Access to Islamic Hedge Funds - Incisive Media

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introduction to shariah Islamic investors eager to access Shariah compliant hedge funds The tremendous growth of Islamic finance has generated innovative investment products. As the Islamic marketplace grows in sophistication, investors are beginning to expect more than the traditional returns offered by real estate and commodity funds. Hedge funds could be the answer. Demand for Islamic financial instruments is expected to increase rapidly with some estimating that 20% annual growth would not be unexceptional. Although some have questioned whether a Shariah compliant hedge fund was possible, one workable solution may have been found. Shariah funds and Shariah compliant investment are of increasing interest to both global Islamic investors and developed western financiers keen to create products that will attract the significant sums available from sovereign wealth funds and high net worth individuals in the Middle East and other Islamic countries. The problem facing the introduction of these products and particularly hedge funds has been how to find a workable solution acceptable to both Shariah scholars and to the investment vehicles. Some attempts have been made to find Shariah compliant solutions for hedge funds but up to now, no one has succeeded. Shariah Capital, working with Barclays Capital and the Dubai government in the form of the Dubai Multi Commodities Centre and its affiliates, believes it has found a solution. One of the reasons few have tried to find a hedge fund solution is the development costs (and time) involved. The hedge fund solution goes beyond the usual development of a financial product because it is not enough just to structure a fund to be Shariah compliant. It is also necessary to ensure compliance of the hedging strategy, the securities held in the investment portfolio and workable legal solutions with the prime broker and eventually the fund administrator. The hedge fund solution requires fundamental changes to the way trades are processed, specifically the contracts underlying the exchange of securities must comply with Shariah rules. Eric Meyer, president, CEO and executive chairman of Shariah Capital, is one of the industry’s most vocal and active champions of Shariah compliant solutions. His company specialises in customising Shariah compliant financial | Access to Islamic Hedge Funds Supplement | November 2008 www.hedgefundsreview.com
introduction to shariah products and platforms as well as consulting and advisory services to global financial institutions and investment companies keen to find ways to become Shariah compliant. Together with its majority joint venture partner, Dubai Commodities Asset Management (51%), Shariah Capital has set up Dubai Shariah Asset Management (DSAM). This partnership is responsible for five funds which are receiving seed capital of $50 million from DMCC. Meyer is dismissive of the naysayers. He says the ‘first’ of anything is always the most difficult. He points to the introduction of the sukuk market, which began in Malaysia in 1990 with the small issuance of RM120 million ($30 million) by Shell Malaysia and has progressed. The largest issuance size to date is RM10 billion ($2.7 billion) by Rantau Abang Capital Berhad. The sukuk market more than doubled in 2007 to exceed $60 billion compared with less than $500 million in 2001. He believes there is tremendous demand for Shariah compliant hedge funds. Shaykh Yusuf Talal DeLorenzo, chief Shariah officer and board member at Shariah Capital and also on the Al Safi Shariah board of scholars, thinks there is always some resistance to new products. “There are few alternatives to Al Safi. It is the first platform of its kind available to Islamic investors in the Middle East and elsewhere. It is the most comprehensive and the biggest. Up to the time of its launch there were a lot of sceptics,” he says. Shaykh Yusuf believes there will be a steep learning curve both for Islamic investors and on the hedge making sense of shariah finance terms fund side before the concept will be fully understood or embraced. He and Meyer are adamant that the Shariah board, which oversees compliance, is not cutting corners or finding trick solutions for complicated problems. On the contrary, Shaykh Yusuf points to the presence on the board (article, page 9) of members from the Auditing and Accounting Organization of Islamic Financial Institutions (AAOIFI), which is working to establish Islamic finance standards. “The Shariah board is now a fairly well-established process and people are familiar with how it works and the processes it goes through. Around 10 years ago AAOIFI was established as the standard-setting body for the industry. All the Al Safi Shariah board are also members of the AAOIFI board. So you will find the broadest possible consensus in putting products together,” comments Shaykh Yusuf. He believes scholars need to find consensus answers and that process does not compromise Islamic principles. “We have 70%–80% industry acceptance for what we are offering. Shariah compliant hedge fund solutions have been tried for four or five years. A couple have launched. So it’s not a completely new subject,” admits Shaykh Yusuf. Meyer agrees that the compliance issue will be a big talking point for some time. However, he believes the quality of the Shariah board for the Al Safi platform is outstanding. “We have done our homework. We’ve done this the right way. We’ve been very methodical, with a good group of Shariah scholars who are Murabaha is a Shariah-compliant sale where the seller expressly mentions the cost he has incurred on the commodities to be sold and sells it to another person by adding some profit or mark-up which is known to the buyer. For example, instead of a bank lending money to a customer who wants to buy a commodity, the bank buys the commodity and sells it to the customer for a declared marked-up sum. That way the bank makes money on the transaction without it being through interest. Sukuk means a financial certificate in Arabic. A sukuk is a security based on the securitisation of performing assets that resembles a bond, complying with Islamic law prohibiting the charging or paying of interest. Sukuk al salam is a form of sukuk based on a salam contract for the delivery of fungible assets. Arboon is a Shariah form of sale contract in which seller and buyer effect a contract in which a portion of the price is paid in earnest money. The buyer then has the right to complete the sale within a specified period of time or to cancel the contract and forfeit the down payment. Source: Shariah Capital. competent legal experts and they have found a solution that is watertight. Clearly, this could become the standard for the funds industry in future years,” comments Meyer. Initially the platform will only be accepting hedge funds that use a long/short strategy. This is what Meyer describes as the “plain vanilla”, basic strategy that is the least difficult to adapt to Shariah rules. Certain sectors are also relatively easy to pass through the Shariah screen. For example, healthcare, technology, commodities and energy tend to be areas most compatible with Shariah law. “We’re selling into a new market so we wanted to keep things as specific as we could. If we start only with equity long/short, that’s fine. We’ll move into technicolour later. We need to start with the basics first,” explains Meyer. “To begin we started working with Barclays prime brokers in New York with a set of regulations and the SEC [US Securities and Exchange islamic financing matures Commission] regulations. This was a very lengthy and complicated process. We first wanted to see it work with the funds we have on the platform,” Shaykh Yusuf says. Despite the significant challenges faced to get the platform up and running, the first funds using the platform seem pleased with the system and there have so far been no problems. Capacity on the platform is large and Meyer for one does not think there will be any problems adding funds once the significant amount of due diligence and paperwork is finished. As the learning curve goes up for Islamic investors, Meyer expects to see demand for the funds on the platform increase. Judging from the feedback Meyer and others are receiving from roadshows around the region detailing Al Safi, Meyer is confident investors will embrace the concept and have confidence in the rigorous application of Shariah laws to its operation. n The term ‘Islamic economics’ first appeared in the 1950s and 1960s as research papers, articles and books began to discuss the subject. By the 1970s the first Islamic banks and finance houses were opening in the Middle East and North Africa (known as the MENA region). Their growth was largely boosted by oil revenues. It was at this point that the first attempts at managing liquidity through commodity murabaha first appeared. Also in 1971 Dubai Islamic Bank opened for business. In the 1980s the numbers of Islamic banks and finance houses blossomed to over 40. Banks at the time put capital into real estate for the long term and murabaha commodities for the short term. By the 1990s international banks like Citi and HSBC began offering Shariahcompliant products. The first industry standards were established by the Accounting and Auditing Organization for Islamic Financial Institutions. During this decade Bahrain and Malaysia emerged as hubs for Islamic finance. In 1994 the first conventional asset managers were invited to manage investments under Shariah supervision and Islamic investing itself expanded to include leasing funds and a few long-only equity funds. By 1999 Dow Jones had launched its Islamic market indices. By the beginning of the next century and millennium, the number of mutual funds had increased to over 60 and the number of Islamic banks operating around the world numbered more than 200. In 2000 some of the major international law firms established Islamic finance practices and began to compete for market share. In 2001 the first Shariah-compliant structured products were introduced in the form of principal protected funds and notes. Real estate and leasing funds grew and the first infrastructure projects were financed under Shariah law. The first sukuk was issued in 2002 by the Malaysia government. Since then the value of these issues has doubled. The following year the first corporate sukuk were issued and the ratings agencies began rating sukuk. In 2006 the first sukuk with US-based corporate assets was issued. Shariah-compliant real estate investment trusts (REITs) and exchangetraded funds (ETFs) were introduced in 2007. In the UK the treasury announced it intended to issue sukuks and the London Metal Exchange (LME) reported that $100 billion in Islamic assets were invested. By 2008 Shariah-compliant hedge funds were on the scene and several initiatives were launched to try to increase their numbers and investment flows into them. Source: Shariah Capital. www.hedgefundsreview.com November 2008 | Access to Islamic Hedge Funds Supplement |
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