After rising rapidly from a low base, Shariah-compliant investment funds may struggle for a while to make further headway, a report by Cerulli Associates says.

The market for funds complying with Shariah law remains “highly challenging” despite growing rapidly from a low base in markets such as Malaysia and Indonesia in recent years, according to Cerulli Associates, the analytics firm based in the US.

Investments complying with Islamic law are banned from earning interest on loans, avoid speculative instruments and portfolios must avoid holding assets linked to areas such as alcohol and gambling. In general terms, Shariah finance is akin to equity rather than debt. There are debt-like structures such as sukuk that seek to mimic in some ways the finance-raising role of bonds while avoiding the interest issue.

In recent years, the rise in oil wealth in parts of the Muslim world, coupled with the rise of an affluent middle class in certain countries with large Muslim populations, has encouraged predictions that Shariah finance and investment will grow rapidly. A hurdle, however, is the lack of a common set of rules in how Shariah law is interpreted in different nations. Typically, the law is more conservatively applied in jurisdictions such as Saudi Arabia than in Malaysia, for example.

Shariah-compliant funds and strategies have been the key growth drivers in Malaysia's asset management space, and will continue to drive the industry's growth going forward, Cerulli said. Shariah wholesale funds' assets under management grew by 35.0 per cent year-on-year to MYR31.7 billion ($7.8 billion) in 2015, largely driven by institutions and corporations.

In Indonesia, Shariah-compliant assets and flows are still much lower than in Malaysia, the report said. The number of such funds has continued to increase, from 73 at the end of 2014 to 91 at end-2015, despite the 3.4 per cent fall in total assets in 2015. This further reduced their market share of total AuM from 4.5 per cent at end-2014 to 3.9 per cent by end-2015. Still, amid market fluctuations, many investors shifted to Shariah bond funds, which saw assets grow by 92.1 per cent to IDR0.7 trillion ($52.7 million).

“However, for Southeast Asian managers, penetrating the Shariah distribution landscape requires significant amounts of patience and resources, and promoting Shariah-compliant funds as socially responsible funds has had limited success so far,” the report cautioned.

“Globally, a lack of standardisation in Islamic investment principles and a limited understanding and awareness among investors and distributors have also hindered growth in the broader Shariah product space. With global sukuk largely dominated by a few countries, there is also limited geographical diversification for global fixed-income strategies,” it said.