assets grow, says Ernst & Young. Home. Available at: http://www.awqaf.org/waqfic/NewsDetails.asp?Id=287&lang=en [Accessed on November 26, 2009]. Gulfbase-a. 2009. Fund Facts. Al-Rajhi Balanced Fund 1. Available at: http://www.gulfbase.com/site/interface/Fund/Free/Fund.aspx?FundID=102&Mid=78 [Accessed on November 26, 2009]. Gulfbase-b. 2009. Fund Facts. Children Fund. Available at: http://www.gulfbase.com/site/interface/Fund/Free/Fund.aspx?FundID=106&Mid=78 [Accessed on November 26, 2009]. Gulfbase-c. 2009. Saudi Gazette. GCC equity funds continue upward trend, says report. Available at: http://www.gulfbase.com/site/interface/NewsArchiveDetails.aspx?n=116468 [Accessed on November 26, 2009]. Gulfbase-d. 2009. Fund Facts. Al-Rajhi Balanced Fund 2. Available at: http://www.gulfbase.com/site/interface/Fund/Free/Fund.aspx?FundID=103&Mid=78 [Accessed on November 26, 2009]. Gulfbase-e, 2009. Fund Facts. Almanarah Medium Growth Portfolio. Available at: http://www.gulfbase.com/site/interface/Fund/Free/Fund.aspx?FundID=232&Mid=452 [Accessed on November 26, 2009]. Gulfbase-f. 2009. Fund Facts. Almanarah High Growth Portfolio. Available at: http://www.gulfbase.com/site/interface/Fund/Free/Fund.aspx?FundID=231&Mid=452 [Accessed on November 26, 2009]. Gulfbase-g. 2009. Fund Facts. Al-Rajhi Local Shares Fund. Available at: http://www.gulfbase.com/site/interface/Fund/Free/Fund.aspx?FundID=104&Mid=78 [Accessed on November 26, 2009]. Dooley, M. Hutchison, M. 2009. Transmission of the u.s. Subprime crisis to emerging markets: Evidence on the decoupling-recoupling hypothesis. Available at: http://papers.nber.org/papers/w15120.pdf [Accessed on November 26, 2009]. Annexures- Returns on the market- Sep-04 5.949563 Oct-04 10.61199 Nov-04 12.71692 Dec-04 -0.50081 Jan-05 0.40302 Feb-05 8.046406 Mar-05 14.15309 Apr-05 9.600803 May-05 12.24685 Jun-05 8.484558 Jul-05 -1.86089 Aug-05 9.523278 Sep-05 1.017751 Oct-05 5.401262 Nov-05 8.362728 Dec-05 1.775616 Jan-06 12.88468 Feb-06 3.245179 Mar-06 -8.79182 Apr-06 -22.4577 May-06 -17.1044 Jun-06 12.80495 Jul-06 -19.6753 Aug-06 4.222637 Sep-06 -0.32662 Oct-06 -15.0975 Nov-06 -11.1916 Dec-06 -4.19845 Jan-07 -13.3593 Feb-07 17.13315 Mar-07 -7.6351 Apr-07 -2.42022 May-07 -1.81112 Jun-07 -6.93789 Jul-07 6.868217 Aug-07 7.445336 Sep-07 -1.16732 Oct-07 7.731872 Nov-07 12.15292 Dec-07 15.3707 Jan-08 -15.3528 Feb-08 5.406893 Mar-08 -6.42306 Apr-08 11.77903 May-08 -10.4075 Jun-08 -1.16974 Jul-08 -6.42076 Aug-08 0.503727 Sep-08 -15.6268 Oct-08 -23.6181 Nov-08 -21.5374 Dec-08 0.181827 Jan-09 -1.6906 Feb-09 -8.41895 Mar-09 10.51983 Apr-09 18.40605 May-09 6.439329 Jun-09 -7.2213 Jul-09 4.869132 Aug-09 -2.79645 Read More