Conventional asset management combines the tremendous progress made since the 1950s in statistical evaluation of historic security pricing and the quantification of expected risk and reward. Many Nobel prizes were awarded to men who advanced our thinking on how to invest our savings, insuring that we had a high probability of achieving both income and capital gain objectives in a rational, coherent fashion.
Modern Portfolio Theory, or MPT, first advanced by Markowitz in his ground-breaking word in 1955, relies on our intuitive sense that we need moderation and diversification among our investments. In 1970s Tobin advanced this work by introducing the risk-free rate of return (wrongly criticized by some Islamic banking neophytes), and later Sharp gave us tools for more careful evaluation of assets through the Capital Asset Pricing Model (CapM).
MPT is the foundation bedrock of conventional asset management. It calls for the diversification among asset classes—cash, fixed income, stocks and alternative investments—and diversification inside these asset classes. By fine-tuning the allocation over time one can reasonably expect MPT to help achieve one’s investment goals.
There are very good critics, of course, such as Mandelbrot (fractal geometry) and Taleb (Black Swan theory), but no matter how valid these critics may sound they still have not given us any practical substitute for MPT. Professional asset managers, in other words, must still allocate their client money according to the same rules and principles that have been with us now for almost 60 years.
Importantly, just as there is no specialized field of professional practice called “Islamic dentistry,” so too there is no real separate body of work called Islamic asset management. In other words, both conventional and Islamic asset management start and continue in nearly identical processes and share nearly all of the same methodologies.
When clients ask a major global asset management bank to manage their wealth using conventional asset management, they generally get very good service and performance, all things considered. No asset manager at Deutsche Bank or Morgan Stanley or Barclays would ever consider deviating from the universally accepted professional rules of asset management, or MPT. They would be terminated if they placed client money into new or untested theories of investing.
As a result, Christians and Jews and Hindus generally get what they ask for when choosing an asset manager. The performance of conventional asset managers has been extensively studied for almost a generation in what is called attribution analysis, and the results are surprisingly homogenous among all the world’s asset managers. Why? Because they all use the same methodologies to invest client funds, founded on MPT of course.
Unfortunately, when a Muslim walks into a bank and asks for sharia-compliant asset management there is either one of two responses. The first is an honest “no, we don’t offer that service here.” Truthfully, no institution anywhere outside of Malaysia can offer Islamic asset management today. Besides myself and a very small group of other analysts, I have never seen a credible Islamic wealth or asset management service developed anywhere, including from some of the most respected names in global and Islamic banking.
The second response is dishonest. We have witnessed some of the most prestigious banks in the world wrongly claim they have Islamic asset management. In one case I was speaking on Islamic asset management at a large conference in Frankfurt, and had a public debate in front of a large audience with several bankers from a prominent European bank. They publicly claimed their derivative-based structured products (with fatwa) could be combined in such a fashion as to achieve the objectives of MPT. I publicly scolded them for speaking nonsense.