This article by CEO Kurt Lieberman originally appeared in Finance Forward, October 12, 2015.
Most discussions of Islamic Finance focus on substitutes for debt and overcoming the prohibition on riba. When Islamic Finance discussions turn to equities, the focus is usually on Shariah compliance of individual companies and investment products built on portfolios of Shariah-compliant companies. An important financial discussion not being held is about leadership by Islamic countries.
Currently there are six countries within the emerging markets where a majority of citizens are Muslim: Egypt, Indonesia, Malaysia, Qatar, Turkey, and United Arab Emirates. Can one or more of these countries become a clear leader in the world? Upon examining the data, the question is not whether, but when.
Two sets of data are very enlightening when doing the examination. The first involves the relative performance of the equity markets in the countries of the emerging and developed markets. The second contains the widely-accepted economic concepts on the role of countries on company valuations. The legal and regulatory system of a country, along with its economic infrastructure, create an environment for corporate governance that is used by the companies within the country. Magni Country Scores measure the respective country’s environment for effective corporate governance. Portfolios built on these scores have outperformed relevant benchmarks over extended periods.
As a group, the long-term performance of the six Islamic countries has been slightly better than the ACWI ex-US benchmark. This strong performance is probably surprising to many investors and deserves greater attention.
An equally weighted portfolio of MSCI Egypt GR USD, MSCI Indonesia GR USD, MSCI Malaysia GR USD, MSCI Qatar GR USD, MSCI Turkey GR USD and MSCI UAE GR USD compared to MSCI ACWI ex-US for five and ten year periods ending 6/30/15 respectively showed outperformance of 54 and 75 bps per year. ACWI ex-US comprises 45 countries which represent all of the countries in the emerging and developed markets with the exception of the United States.
Even more surprising is that this performance occurred despite the six countries having material weaknesses in their respective environments for corporate governance. Specifically, all of them have below average Magni Country Scores when compared against the 45 countries in the same international benchmark. Only Indonesia and Malaysia score higher than the average for the countries in the emerging markets.
Looking forward there is good news. Over the past year these six countries improved their environments for corporate governance faster than the other major countries in the world. Should the relatively faster pace of improvement continue, the Islamic countries will improve their ranking and probably begin to be recognized as leaders among the countries in the emerging markets. Further, one of these countries could soon overtake Ireland which is currently the lowest ranked country in the developed markets.
The six countries share some common strengths and weaknesses in their environments for effective corporate governance. The financial statements of public companies in these countries have similar reliability and accuracy in representing the actual operating performance when compared to other countries. Further, some key shareholder property rights are protected as well as these same rights are protected in other countries. Such rights are established and enforced by the laws and regulations related to corporate legal entities.
At the same time, the countries have some common opportunities to improve their environment for corporate governance and hence to improve their Magni Country Scores. Strengthening financial systems are important as they help reassure investors that their property rights to future profits are protected from corruption. Increasing governmental transparency, especially related to monetary and fiscal policy, would reduce uncertainty and enable businesses to invest capital more confidently (i.e., reduced risk discount applied to investment proposals). Egypt, Qatar, and the United Arab Emirates could also improve the accuracy and completeness of economic and other information published by their respective governments. Collectively, such improvements would have meaningful impact on each country’s ranking.
Fortunately, these improvements are consistent with Islamic values. Strengthening banking regulations and payment systems increase Amanah (trust) in the financial system. Increasing governmental transparency increases Adl (justice) and reduces the potential for transactions involving Gharar (“deceptive uncertainty”) as parties to transactions are dealing with comparable, accurate information. By the end of this current decade, the world may be talking about one or more Islamic countries as leader(s) among the countries of the emerging markets.