SYDNEY (Reuters) – Islamic exchange-traded funds (ETFs) are struggling to attract fresh investors, in contrast to a move by Western investors into conventional ETFs – a difference due to the Gulf’s plain-vanilla investment culture and the way in which institutions choose financial products.

ETFs are funds which track indexes of shares, bonds or commodities and are traded like stocks. Their sharia-compliant versions follow religious principles such as bans on interest and gambling.

Since demand for some other Islamic financial products such as sukuk is surging, it might seem reasonable to expect rapid growth in Islamic ETFs, especially since the slump in Gulf and global stock markets is hurting traditional stock-picking equities investment.

Conventional investors moved $111.7 billion into equity exchange-traded products worldwide and $172.4 billion out of equity mutual funds last year, a report by global investment manager BlackRock showed.

Conventional fixed income exchange-traded products saw record-breaking inflows of $25.5 billion in the January-April period and $49.9 billion last year, according to BlackRock.

But amounts of fresh money committed to Islamic ETFs have stayed steady or even dropped. The trend can be seen in products launched in 2007 by iShares, the world’s largest ETF provider.

Combined assets in iShares’ three Islamic ETFs stood at $95.8 million on June 25, representing modest growth from $82.9 million at inception, iShares data showed. That was a 42 percent drop from the all-time high of $164.5 million hit last September.

Others have had less success in raising capital: BNP Paribas launched its Islamic ETF in 2007 and had only $27.5 million in assets as of this month. Deutsche Bank launched its own offering in 2008 and had $8.9 million in assets as of June.

One attraction of ETFs is that they can provide investors with access to themes that have a low correlation with equities markets. But Islamic ETFs focused on asset classes other than equities have yet to appear, even though major index providers offer large families of sharia-compliant indexes.

Investor interest in multiple Islamic investment themes exists, said Tariq Al Rifai, director of Islamic market indexes for S&P Dow Jones Indices, but it has not so far translated into ETF launches. “Our sukuk index is very popular, but products remain manager-driven.”

FINANCIAL PLANNING

For the foreseeable future, growth of Islamic ETFs is likely to depend mainly on the cash-rich Gulf. But the structure of the region’s financial industry is not helpful.

In the United States and Europe, many ETFs are sold by individual financial planners, who do not make money based on the cost of the products which their clients buy. The planners have no compunction in introducing clients to ETFs, and many clients are drawn by ETFs’ low costs. The ETF from BNP Paribas, for example, charges a management fee of just 0.50 percent.

In the Gulf, institutional investors are usually catered to by placement agents and fund marketers, not financial planners. These agents, who charge commissions on their sales, prefer to sell private equity, hedge funds and real estate, where margins are higher for them – a hedge fund can charge a 2 percent management fee and a 20 percent performance fee.

“The investment advisor channel in the Gulf has not been as well developed as it could be. That is the issue,” Rifai said. “At some point it will take off…Give it another three years.”

Saeid Hamedanchi, chief executive of California-based investment management firm ShariaShares, said: “The biggest factor is the lack of knowledge of the ETF industry in the GCC (Gulf Cooperation Council).” This is aggravated by most ETF providers having a limited Gulf presence, he added.

Also, analysts still see a preference for familiar real estate and private equity investments among Gulf investors – perhaps because with economies growing strongly and some real estate markets such as Saudi Arabia’s still strong, local investors are thinking in terms of big pay-offs.

In the West, slow growth and weak asset markets have prompted investors to focus more on minimizing their investment costs – one of the major attractions of ETFs.

For ETFs to be fully cost-effective, however, they need to reach an optimal size, and Islamic ETFs may not yet have arrived at this threshold.

Lipper, a Thomson Reuters company, compiles a “death list” of ETFs in Europe which it believes could be under review for profitability reasons. It defines those ETFs as over three years old and holding under 100 million euros ($121 million) in assets.