Although there are many types of hedge funds, most involve short selling to profit from falling markets. Usually, the hedge fund manager borrows stock, sells it and repurchases when the price falls to provide it back to the original investor. This is an exploitative transaction as the investor’s loss is the hedge fund manager’s gain. Furthermore, if the market moves against the hedge fund manager and in favor of the original investor, the former may be unable to fulfill financial obligations. Most Shariah scholars will not approve of hedge funds because of the injustices inherent in short selling. Hedge funds also lack transparency. In my view, these scholars are correct. The Islamic finance industry does not need hedge funds, and they are an innovation that Shariah compliant investors can, and should, live without. Even in the west, many question the morality of hedge funds which are all too often highly speculative.
PROFESSOR RODNEY WILSON:
The lack of demand for Islamic hedge funds can neither be fully explained by Shariah concerns nor with reference to the complexity of hedge fund structures. It can simply be explained by referring to the supply side of the equation. Until recently, no one has been able to bring a WOW product to the market. Islamic investors are not willing to pay lucrative hedge fund management and performance fees for the products which otherwise are not that much different in terms of risk-adjusted return from simple equity funds. The day a quality Shariah compliant hedge fund hits the market, it will create its own demand. So far, fund managers bringing hedge funds to the Islamic market have, by and large (with a couple of exceptions), brought in only long/short strategies. No one has genuinely attempted to create Shariah replicas of other strategies, like global macro arbitrage, distressed portfolios etc. As this may require specialized Shariah technicians to work with fund managers on an ongoing basis, fund managers have tended to shy away from such strategies, given that there are only a few genuine Shariah technicians in the world. Another reason for the absence of quality Shariah compliant hedge funds is that a number of western investment (and now local) banks have started offering Islamic structured products that give Islamic investors exposure to many alternative asset classes, with capital protection if desired. This, in my opinion, has killed the business of Islamic hedge funds. We at BMB Islamic have been working with leading alternative assets managers (including hedge funds) to develop a first-of-its-kind platform — called the SHARE Platform — which offers risk-return profiles of top-performing hedge funds, private equity and other alternative funds to Islamic investors in a way that does not compromise Shariah requirements. Once this product is out in the market, there will probably be no need to develop an Islamic hedge fund. After all, if my orange tree also gives me apples, why should I bother planting an apple tree? I must clarify, however, that I am not against Islamic hedge funds. I am only trying to make a simple point here that if you are thinking of developing a mediocre Islamic hedge fund, don’t bother. It’s not worth it! DR HUMAYON DAR: CEO, BMB Islamic, UK
Conventional hedge funds do not necessarily provide any protection but are by nature quite speculative. The lack of regulation leads to high-frequency trading with an often opaque trading strategy. In addition, the active application of short-selling strategies and use of derivatives result in a highly speculative environment with a significant potential total loss to the investor. It is this speculative nature and lack of transparency that make hedge funds non-compliant with the Shariah. The original underlying principle to seek to offset potential losses by hedging the investments, however, is not necessarily against the Shariah. There is after all nothing against risk mitigation. However, it is not just through conventional hedge fund type strategies that an investor can achieve risk mitigation. By applying appropriate diversification, an investor will be able to achieve a significant level of risk mitigation — albeit not with the potential of achieving speculative returns. Then again, the potential downside should also be significantly lower. DR NATALIE SCHOON: Head of product management, Bank of London and the Middle East
The principal characteristic of hedge funds is the use of ‘gearing’ or ‘leverage’. That is to say, hedge funds typically magnify returns — and, of course, the risks inherent in achieving these returns — by either using derivatives such as futures contracts or by borrowing at interest. In so far as hedge funds use leverage, therefore, they cannot be Shariah compliant, and the great majority of investors are intuitively aware of the fact and therefore wary of hedge funds. The impossibility of Islamically acceptable ‘leverage’ or ‘gearing’ is not just an issue in relation to hedge funds, of course. It is the ‘elephant in the room’ or ‘inconvenient truth’ of the entire Islamic finance industry, where a cadre of experts consistently works to justify the inherently unjustifiable. CHRIS COOK: Principal, Partnerships Consulting
I do not believe the mass investors are ready for Islamic hedge funds at present. The industry needs to focus on more real economy solutions for the customers. AFAQ KHAN: Head of Islamic banking, Standard Chartered, UAE
|