Robert Hegt: Good morning and good afternoon. I'm Robert Hegt, a member of Ashmore's Client team. Welcome to everyone and thank you for joining today's Ashmore webinar titled 'Shariah Investing in Emerging Markets: Sukuk and Equities'. 

Today we are joined by Mohammed Al Alwan, Fernando Assad and Adrian Petreanu. Mohammed is Head of Equities for Ashmore Investment Saudi Arabia and manages both Shariah and conventional Saudi equity portfolios. He has 21 years' investment experience and joined Ashmore in 2021. Fernando is Head of the Global EM Active Equity Strategy, which has also applied to quote both Shariah and conventional equity portfolios. He has 26 years of experience of which 18, with Ashmore. Adrian is a Portfolio Manager in Ashmore's Global EM Corporate Debt team, managing dedicated EM Sukuk portfolios as well as conventional corporate bond portfolios. He has 28 years of investment experience and joined Ashmore in 2013. 

So, let's start with equities. Mohammed, first for you. Given the financial ratios and prohibited industry restrictions, is the Shariah EM universe in Saudi Arabia diverse enough for you?

Mohammed Al Alwan: Hi Robert. Thanks for having me. Yes, it is. Actually, if you look for the index composition between Shariah and non-Shariah, they exhibit the same kind of industry exposure and even index concentration of names within each respective universe. However, what we have noticed historically is that the Shariah strategy in Saudi specifically has been outperforming the non-Shariah strategy, even on a passive basis due to the sector exposure within conventional banks. Shariah banks have been outperforming the non-Shariah banks and because the space within Shariah names is limited, especially for mega large cap where there are no substitutes, they exhibit a  premium valuation historically versus conventional names.

Robert Hegt: Thank you. Fernando, if you look at the global universe, how does that look between Shariah and conventional strategies?

Fernando Assad: If we start from the passive point of view, the MSCI EM unconstrained index has about 1,200 stocks, there are 400 stocks in the MSCI EM Islamic index, and overall, our universe is vast, it's bigger than the indices itself. There are about 8,000 stocks in the Ideal-Ratings Shariah compliance universe. From a sector perspective, the sectors are pretty broad. It's exposed to all the 11 sectors in the unconstrained version. You get fewer financials, fewer media names given the industry restrictions, but more tech and more materials in the Shariah world, and in terms of countries, around 20 of the 24 countries at the moment are represented. So, pretty broad and within our active managed strategy, pretty broad as well. We have over 10 countries and nine sectors invested at the moment.

Robert Hegt: Thank you. Now Adrian, we've been talking about equities. How is it in your world in Sukuk relative to bonds? What is our participation in the Shariah debt markets and how does that universe look?

Adrian Petreanu: Thank you, Robert, and again, thank you for having me here. Yes, it's a good question. People underestimate the length of the involvement of EM investors in the Shariah space. I can recall the first Sukuk coming to the market back in 2001 when it was the first corporate coming out of Indonesia, and then quickly followed by the first sovereign coming out of Malaysia with a benchmark deal in 2002. 

Subsequent to that, for a number of years, the Sukuk was not part of the broad EM indices, but as liquidity has grown, in October 2016, JP Morgan followed index committee consultations – and we are a member of the index committee – it was decided that actually Sukuk should be part of the JP Morgan indices, both the MB index and the CEMBI for corporates and the GBI-EM. And the rest is history. Since they became part of the index, we are now at about just under 7% in terms of weight of international Sukuk. The dollar-denominated Sukuk as part of the indices has seen liquidity increase tremendously. We're talking about a market of about $100bn and we are very active in this. We like the fact that this market is very well supported by local pools of capital, and that it exhibits better risk-adjusted returns, especially in downturns, it tends to outperform. There's very, very sticky money in this space. So, we like these instruments both for Shariah-specific strategies but also for our broader portfolios. We do run an overweight in Sukuk versus the index.

Robert Hegt: I was going to stay with you there Adrian, because you made an interesting point on risk return. So, emerging markets from time to time can be volatile, they can have turbulent times. How do Sukuks typically perform in those types of turbulent times relative to conventional bonds?

Adrian Petreanu: It is a good question. Sukuk tends to outperform in downturns in the market and underperform in strong markets, first because of a better average quality. We have over 70% of these which are investment grade, which is slightly more than the weighting of investment grade in the broad index. Credit rating wise, it's also better, but most importantly I would say is the strong and growing local demand for these instruments, and very strong support in new issuance. We tend to see when new issues come to the market, these deals being several times oversubscribed – more than what you see in the normal bonds. And we don't have what we call that much ‘ tourist money’, crossover investors, people that come tactically in these instruments and then they might decide to trade out it. It's very sticky money in the Sukuk space, which gives them this ability to deliver better a sharp ratio over the cycle. But really, they do best in a down market when they really outperform.

Robert Hegt: Thank you. Switching back to equities then, Fernando, when you look at your conventional and your Shariah portfolios, do they achieve similar returns and similar characteristics, or are they quite different?

Fernando Assad: I think if we think about over the long run, say 10 years, they achieve pretty similar returns and volatility. The last 10 years has seen around a 6.5% annualised return for the Shariah universe, 7.4% for the unconstrained, so give-or-take 7% for both. Volatility is also similar, the Shariah 16%, the unconstrained 16.6%. 

What you tend to see is because of the lack of financials and the financial ratios that remove some of the higher leveraged companies in emerging markets (EM), it tends to have a little bit less cyclicality but not too significant. And then it really depends on the key macro reasons for an upturn or a downturn in the markets to see which one is going to outperform in the short run.

Robert Hegt: Thank you. And if you apply that in Saudi Arabia, Mohammed, what does it look like there in terms of returns and characteristics of the portfolios?

Mohammed Al Alwan: Yes, so it depends on the timeframe. If we look for example, for the last 15 years, Shariah passive indices have outperformed the conventional one by 55%. If you go for the last 10 years, it has outperformed by 7% and mostly because of materials, which represent a bigger part of the Shariah space, has been not doing very well, mostly the chemical sectors. But if you go less than 10 years, they are pretty much in line in terms of return characteristics. And in terms of volatility, pretty much they are close to each other as well.

Robert Hegt: Interesting. So, if you start looking in depth into your equity portfolios, do you see any sort of particularly differences between your conventional and your Shariah equity portfolios? Be it in sector exposure or in other characteristics like valuations? Mohammed, starting with you.

Mohammed Al Alwan: Yes, so there are differences not in terms of sector exposure, but in terms of dispersion of valuation within sectors and more specifically within the banking sector, since banking represent like almost 45% from the index. What we have seen historically is that Shariah banks demand a premium valuation versus conventional banks. And this has been going on for the last 20+ years. So, this explains part of the outperformance of the Shariah indices and periods where banking stocks do very well. Usually, Shariah banks have been delivering better return versus their conventional peers. I think the reason is if you are conventional, pretty much all the names within the banking sectors are perfect substitutes, but if you're Shariah, the substitute becomes very limited. So, this results into names that are bigger and the index demanding a higher premium,  even if they trade at similar valuation to the conventional counterparts.

Robert Hegt: Thank you. How is that in a global portfolio, Fernando? What are the differences in sector weightings and characteristics?

Fernando Assad: Yes, so in terms of overall, it’s a similar picture as Mohammed just explained: fewer financials for the universe, and for the active equity Islamic portfolio as well. Then if you go into the rest of the universe, what ends up happening given the restrictions is you end up with an index with more India and more Korea, and less China and less Brazil. India and China in particular drives a lot of the relative performance versus the unconstrained. For us, in terms of the portfolios there are lots of similarities. It's pretty much the same active weights on a country basis, and the same active weights on an industry and sector basis because we can find the compelling stocks, even with the financial ratio restrictions, with the exception of the banks, there are lots of compelling banks in the unconstrained universe that don't make the cut here, but over the last few years you tend to be able to supplement with some other compelling domestic opportunities, be it in the consumption space, or the industrials space. Tech in general has been a compelling area for our portfolios across the board, constrained and unconstrained. So, we have had plenty of choice there and plenty of opportunity to have the same active weights as well.

Robert Hegt: Thank you. Adrian, you manage dedicated Sukuk portfolios, but do Sukuk also have a place in a conventional bonds portfolio? Do you use them there as well?

Adrian Petreanu: Yes, absolutely. I mean as I mentioned before, they tend to offer a more defensive position, so it's actually quite good as part of the defensive part of the portfolio, but also maybe surprisingly it adds liquidity to the portfolio. These markets are actually very liquid and on average we see bigger sizes in Sukuk bonds also because it's a slightly smaller universe compared to the broad universe. But for example, the average size of a conventional corporate bond is $300m. The average size for an international Sukuk dollar bond is $350m. So you have slightly higher size and, as I mentioned before, you have better credit quality, it's more investment grade names and the bid-ask spread tends to be tighter because there's a lot of competition, especially in the Middle East where you have both international banks and local banks quite actively market-making in those instruments. You tend to see about 5%-10% tighter bid-ask spreads in these instruments. Now, better liquidity together with a better sharp ratio makes this quite an attractive instrument type to have, even in a non-dedicated Shariah portfolio.

Robert Hegt: Okay, thank you. So, I received a question here on investment process and I'm going to ask these to all three of you, maybe starting with Fernando. Fernando, is there any way in which you have to modify your investment process when managing Sharia portfolios compared to conventional portfolios?

Fernando Assad: Yes, lucky, or maybe in terms of the availability of resources here at Ashmore, we don't need to change our investment process given the Shariah universe and Shariah restrictions. It's the same process; it's just tailored to the Shariah universe. It's top-down macro driven, like the unconstrained strategy. It's highly active as the name of the strategy suggests. 

And in very much a structured process, the key difference that you have in terms of characteristics of the universes, unconstrained and Shariah, given the MSCI EM indices is the much higher turnover in the Shariah indices. To give you a flavour, over the last 12 months, the Shariah universe turnover was around 42%. So that’s almost 50% of the index that has changed, while it's only sub-5% for the unconstrained. I think that for most investors out there, this turnover level presents a challenge because, if you say you've a three to five-year time horizon and you buy something and just leave it there, from a bottom-up perspective, it becomes quite hard if the whole index in the universe changes that significantly. 

For the active equity strategy, which we started the unconstrained strategy in 2011, we created that strategy to handle high liquidity needs, to handle high volatility periods, macro and micro driven, and to take advantage of Ashmore's macro excellence. So, it has fitted very well, we believe, within that high turnover of the Shariah context, and we have been managing the strategy since 2020 with quite good results. We have had separate portfolio segregated accounts for over 10 years, some with Shariah restrictions as well. So, we are well-versed in dealing with the different dynamics of the Shariah universe.

Robert Hegt: Thank you, Fernando, you're selling yourself short. Your team have achieved amazing results in Shariah portfolios, but anyway, thanks for that answer. Mohammed, how is it with you? Do you have to modify your process when managing Sharia-compliant portfolios?

Mohammed Al Alwan: No, not at all. It's very much similar to what Fernando mentioned. We pretty much follow the same investment philosophy and the process in the Shariah strategy versus the conventional strategy. Maybe the differences would be since we are benchmark agnostic as a manager, whether on a Shariah or conventional, sometimes we run a much higher tracking error in the Shariah strategy because the index concentration is much more than a conventional strategy. But in terms of investment process and philosophy, we pretty much follow the same.

Robert Hegt: Thank you and Adrian, on your end in Sukuk?

Adrian Petreanu: Yes, I concur with Fernando and Mohammed. I mean, just as an addition to what was said before, I would mention that the credit analysis and the discussion of both sovereign and corporate Sukuk takes place in the same investment committee where we discuss non-Sukuk instruments. So, we are agnostic of the nature of the instruments when we discuss the credit profile. And as a matter of fact, in quite a number of both countries and corporates, you have the situation where you have Sukuk alongside normal bonds. So, our credit view is done independent of the instrument and it's basically the same process.

Robert Hegt: I received a question for Fernando. Fernando, what factors do you think are going to make EM Shariah active equity more interesting for investors to consider compared with developed markets which are heavily invested in US markets in particular?

Fernando Assad: Yes, so I think not too dissimilar than the unconstrained universe, where what you have at the moment in EM is the tailwind of the US dollar currency weakness and strength in a number of EM currencies. So that's similar and very compelling. 

The valuations are significantly different. If you look at industry-by-industry, particularly in tech, you have the same exact drivers. Sometimes companies are producing and selling into the same exact countries at 50%-plus discounts in terms of valuations. So: same drivers, same earnings directions in tech, particularly artificial intelligence (AI)-driven, just a lot more compelling on the valuation. So, much higher room for performance from here. 

And again, it is the diversity of the universe that makes it increasingly compelling. What we don't have in the EM universe is corporates and countries as much as in developed markets that are trading at a significant valuation premium versus history. They are undergoing a number of political challenges in places like developed Asia and developed Europe as well. But at least within the EM space, look at the Koreas, Taiwan, China, South Africa, and Brazil, the challenges that they have seem to be well understood and well-priced. And on the other side you have significant earnings upward trajectory that you may not have in developed markets in the coming years.

Robert Hegt: Indeed, it's very comprehensive. Well, we've run slightly over the 25 minutes I wanted to do for this. We haven't answered all the questions, but we will follow up after the webinar. Fernando, Adrian, Mohammed, thank you for your time today. I really appreciate you taking time out of a busy schedule. To all attending, again, thank you for joining today's Ashmore webinar. If you have any questions or would like any follow up information, please contact your Ashmore representative. And as I said, any questions we didn't answer, we will come back to you. This concludes today's webinar. Thank you very much. Until next time.