Access to Islamic Hedge Funds - Incisive Media

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success of al safi Investors keen to find route to Shariah compliant hedge funds Islamic scholars have long disagreed about the merits of hedge fund investments. To many, common hedge fund techniques such as short selling and leverage can never be squared with the principles espoused by Shariah. To others, concepts used successfully in other spheres of Islamic finance such as the sukuk market can be tweaked to make hedge fund investment acceptable. For the past 10 years there have been various attempts to develop a Shariah compliant hedge fund investment route to cater for ethical Islamic sovereign wealth investors, pension funds, other institutional investors and retail investors. Several have launched and failed, mainly due to the lack of a significant sponsor prepared to supply the seed capital necessary to create a profitable platform. Although several fund-linked derivatives exist, their uptake among the Islamic investor community has been slow with assets dripping in rather than flowing. While significant assets from Islamic investors have gone into alternative funds and hedge funds, there is a growing demand for Shariah compliant hedge funds. With a serious alternative to non-Shariah compliant investing in existence through the Al Safi platform, Islamic investors and institutions can begin to diversify portfolios and add alternative investment strategies that conform to the principles and ideals of the Islamic faith. Factors that in the past restricted the growth of Shariah compliant hedge fund investing – such as increased fees, restricted investment universe and lack of world-class managers – have been solved by the Al Safi platform. By tackling these obstacles the Al Safi platform has opened the floodgates to a new era of liquid, profitable Shariah compliant hedge fund investing. While the number of funds signed up to Shariah compliant platforms remains small, the prospects for growth are positive. The potential demand for Islamic hedge funds is huge, say many market observers, particularly as investors in the Middle East look for new investment opportunities. “We started creating the Al Safi platform 18 months ago because we saw there was a demand for Shariah compliant alternative investments among Islamic institutional investors,” says Frank Gerhard, director and head of fund linked derivatives product strategy at Barclays Capital in London. The request, he says, came from the sales group. “They were looking to expand the Shariah governed investable universe for clients,” confirms Gerhard. There were some Shariah compliant products, but collectively they did not offer wide diversification across instruments or portfolios. The team at Barclays Capital sat down and the result was the idea to create a one-stop-shop solution that would allow hedge funds to carry on with their lucrative strategies but within a Shariah compliant framework that did not add unnecessary burdens to the hedge fund or impose punitive charges on investors. Proportion of funds targeting asset class (as a % of total) The result was the Al Safi Trust Platform. The name of the solution is indicative of its ambitions. Al Safi means ‘pure’ or ‘clear’. What Barclays Capital, the investment banking side of Barclays Bank, and the Dubai Multi Commodities Centre Authority (DMCC), an agency of the Dubai government, has created is a Shariah compliant platform for hedge funds. It committed to seed five commodity hedge fund managers on Al Safi with $50 million each, a total of $250 million for a Shariah compliant fund of funds products to be offered under the Dubai Shariah Asset Management (DSAM) brand. Al Safi is a comprehensive Shariah compliant platform comprised initially of single strategy alternative investment managers with Shariah Capital as the Shariah advisor and Barclays Capital as the prime broker and eventually the structured product distributor. Barclays Capital was not the first to try to find a solution. Newedge, jointly owned by Calyon and Société Générale, launched its Shariah target asset classes of shariah compliant fund universe 100 80 60 40 20 0 10 27 8 54 Global 1 27 7 67 Europe 29 8 63 North America Middle East Asia Pacific Shariah compliant fund universe Source: Eurekahedge Islamic Funds Database, Investment Company Institute, Ernst & Young Analysis 26 14 7 49 Shariah compliant funds by geographical mandate 5 11 10 15 13 51 18 13 10 7 52 10 6 20 22 42 Conventional mutual fund universe compliant offering in October 2005. Only a handful of hedge funds are currently listed on its platform, including the Al Raed Emerging Markets Fund (North of South Capital), the Old Mutual Al Saqr Fund (Old Mutual) and the Lucerne Shari’a Istithmar Fund (ReachCapital Management). London-based Islamic financial services company Amiri Capital intends to launch a Shariah compliant fund of funds within the next few months. BNP Paribas is looking to offer structured products referenced to Shariah compliant hedge funds. Citi is believed to be developing an Islamic hedge fund platform. Despite these various initiatives, little progress has been made. However, Barclays Capital hopes that as investors become more comfortable, high-profile allocations by entities such as the DMCC could persuade other Islamic investors to follow suit, in turn causing assets under management to slowly inflate. “It is possible that some Islamic institutional investors may wait Other Money market Balanced Fixed income Equity 10 | Access to Islamic Hedge Funds Supplement | November 2008 www.hedgefundsreview.com
success of al safi typical asset allocations Alternatives Real estate Cash/Deposits 15% Exposure to cash/deposits and fixed inc largely through balanced funds 5% 80% Equities dominate asset allocation due to ease-of-access and availability through mutual funds Mass affluent investors Fixed income Equity Source: Industry Interviews, Ernst & Young Analysis until they see others getting involved before they start investing in hedge funds themselves,” notes Shaykh Yusuf Talal DeLorenzo, the chief Shariah officer at Shariah Capital, one of the companies involved with the Al Safi platform. “There is potential for Al Safi to attract billions in investment,” declares Eric Meyer, chairman and chief executive of Shariah Capital. “Based on this assumption, we have been willing to undergo significant time and expense to get the platform right,” he says. The success of Al Safi, Barclays Capital believes, will come from its entirely different approach, basing its short selling mechanism on the concept of arboon. An arboon contract entitles the investor to purchase an asset at an agreed price at any time up to the maturity of the contract. The investor provides a deposit to the counterparty, which is forfeited if the investor decides not to proceed with the purchase (article, page 12). “With the capital support of a sovereign government and the prime broker and structuring expertise of Barclays Capital, the Al Safi Trust Platform is a historic development that unites modern investment strategies with Shariah,” adds Meyer. David Rutledge, chief executive of DMCC, agrees. “It [the platform] enables us to access exceptional managers with strong track records in order to achieve our goal of delivering diversified exposure across a range of commodity sectors to both institutional and individual investors interested in Shariah compliant investment products and solutions.” While there is still a lot of scepticism, not least from the media, those involved in the Al Safi platform are convinced the solution it presents 20% Allocation across the private equity and real estate asset classes but focused internationally 15% >5% >5% 60% Equity allocation split between local and international HNWI/UHNWI 10% Limited investment in real estate 30% Cash/deposits allocations required to meet shortterm obligations 60% Regional listed equities dominate allocation Takaful operators could become a standard for future Shariah compliant hedge fund platforms and products. According to Gerhard, roadshows throughout the region by Barclays Capital aimed at assessing and attracting investor interest in seeding more funds has shown “significant interest from corporate treasuries, but also from banks. We also have some players in the wealth management space who are interested in seeding. There is interest in using the platform as an open architecture means of creating and launching their own products,” explains Gerhard. Barclays Capital expects to have a commitment from at least one wealth manager in the region to go ahead and start seeding funds, probably by the end of 2008. The investment, although relatively small at the start, is expected to overtake the $250 million seed captial put up by DMCC. Gerhard believes there was initial scepticism about the idea. However, once investors understand the detail of the operation and how Barclays Capital through DSAM ensures Shariah compliance, they are keen to become involved. Barclays Capital has also made a significant investment in both time and money – as well as in part staking its reputation on the success of the platform – in providing its prime brokerage services to the platform. He points to the blue chip fund managers the platform is attracting. “There is real appetite from investment managers to find a way to access the alternative investment space in the Middle Eastern region. Multi-billion funds with an average size of $2–$3 billion in assets under management (AUM) are approaching us and want to market themselves through the platform. The largest number of enquiries are coming from equity long short managers,” says Gerhard. Once investors and hedge fund managers have been introduced to the notion of Al Safi as a “new instrument”, the feedback from them is extremely positive. “Once managers appreciate the concept they are keen. They see the platform as a sensible way of approaching the challenge of delivering Shariah governed hedge funds,” Gerhard notes. Typical Middle Eastern investors already have significant experience in alternative investments so they are familiar with the concept of hedge funds. “At the moment we are seeing a very strong move towards Shariah governed solutions. If we can provide generally attractive returns in the Shariah space compared with non-Shariah, there is appetite. But we have to offer both: attractive returns and a credible solution,” declares Gerhard. Middle Eastern investors are already one of the most important alternative investors globally. The high net worth and ultra high net worth individuals as well as large institutional investors and banks are interested in alternatives. “We already see strong interest for the ethical investment aspect across the board. Investors are already beginning to migrate portfolios to Shariah compliant vehicles. It depends how much of the allocations they can move and on the ability of a manager to generate returns in the Shariah compliant space. We see Al Safi as providing a solid environment for Shariah governed hedge funds,” concludes Gerhard. Having the competitive edge Gerhard believes Barclays Capital through Al Safi has a competitive edge. He points to the months of negotiation needed to hammer out prime brokerage documentation that was acceptable not only to the bank but also to the Shariah scholars. “Yes, the arboon structure has been available for five or seven years as a theoretical solution to this specfic problem. But implementation and delivery was the challenging part. We had to make sure it met all the requirements to provide a proper arboon structure and that we could implement the solution reliably in the prime services context,” Gerhard says. Having now found a solution, he says Barclays may have a small window where it will lead the market. But he also believes “it is important to have competitors in the market. It helps make the market efficient. But it’s also good to have the lead with a reliable, credible and transparent Shariah solution,” notes Gerhard. The future of the platform is hard to predict. While Gerhard believes its capacity is huge, it is also necessary to start small and grow. “We need to walk before we can run. We’re still in the ramping-up phase of the platform. We are getting the initial funds up and running and broadening discussions with seed investors. As we grow the platform, we need to make sure the funds and infrastructure stay within the Shariah requirements and that we are offering more and more diversification across managers. Then we can branch out into structured products where we may address the need for cash substitutes and introduce derivative instruments. That’s very much stages three and four, after diversification is achieved.” Addressing what some may see as a delay in launching more funds on the platform, Gerhard answers simply. “It is about timing. Actually our timing was very fortunate. In this space returns in commodity and equities have not been encouraging. By delaying we feel we have given a better choice, from an investor’s perspective,” he says. Barclays Capital was also keen to ensure the platform did not penalise investors on the fee side or on any other economic parameters for choosing a Shariah-governed solution. “It was quite important from the beginning not to have to say to an investor choose one or the other. Ethical investors are also seeking returns. It won’t work if the economics are not right. The solution has to be sustainable. There is no question in our minds regarding this,” he declares. Looking at the platform, Gerhard sees success in simply getting the project up and working. He says they are at the beginning of the process. “On the one hand we are very pleased and thrilled that we’ve got the pilot off to such a good start where other competitors have failed. We are enjoying that,” says Gerhard. “We have had very positive feedback from the industry. Over time we will provide further innovations available within the same rigorous scrutiny. But at the moment we want to make sure the confidence of investors in this product is justified; that they see a transparent platform that is guided by Shariah principles. Time will tell if the platform becomes the Shariah standard. At the moment we want to give the market a transparent, credible solution,” concludes Gerhard. n www.hedgefundsreview.com November 2008 | Access to Islamic Hedge Funds Supplement | 11
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