Fintech plays plow forward in Southeast Asia as robo-advisor technology emerges as an important trend in Shariah-compliant investments – especially in Malaysia
As the fintech space continues to transform Southeast Asia, robo-advisor technology is emerging as a unique trend in Shariah-compliant investments. This is especially true in Malaysia, where artificial intelligence (AI) could endanger fund managers’ jobs while introducing new investment options to stakeholders.
Robo-advisors are algorithm-based products designed to manage asset portfolios by matching individual risk appetites against stock indexes. They’ve been around for years, but have yet to truly penetrate the global Islamic fund and wealth management market, whose assets under management (AuM) at the end of the first quarter of 2017 stood at $70.8 billion, according to estimates by the Malaysia Islamic Financial Centre and Thomson Reuters.
Shariah-compliant robo-advisors emerged in Malaysia in mid-2016, said Natasha Ishak, manager of banking and financial services at recruitment agency Hays Malaysia. Ishak works closely with the country’s banking industry executives, and her work includes research into the potential disruptions that technology will bring to the sector. She estimates Malaysia will likely see a surge in robo-advisor activity within the next three years.
“Right now robo-advisors are still mainly being used for high-frequency trading, so it’s not as developed as it could be,” Ishak told Salaam Gateway. “If we look at Malaysia itself, in terms of the infrastructure and the algorithms they’re plugging into the robo-advisors, it’s not as sophisticated as I’m sure it will be ten years from now.”
Robo-advisors can potentially shake up the wealth management industry in Malaysia by offering cheaper and more efficient options to a segment that has historically not had much access to investment advice.
Malaysia is in a unique position when it comes to robo-advice due to its leading position in Islamic finance and its Muslim-majority population of middle-income earners.
Islamic finance has an established presence and is highly visible on Malaysia’s financial landscape. The country has the highest number of Islamic funds in the world, totalling 328 in 2016, with assets under management (AuM) of 149.64 billion Malaysian ringgit ($34.9 billion), equivalent to 21.49 percent of total AuM, according to Malaysia’s Securities Commission. The nation’s Islamic funds AuM is second only to Saudi Arabia. The size of the nation’s Islamic capital market was 1.7 trillion ringgit in 2016.
Policy-wise, Malaysia’s government released its five-year Islamic Fund and Wealth Management blueprint in January this year that sets out strategy to position the country as a global hub for Islamic funds, establish it as a regional centre for Shariah-compliant sustainable and responsible investment (SRI), and develop it as an international provider of Islamic wealth management services. At the same time, the country’s securities regulator and central bank are working to hash out regulations for fintech companies looking to establish themselves through a sandbox initiative, which is currently underway.
‘AN EFFICIENT ALTERNATIVE’
New York-based Wahed Invest, the world’s first Shariah-compliant robo-advisor, was built on the theory that the biggest value-add of the tech is its ability to be hyper efficient without compromising on ethics. “We built this to provide an efficient alternative, and to prove that there does not have to be a cost to being Muslim,” the company’s CEO Junaid Wahedna told Salaam Gateway.
Wahedna points to excessive charges imposed on clients, particularly those who choose to invest in line with Shariah. Costs such as custody fees, management fees and brokerage fees can come up to a whopping 3 percent of the total investment, and are opposed to Islamic laws with relation to interest rates. For players like Wahedna, these elements are seen as impediments to efficiency, resulting in an industry that lags 20 years behind its conventional counterpart.
“The whole process is inefficient; people are paying up to 3 percent in fees just for investing in a halal way,” he explains. “No active manager can beat the market consistently after its fees are taken into account, and studies and math show that.”
According to PricewaterhouseCoopers (PwC) 2016 Global Fintech report, robo-advisors come into play by introducing “more transparent, traceable, efficient and customer-centric standards along the overall value chain” by delivering “easier, faster and more user-friendly investment based solutions.”
Wahedna says his company’s robo-advisors reduced the inefficiencies in the market by cutting out ‘middleman fat,’ while also charging a single “wrap fee” capped at 0.99 percent of the total transaction.
“You’ve got too many people with their hands out,” Stuart Yeomans, CEO of Malaysia-based Farringdon Group told Salaam Gateway. Farringdon owns Asia’s first robo-advisor named Algebra. To Yeomans, middlemen aren’t just wealth managers, but include the lawyers, sales teams and strategies that bloat costs and weaken supply chains.
“For us, being efficient and ethical is a premise, regardless of whether it slows us down or we don’t make as much money,” adds Wahedna. “I feel that’s really the point of Islamic finance – you have to put the ‘Islamic’ before the ‘finance’ because it’s quite an oxymoron otherwise.”
ACCESSING A NEW MARKET
The introduction of robo-advisors may very well open up key markets for the Islamic wealth management industry via competitive pricing and the promise of Shariah compliance, which is a tricky process even for seasoned wealth managers who usually only get certified once per year.
Shariah-compliant robo-advisors come with the assurance that all portfolio plays have been thoroughly vetted and cleared as permissible. Negative screening approves of stocks that meet the thresholds for non-permissible income, debt, and investments, and do not engage in certain business activities such as gambling, adult entertainment, pork, alcohol, tobacco, or firearms. Wahed Invest is signed off by U.S.-based Straightaway Ethical Advisory and Farringdon by Malaysia-headquartered Amanie Advisors.
The Muslim market also intersects with the growing global middle class that has largely been excluded from the investment market. According to Hay’s Ishak, middle-income earners are currently a target market for financial institutions as they make up the majority of Malaysia’s Muslim population, and are largely uninvolved in investing.
“Lower income people tend to do their own research and trade themselves, while higher income earners will have their own wealth advisors and fund managers,” she said.
Wahedna pointed out that the majority of Muslims live in the developing world, and many of them don’t possess the capital necessary to qualify for wealth managers’ services. Robo-advisors will likely be most beneficial for investors coming from this segment of the population as they do not discriminate between the assets of a middle-income earner and a high-net-worth individual.
“Even if you only have $100, your expected return capital is the same as someone with $10 million,” says Wahedna. “It’s bringing democracy to your investing.”
The biggest losers of the rise of robo-advisors will be traditional wealth managers and advisors, who will have to compete to stay relevant amidst a technology revolution. Ishak pointed out that robo-advisors are dominating more than 80 percent of daily traded stock in mature markets. Wealth managers will likely lose out in the retail sector, which is where robo-advisors will make the biggest impact.
The cheap AI version will easily claim 50 percent of that lower segment of the investment spectrum in the next decade, said Yeomans.
However, wealth managers won’t face serious competition for their high-net-worth clients, who prize a personalized experience over cost. Yeomans said it is highly unlikely we will see millions being invested via a robo-advisor, and in fact, Farringdon core traditional wealth advisory business is subsidizing the tech. He added that Farringdon maintains its traditional services to cater to its high-net-worth clients with more complex portfolios and bigger risk appetites.
PwC’s report suggests that certain high-net-worth clients might not see robo advice as adding value, as they will not be able to handle the more complex aspects of their portfolios.
“If we were to look at funds that are a lot bigger in size, where the risk appetite is higher, you can’t really take out the fund managers and financial advisors completely because the risk exposure and compliance aspect of things are not going to be covered,” said Ishak.
($1 = 4.2820 Malaysian Ringgit)
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