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Access to Islamic Hedge Funds


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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. Published by Hedge funds Review in association with Barclays Capital.

Published in: Economy & Finance, Business
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Access to Islamic Hedge Funds

  1. 1. November 2008 l Access to Islamic Hedge Funds Supplement The voice of The alTernaTive invesTmenT indusTry In association with Access to Islamic Hedge Funds CHAlleNgeS to SettINg up dmCC ACCeSS to Al SAFI FuNd proFIleS Islamic investors are eager to access Three hedge funds are operating from Running a Shariah compliant hedge Dubai Multi Commodities Centre is seeding Shariah compliant the Al Safi platform. fund presents some five funds on the Al hedge funds and A wide range of challenges. The Al Safi platform, putting fund managers are long/short funds Safi platform may its seal of approval keen not to sacrifice are hoping to join have the solution. on the project. strategy and them in the 6 13 15 return. 18 near future.
  2. 2. access to islamic hedge funds Contents 4–5 Introduction to Shariah Editor Margie Lindsay The tremendous growth of Islamic finance has generated innovative investment products. As the +44 (0)20 7484 9889 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. US Editor 6–7 Challenges to setting up Kris Devasabai +44 (0)20 7484 9748 Running a Shariah hedge fund is a daunting task. Many issues, particularly ensuring the underlying stocks traded are all compliant, has scuppered attempts in the past. The Al Safi platform thinks it may Production have the answers that will be able to provide ethical Islamic investors with an acceptable product. Amanda Allen 8–9 Al Safi Trust Platform Publisher Scepticism among some Islamic scholars about how to make hedge funds mainstream in the Islamic Jonathan Greene investment community has challenged attempts to set up Shariah compliant funds. The question now +44 (0)20 7484 9867 is whether the Al Safi Trust Platform has addressed those concerns and found a workable solution. 10–12 Success of Al Safi Advertising Luther Rahman Islamic scholars have long disagreed about the merits of hedge fund investments. Nevertheless +44 (0)20 7968 4514 ethical Islamic investors are keen to tap into the high returns offered by hedge funds. One of the main stumbling blocks has been shorting. The short arboon sale may be an acceptable Advertising production alternative to both scholars and investors. Melanie Law 1–14 DMCC profile +44 (0)20 7316 9837 A strategic initiative of the Dubai government created the Dubai Multi Commodities Centre. Now DMCC is playing an active role in seeding the first five hedge funds on the Al Safi Trust Platform. Advertising/editorial fax +44 (0)20 7930 2238 15 Access to Al Safi for investors Managing Director There is growing demand in the Middle East for access to Shariah compliant alternative Matthew Crabbe investments like hedge funds. +44 (0)20 7484 9814 16 Access to Al Safi for hedge funds Hedge fund managers are keen to tap into Middle Eastern investors, particularly as sources of new cash Marketing manager is squeezed by the financial downturn. Putting a fund on the Al Safi platform could be a solution. +44 (0)20 7484 9953 17 Why hedge funds? Head office While hedge funds were originally attractive only to high net worth individuals and family offices, Haymarket House, institutional investors are now eager to take advantage of the higher returns largely uncorrelated 28–29 Haymarket to markets offered by these alternative investments. London SW1Y 4RX 18–19 Fund profile: DSAM Kauthar Gold Fund (Tocqueville Asset Subscription and circulation enquiries Management +44 (0)20 7484 9890 20–21 Fund profile: DSAM Kauthar Energy Fund (Lucas Capital Management) Subscription renewals 22–2 Fund profile: DSAM Kauthar Natural Resources Fund (Zweig-DiMenna +44 (0)20 7484 9896 International Managers) All reports written by Margie Lindsay 24–25 Fund profile: Peconic Partners 26–27 Strategy profile: EnTrust Capital Information on hedge fund managers in Hedge Funds Review is based 28–29 Fund profile: Van Eck Hard Assets 2x Fund (Van Eck Global) solely on information supplied by those managers. The accuracy has 0–2 Fund profile: Caduceus Capital (OrbiMed Advisers) not been verified by Hedge Funds Review. We take no responsibility for –4 Strategy profile: Alkeon Capital Management it. No information in this magazine should be taken as a solicitation 5 Contact details for the Al Safi Trust Platform for investment in any of the investments reported on. © 2008 Incisive Media Group Cover picture: Alhambra, the palace and fortress complex of the Moorish monarchs of Granada in southern Spain, is a reflection of the culture of the last days of the Nasrid emirate of Granada. It is a place where artists and intellectuals took refuge. Alhambra mixes natural elements with manmade ones and is a testament to the skill of Muslim craftsmen of that time. The literal translation, ‘red fortress’, derives from the colour of the red clay of the surroundings of which the fort is made. November 2008 | Access to IslAmIc Hedge Funds supplement |
  3. 3. 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 available from sovereign wealth the Dubai government in the form workable legal solutions with the instruments is expected to increase funds and high net worth individ- of the Dubai Multi Commodities prime broker and eventually the fund rapidly with some estimating that uals in the Middle East and other Centre and its affiliates, believes it administrator. The hedge fund solu- 20% annual growth would not be Islamic countries. has found a solution. tion requires fundamental changes unexceptional. Although some have The problem facing the introduc- One of the reasons few have to the way trades are processed, spe- questioned whether a Shariah com- tion of these products and particu- tried to find a hedge fund solution cifically the contracts underlying the pliant hedge fund was possible, one larly hedge funds has been how to is the development costs (and time) exchange of securities must comply workable solution may have been find a workable solution acceptable involved. The hedge fund solution with Shariah rules. found. to both Shariah scholars and to the goes beyond the usual development Eric Meyer, president, CEO and Shariah funds and Shariah com- investment vehicles. of a financial product because it is executive chairman of Shariah pliant investment are of increasing Some attempts have been made not enough just to structure a fund Capital, is one of the industry’s interest to both global Islamic inves- to find Shariah compliant solutions to be Shariah compliant. It is also most vocal and active champions tors and developed western finan- for hedge funds but up to now, no necessary to ensure compliance of of Shariah compliant solutions. His ciers keen to create products that one has succeeded. Shariah Capital, the hedging strategy, the securities company specialises in custom- will attract the significant sums working with Barclays Capital and held in the investment portfolio and ising Shariah compliant financial 4 | Access to IslAmIc Hedge Funds supplement | November 2008
  4. 4. introduction to shariah products and platforms as well as fund side before the concept will competent legal experts and they Commission] regulations. This was consulting and advisory services be fully understood or embraced. have found a solution that is water- a very lengthy and complicated to global financial institutions and He and Meyer are adamant that tight. Clearly, this could become the process. We first wanted to see it investment companies keen to find the Shariah board, which oversees standard for the funds industry in work with the funds we have on the ways to become Shariah compliant. compliance, is not cutting corners future years,” comments Meyer. platform,” Shaykh Yusuf says. Together with its majority joint or finding trick solutions for com- Initially the platform will only Despite the significant chal- venture partner, Dubai Commodities plicated problems. On the contrary, be accepting hedge funds that lenges faced to get the platform up Asset Management (51%), Shariah Shaykh Yusuf points to the pres- use a long/short strategy. This is and running, the first funds using Capital has set up Dubai Shariah ence on the board (article, page 9) what Meyer describes as the “plain the platform seem pleased with the Asset Management (DSAM). This of members from the Auditing and vanilla”, basic strategy that is the system and there have so far been partnership is responsible for five Accounting Organization of Islamic least difficult to adapt to Shariah no problems. Capacity on the plat- funds which are receiving seed cap- Financial Institutions (AAOIFI), rules. Certain sectors are also rela- form is large and Meyer for one does ital of $50 million from DMCC. which is working to establish tively easy to pass through the Sha- not think there will be any problems Meyer is dismissive of the nay- Islamic finance standards. riah screen. For example, healthcare, adding funds once the significant sayers. He says the ‘first’ of any- “The Shariah board is now a fairly technology, commodities and energy amount of due diligence and paper- thing is always the most difficult. well-established process and people tend to be areas most compatible work is finished. He points to the introduction of are familiar with how it works with Shariah law. “We’re selling into As the learning curve goes up for the sukuk market, which began in and the processes it goes through. a new market so we wanted to keep Islamic investors, Meyer expects Malaysia in 1990 with the small Around 10 years ago AAOIFI was things as specific as we could. If we to see demand for the funds on the issuance of RM120 million ($30 mil- established as the standard-setting start only with equity long/short, platform increase. Judging from lion) by Shell Malaysia and has pro- body for the industry. All the Al Safi that’s fine. We’ll move into techni- the feedback Meyer and others are gressed. The largest issuance size to Shariah board are also members of colour later. We need to start with receiving from roadshows around date is RM10 billion ($2.7 billion) by the AAOIFI board. So you will find the basics first,” explains Meyer. the region detailing Al Safi, Meyer Rantau Abang Capital Berhad. The the broadest possible consensus in “To begin we started working with is confident investors will embrace sukuk market more than doubled in putting products together,” com- Barclays prime brokers in New York the concept and have confidence in 2007 to exceed $60 billion compared ments Shaykh Yusuf. with a set of regulations and the the rigorous application of Shariah with less than $500 million in 2001. He believes scholars need to find SEC [US Securities and Exchange laws to its operation. n He believes there is tremendous consensus answers and that process demand for Shariah compliant does not compromise Islamic princi- hedge funds. Shaykh Yusuf Talal ples. “We have 70%–80% industry ISLAMIC FINANCING MATURES DeLorenzo, chief Shariah officer and acceptance for what we are offering. board member at Shariah Capital and Shariah compliant hedge fund solu- The term ‘Islamic economics’ first appeared in the 1950s and 1960s as also on the Al Safi Shariah board of tions have been tried for four or five research papers, articles and books began to discuss the subject. By the scholars, thinks there is always some years. A couple have launched. So 1970s the first Islamic banks and finance houses were opening in the Middle resistance to new products. it’s not a completely new subject,” East and North Africa (known as the MENA region). Their growth was “There are few alternatives to Al admits Shaykh Yusuf. largely boosted by oil revenues. It was at this point that the first attempts Safi. It is the first platform of its Meyer agrees that the compliance at managing liquidity through commodity murabaha first appeared. Also in kind available to Islamic investors issue will be a big talking point for 1971 Dubai Islamic Bank opened for business. in the Middle East and elsewhere. It some time. However, he believes In the 1980s the numbers of Islamic banks and finance houses blossomed is the most comprehensive and the the quality of the Shariah board for to over 40. Banks at the time put capital into real estate for the long term biggest. Up to the time of its launch the Al Safi platform is outstanding. and murabaha commodities for the short term. there were a lot of sceptics,” he says. “We have done our homework. By the 1990s international banks like Citi and HSBC began offering Shariah- Shaykh Yusuf believes there will We’ve done this the right way. We’ve compliant products. The first industry standards were established by the be a steep learning curve both for been very methodical, with a good Accounting and Auditing Organization for Islamic Financial Institutions. During Islamic investors and on the hedge group of Shariah scholars who are 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 MAKING SENSE OF SHARIAH FINANCE TERMS 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 Murabaha is a Shariah-compliant sale where the seller expressly mentions and millennium, the number of mutual funds had increased to over 60 and the the cost he has incurred on the commodities to be sold and sells it to another number of Islamic banks operating around the world numbered more than 200. person by adding some profit or mark-up which is known to the buyer. For In 2000 some of the major international law firms established Islamic example, instead of a bank lending money to a customer who wants to buy finance practices and began to compete for market share. In 2001 the a commodity, the bank buys the commodity and sells it to the customer first Shariah-compliant structured products were introduced in the form of for a declared marked-up sum. That way the bank makes money on the principal protected funds and notes. Real estate and leasing funds grew and transaction without it being through interest. the first infrastructure projects were financed under Shariah law. The first sukuk was issued in 2002 by the Malaysia government. Since then Sukuk means a financial certificate in Arabic. A sukuk is a security based the value of these issues has doubled. The following year the first corporate on the securitisation of performing assets that resembles a bond, complying sukuk were issued and the ratings agencies began rating sukuk. In 2006 the with Islamic law prohibiting the charging or paying of interest. first sukuk with US-based corporate assets was issued. Shariah-compliant real estate investment trusts (REITs) and exchange- Sukuk al salam is a form of sukuk based on a salam contract for the traded funds (ETFs) were introduced in 2007. In the UK the treasury delivery of fungible assets. announced it intended to issue sukuks and the London Metal Exchange (LME) reported that $100 billion in Islamic assets were invested. Arboon is a Shariah form of sale contract in which seller and buyer effect a By 2008 Shariah-compliant hedge funds were on the scene and several contract in which a portion of the price is paid in earnest money. The buyer initiatives were launched to try to increase their numbers and investment then has the right to complete the sale within a specified period of time or to flows into them. cancel the contract and forfeit the down payment. Source: Shariah Capital. Source: Shariah Capital. November 2008 | Access to IslAmIc Hedge Funds supplement | 5
  5. 5. challenges to setting up al safi Shariah poses challenges to hedge fund managers Running a Shariah hedge fund is a daunting task. A number of issues, not least of which is ensuring the underlying stocks traded are all compliant, has scuppered attempts to create a solution acceptable for both hedge funds and ethical Islamic investors. The Al Safi platform thinks it may have the answers. Although the demand for Shariah same time allowing funds to continue cial product. It is not enough just to This costs. Few financial institu- compliant products is growing, to pursue the strategies that create structure a fund. It is also necessary tions are willing to take the time and hedge funds have been one of the alpha. to ensure compliance of the hedging spend the money needed to find a last alternative investment vehicles Some investors, unaware of the strategy and the securities held in the workable and sustainable solution. to attempt the daunting task of being variety of strategies available to investment portfolio. Barclays Capital, as prime broker, Shariah compliant. An impressive managers, expect all hedge funds to The hedge fund solution also has made the financial commitment and combined effort of a number of be extremely speculative and there- needs some fundamental changes and seen the potential rewards of companies and factors has produced fore at odds with the Shariah prohi- to the way trades are processed. In stealing a march on competitors what Barclays Capital hopes will be bition of undue speculation. Others particular the contracts that underlie also eager to offer Shariah compliant the blueprint for future Shariah com- think only of short sales and con- the exchange of securities need to hedge funds and related products to pliant hedge fund platforms. clude hedge funds must be prohibited comply with Shariah rules. eager investors. It is not only hedge funds that by Islamic law. These transactions are the pre- In theory at least there should be need to be convinced that the efforts Despite the solution the Al Safi serve of the prime broker. The role nothing controversial about the way at finding a way to comply with Sha- platform presents, it may take some of the prime broker, as well as all the the Al Safi Trust Platform operates riah law are worthwhile. Bankers, time before investors are comfort- regulatory requirements coupled with or invests. The Shariah supervisory investors and many in the media have able, and trusting, enough for this Shariah rules, has daunted many. board insists every aspect of the plat- questioned whether it would ever be to translate into demand for Shariah To find a solution, a prime broker form’s (and individual hedge funds’) possible to find a way to make hedge compliant funds. needs lawyers, internal and external operations are unambiguously com- funds Shariah compliant. Although One of the reasons it has been so counsel, and more than one set of pliant and transparent. The board there are still plenty of sceptics, the difficult to come up with a workable each, to work with Shariah experts, also uses contractual norms estab- Al Safi Trust Platform seems to have solution is simply the development traders and investment managers to lished by the classical jurists of raised the bar on standards, intro- costs. A solution for hedge funds ensure that every step of the process Islam. ducing a relatively fast and easy way goes beyond the usual development is feasible, compliant and, ultimately, The result is a bit of a paradox: an of ensuring compliance while at the costs (and time) needed for a finan- profitable. innovative new hedge fund platform 6 | Access to IslAmIc Hedge Funds supplement | November 2008
  6. 6. challenges to setting up al safi (Al Safi) based on Islam’s ancient used for conventional hedge funds. from that fund other than in a special find unusual is the purification laws using ‘old’ tools to make it work. Another problem the Shariah super- situation, like when a trade in a non- process. Although all the company visory board has to deal with is how a Shariah compliant stock is made. stocks traded are screened for unac- Short arboon manager can temporarily ‘cash out’ of If the fund invests in sectors in ceptable primary business activi- The platform and fund managers a position. The money has to be held which purification often arises – for ties, there are some companies with do not sell what they do not own. in a non-interest bearing account or, if example, retail outlets or REITs – or acceptable primary businesses, like By using a prescribed methodology the term is longer than say, overnight, if it invests in a variety of sectors, the manufacture of spare parts for developed and certified by the Sha- the cash needs to be invested in a Sha- the board will recommend a flat puri- cars for example, that might own or riah supervisory board, hedge funds riah compliant, short-term instrument fication rate of, say, 1.5% be applied engage in unacceptable businesses, implement a Shariah compliant short like a murabahah. to the investor’s net earnings. like the sale of alcohol at company sale equivalent, known as the short If a fund holds stocks that have canteens or restaurants they own Purification arboon sale. This alternative method, especially high revenues from unac- and operate at their factories. which replicates the economic results One potential glitch is what to do ceptable activities (still less than 5%), When the Shariah monitoring of a short sale without using the when a fund accidentally trades an the board has the right to recommend processes show that revenues from borrow-and-sell method of shorting, unacceptable stock. While all com- a higher purification rate. an unacceptable source exceed 5% needed two steps to be possible. panies are screened for unacceptable If a manager or a trader inadvert- of total revenue, then the company First was the creation and certi- primary business activities, a man- ently purchases an unacceptable will be screened out and declared fication by means of a fatwa of a ager may not realise a stock being stock, the board will deliberate and unacceptable for Shariah compliant Shariah compliant short sale method- traded is not on the list until after could recommend an appropriate investments. ology. The second was the modifica- the trade is made. When the Shariah amount to be purified from the fund’s But if the ‘impure’ revenues are tion of prime broker documentation monitoring processes discovers a profits resulting from the oversight. less than 5%, the stock may be held. to replace conventional short sale profit was made from a non-Shariah Investors will be told about all rec- Investors will be responsible for methods with the approved, Shariah compliant stock, a few remedial steps ommendations made by the board on purifying the investment by giving a compliant short sale arboon (article, can be taken. purification through the Al Safi Trust commensurate portion of fund earn- page 12). First, the company will be ‘screened administrator. ings to charities of their choice. The platform also uses an alterna- out’ and declared unacceptable for The Al Safi Trust and hedge fund While different Shariah supervisory tive set of prime brokerage documen- Shariah compliant investments for managers are not responsible for boards have different ways of dealing tation for all trades, whether long or the future. If ‘impure’ revenues from portfolio purification. Investors are. with purification, the Al Safi Trust short. This ensures every trade is the transactions are less than 5%, This way investors can donate purifi- Shariah supervisory board takes a done under Shariah rules: no interest, the stock can be held, but investors cation money to the charities of their practical approach, offering different no prohibited terms and conditions will be responsible for ‘purifying’ the choice. Although the platform will solutions for different managers. and no prohibited operations (like investment. This is done by giving recommend how much should go to Stock dividends is another area the purchase or sale of prohibited an equal proportion of the earnings charity, investors make the final allo- where there are special rules. While businesses such as pork or alcohol to charities chosen by the fund. cations themselves. many Shariah compliant funds cal- production, banks and insurance Different Shariah supervisory culate purification liabilities and then Dealing with cash and purification companies). boards have different ways of dealing pay the them from dividends, this is All managers on the platform are with purification. The Al Safi Trust Clear investment guidelines have not the practice of the Al Safi Trust contractually obligated to execute Shariah supervisory board takes a been given to all the hedge fund man- or its sub-trust managers. There are short sales through Barclays Capital practical approach. It offers different agers on the platform on how to deal three main reasons. Not all stocks prime brokerage. Managers can solutions for different managers. The with cash. Cash is never to be depos- pay dividends. Hedge fund managers initiate long-only trades with other board studies the strategy and sector ited in interest-earning accounts or are active traders of stocks and many brokers, but they need to be settled at concentration(s) of each fund on the instruments. If a manager needed to only occasionally hold stocks long Barclays. platform. If it finds the fund invests “cash out” temporarily a position, the enough to collect dividends. Finally, Shariah compliant contracts allow exclusively in a particular sector in money will be held in a non-interest the Al Safi Trust Platform funds Barclays Capital Prime Brokerage which there is almost never any need bearing account or, if the term is have already been given a purifica- to process trades initiated by hedge for purification, such as healthcare, likely to be longer, invested in a Sha- tion formula by the Shariah supervi- fund managers, avoiding all the pro- technology or telecommunications, riah compliant, short-term instru- sory board. So investors should not hibited elements present in prime then the Shariah board will recom- ment like a murabahah. be troubled by dividends and com- brokerage contracts commonly mend there is no need for purification Another area hedge funds may plex purification formulas. n ESTIMATED GROWTH OF ASSETS/NET ASSET FLOW FATWA APPROVALS EqUITy HEDGE (TOTAL) 1990–q2 2008 Short sale equivalent structure Fatwa relating to arboon structure to effect short sales of securities and long 8,000 7,634 7,601 7,591 Number of funds Hedge funds 7,241 sales and purchases of securities’ Fund of funds 7,000 6,665 Dated 12 Rabi’al Awwal 1426 AH (short sale equivalent fatwa) 5,782 6,000 Option equivalent structure 5,065 Fatwa relating to arboon structure to effect options trading 5,000 4,598 Dated 12 Rabi’al Awwal 1426 AH (options equivalent fatwa) 3,904 4,000 3,335 3,102 2,848 Platform solution 3,000 2,642 2,572 2,564 2,462 2,392 Fatwa relating to Shariah governed equity trading software which will be 2,462 2,006 1,996 2,000 used by Shariah Capital 1,654 1,654 1,277 1,232 Dated 12 Rabi’al Awwal 1426 AH 937 1,000 781 694 550 530 515 538 477 426 389 377 291 237 168 127 Fatwa relating to financial screen for Shariah compliance 0 80 Dated 9 Rajab 1424 AH (Shariah screens fatwa) 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 Q1 Q2 08 08 Source: Hedge Fund Research November 2008 | Access to IslAmIc Hedge Funds supplement | 7
  7. 7. al safi trust platform Innovative one-stop solution could lead way for Shariah compliant funds There is a lot of scepticism among Islamic scholars about how to make hedge funds mainstream in the Islamic investment community. One of their major concerns is that hedge funds are perceived as trading in risk to obtain returns through speculation, which is forbidden under Shariah law. Al Safi is an independent, Cayman based Shariah compliant investment the prohibited elements – interest, SEARCH FOR ISLAMIC Islands-based alterative investment product that goes beyond any- prohibited terms, prohibited trans- FINANCING STANDARDS platform designed specifically for thing previously experienced in the actions, prohibited fees – that are Shariah compliant hedge fund strat- Islamic market. present in prime brokerage contracts The Islamic finance industry is egies. Initially the platform will offer For the first time Islamic investors used for conventional hedge funds. rapidly growing and evolving. While commodity and long/short equity have access to sophisticated trading Through a refined Shariah there are still many outstanding hedge fund investment strategies to strategies, world-class managers screening process using proprietary issues – and no doubt there will investors. and a completely new avenue for metrics and software, managers on continue to be as the industry The platform provides what commodity investment. the Al Safi Trust Platform choose evolves – standards are important. Barclays Capital calls a one-stop To ensure compliance, each man- only from a universe of Shariah They give shape to the market solution for investment managers ager is subject to oversight and compliant stocks. and help define the characteristics and investors. All of the prime bro- regular audits by a panel of Shariah Every fund on the Al Safi Trust of the industry as well as kerage, administration and Shariah scholars and all securities are pre- Platform is subject to the same providing the basis for continuing compliance functions are provided screened for Shariah compliance. contractual obligation to invest development, according to Dr on the platform in a turnkey solu- Shorting is accomplished through according to the guidelines estab- Mohamad Nedal Alchaar, secretary tion. a methodology based on a classic lished by the Shariah supervisory general of the Accounting and One of the main issues the plat- transaction known as an arboon board and subject to Shariah over- Auditing Organization for Islamic form deals with is the short selling, and by a set of exclusive prime bro- sight and auditing. Financial Institutions (AAOIFI). which is the bread and butter of kerage agreements that enable an The Al Safi Trust itself is subject AAOIFI is an Islamic international, hedge funds. Perhaps the trickiest arboon sale rather than a borrowing to oversight by a panel of Shariah autonomous, non-for-profit of the Shariah compliance issues, of securities. This replicates the eco- scholars. These scholars oversee all corporate body that prepares the platform has developed not just nomics of a conventional short sale investments made by the hedge fund accounting, auditing, governance, a solution to shorting but also a way (article, page 12). managers. ethics and Shariah standards to ensure the stocks traded by all the All managers on the Al Safi Trust The Shariah supervisory board for Islamic financial institutions hedge funds are Shariah compliant. Platform are contractually obligated has reviewed the structure and the and the industry. Professional Dubai Shariah Asset Management to buy and sell stocks exclusively operations of the Al Safi Trust and qualification programmes are (DSAM) brands and distributes a through Barclays Capital Prime has certified with a fatwa that these supported by the organisation. fund of funds product featuring the Brokerage. The Arboon short sale comply with Shariah. These include the Certified Islamic long/short equity commodity hedge equivalent allows Barclays Capital The Shariah supervisory board Public Accountant (CIPA), the fund managers on Al Safi. Through to process trades by the platform’s has also published investment Shariah advisor and auditor (CSAA) this fund of funds, DSAM offers hedge fund managers in a Shariah guidelines for each hedge fund and the corporate compliance Islamic investors a commodities- compliant manner that avoids all manager and has appointed an programmes. The organisation is supported by 155 members from 40 countries, including central TARGET ASSET CLASSES OF ISSUED ISLAMIC FUNDS banks, Islamic financial institutions and other participants from the 100 international Islamic banking and Other % 9 10 finance industry. 80 14 12 AAOIFI has gained support Private equity and for the implementation of its real estate 20 60 standards. These are now adopted Money market and 45 10 in Bahrain, the Dubai International commodities 40 9 Financial Centre, Jordan, Lebanon, Balanced Qatar, Sudan and Syria. The relevant 5 20 Fixed income authorities in Australia, Indonesia, 40 Malaysia, Pakistan, Saudi Arabia 27 Equity 0 and South Africa have issued guidelines based on AAOIFI’s 2002 2006 standards and pronouncements. Source: Global Insight, Ernst Young Analysis 8 | Access to IslAmIc Hedge Funds supplement | November 2008
  8. 8. al safi trust platform executive representative to monitor reporting and before the EDGAR be considered is usually corporate on exchanges around the world, on a full-time basis the trades and database (electronic data gathering, debt. This indicates interest and the of which more than two thirds are operations of the platform and each analysis and retrieval of SEC fil- more debt, the more interest paid. Shariah compliant. fund manager. ings) established by the US Securi- Islamic indices measure corpo- Hands-on scholarly input Through daily exception reports ties and Exchange Commission in rate debt in two ways. One divides prepared by Barclays Capital, pur- the late 1990s. total assets by total debt. The other In addition to the screening soft- chases of any stocks not on the Shariah boards that have approved divides market capitalisation by ware, the platform uses a process approved list can be reversed before and supervise the Dow Jones Islamic total debt. involving its Shariah board in the these are cleared for inclusion in a Market Indexes, the FTSE Islamic According to the Shariah super- vetting of stocks for possible inclu- manager’s portfolio. Indexes, the MSCI Barra Islamic visory boards of these indices, if sion in the portfolios of the plat- Indexes, the Standard Poor’s the ratio of debt/assets or the ratio form’s hedge fund managers. Selecting Shariah compliant stocks Islamic Indexes, and others, believe of market capitalisation/assets is The Shariah advisor may be The stock selection needs to be the screening criteria developed for less than 33%, the stock will pass asked by fund managers about any automated but robust. The Sha- the Al Safi Trust are superior to all through the screens. If it is greater, stock that has been rejected. While riah screening process uses propri- others. This is because the screening the stock will be screened out and hedge fund managers have access etary metrics and software so fund method used by the indices often declared unacceptable for Shariah to the results of screening soft- AD managers are able to choose from throws out good companies as well compliant investments. ware, they can also ask the opinion an expansive universe of stocks. as bad. The board thinks it is only The refined screens used for Al of the Shariah advisor whenever The enhanced screening criteria is a matter of time before the Al Safi Safi do not focus on debt. They they encounter a stock where there stricter from a Shariah standpoint Trust criteria are adopted as the focus directly on what is prohibited: may be questions. For example, the than the present screening criteria industry standard. interest. Debt is not prohibited by manager may have direct access used by well-known Islamic indices. The refined screens developed for Shariah rules. What is prohibited is to information about a company’s Nevertheless, it allows managers to Al Safi hedge funds focus directly the by-product of modern, conven- plans to restructure debt within a choose from a large universe and on what is prohibited. Other tional debt, which is interest. certain period of time, or to liqui- can be added to. screens focused indirectly on these This results in a more refined date a business that disqualifies it The screening process is designed elements. The well-known screens screen that is more exacting for from inclusion, or to merge with a to weed out “unacceptable” compa- begin by considering a company’s companies to pass. Using advanced larger company and become com- nies. It has been designed to accom- primary business and then by scru- software and data feeds, fund man- pliant. This information could affect modate screening criteria developed tinising its financials. agers on the platform have access whether or not a company meets by Shariah boards before electronic The first of the financial items to to 45,000 stocks that are traded Shariah standards. n RENOWNED SCHOLARS FORM AL SAFI SHARIAH SUPERVISORy BOARD Shariah Capital draws on the top Financial Institutions (AAOIFI). the leading authority on Islamic finance and has presented numerous tiers of internationally recognised Sheikh Nizam is an advisor to legal theory and Islamic finance in research papers at industry Shariah scholars to form separate a number of banks and financial Malaysia. conferences. He holds a PhD in Shariah boards for each of its institutions including National A former associate professor Islamic law from Umm Al Qurra projects. This means Shariah scholars Bank of Abu Dhabi, Investcorp, in Islamic law and deputy rector, University in Mecca, Saudi Arabia. work on projects best suited to the Gulf Finance House, Citi Islamic student affairs and disciplines, at Shaykh yusuf Talal DeLorenzo particular areas of their expertise. Investment Bank, Royal Bank of the International Islamic University (US), non-voting executive This process, says Shariah Capital, Canada, Islamic Bank of Britain Malaysia, his areas of specialisation representative ensures the right scholars develop, and European Islamic Investment include Islamic legal theory, Islamic certify and supervise the financial Bank. He is frequently called upon banking and finance and Islamic law Shaykh Yusuf Talal DeLorenzo, the products and services endorsed by to consult with governmental and of zakat. chief Shariah officer at Shariah the company. regulatory authorities on issues Dr Daud is a member of a number Capital, is a scholar of Islamic The scholars on the Al Safi Shariah related to Islamic finance of international Shariah supervisory transactional law. He is the author of Compendium of Legal Opinions supervisory baord is made up of Having taught tafsir, hadith and boards including the Dow Jones on the Operations of Islamic Banks, leading scholars in Islamic finance fiqh in Bahrain since 1976, Sheikh Islamic Market Indexes, HSBC drawn from Bahrain, Malaysia, the Nizam contributes original research (Malaysia), Unicorn Investment the first English/Arabic reference US and UAE. on many aspects of modern Islamic Bank (Bahrain), BNP Paribas, Oasis on the fatwas issued by Shariah finance and is the author of several Asset Management, the Japan Bank boards. Shaykh Yusuf also wrote the Sheikh Nizam yaquby (Bahrain), introduction to Islamic Bonds, the articles and publications published for International Co-operation, the chairman in English and Arabic. He recently Shariah board of AAOIFI and others. 2003 book that introduced sukuk. Sheikh Nizam Yaquby has an participated in the development and His work has appeared in academic Dr Mohammad Abdul Rahim advanced degree in Economics certification of several international and industry journals and as chapters Sultan Al Olama (UAE) and Comparative Religion from sukuk issues. in books. McGill University and has authored Dr Mohammad Abdul Rahim Sultan Shaykh Yusuf was a special Dr Mohd Daud Bakar (Malaysia) numerous fatwa related to innovative Al Olama is a member of the faculty consultant to the Asian Development Shariah-compliant financial products. Dr Mohd Daud Bakar is the of Shariah at UAE University and Bank and the Islamic Development Sheikh Nizam is internationally president/CEO of the International a member of the fatwa committee Bank on their joint project for the known as one of the leading scholars Institute of Islamic Finance and at the department of religious Islamic Financial Services Board. He is of modern Islamic finance. Amanie Business Solutions, a and charitable affairs in Dubai. In a member of the Council of Scholars, He serves on the Shariah consulting company. He is also the addition, he is a member of the board ISRA, Central Bank of Malaysia and supervisory boards of over 40 chairman of the central Shariah of AAOIFI and serves as a member a member of the governing council financial institutions worldwide, advisory council of the Central of the Shariah boards of Mawarid of the International Centre for including several key memberships on Bank of Malaysia and a member of Finance, Manazel Real Estate, Al Education in Islamic Finance (INCEIF) the boards of the Dow Jones Islamic the Shariah advisory council of the Mada’in Finance and others. in Malaysia. Recently, Shaykh Yusuf Market Indexes and the Auditing and Malaysian Securities and Exchange Dr Mohammad has written was appointed a member of AAOIFI’s Accounting Organization of Islamic Commission. He is considered extensively on modern Islamic Shariah board. November 2008 | Access to IslAmIc Hedge Funds supplement | 9
  9. 9. 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 particularly as investors in the The result was the Al Safi Trust compliant offering in October 2005. been various attempts to develop Middle East look for new investment Platform. The name of the solution Only a handful of hedge funds are a Shariah compliant hedge fund opportunities. is indicative of its ambitions. Al Safi currently listed on its platform, investment route to cater for ethical “We started creating the Al Safi means ‘pure’ or ‘clear’. What Bar- including the Al Raed Emerging Islamic sovereign wealth inves- platform 18 months ago because we clays Capital, the investment banking Markets Fund (North of South Cap- tors, pension funds, other institu- saw there was a demand for Shariah side of Barclays Bank, and the Dubai ital), the Old Mutual Al Saqr Fund tional investors and retail investors. compliant alternative investments Multi Commodities Centre Authority (Old Mutual) and the Lucerne Shari’a Several have launched and failed, among Islamic institutional inves- (DMCC), an agency of the Dubai Istithmar Fund (ReachCapital Man- mainly due to the lack of a signifi- tors,” says Frank Gerhard, director government, has created is a Shariah agement). cant sponsor prepared to supply the and head of fund linked derivatives compliant platform for hedge funds. London-based Islamic financial seed capital necessary to create a product strategy at Barclays Capital It committed to seed five commodity services company Amiri Capital profitable platform. Although sev- in London. The request, he says, hedge fund managers on Al Safi with intends to launch a Shariah compliant eral fund-linked derivatives exist, came from the sales group. “They $50 million each, a total of $250 mil- fund of funds within the next few their uptake among the Islamic were looking to expand the Shariah lion for a Shariah compliant fund of months. BNP Paribas is looking to investor community has been slow governed investable universe for cli- funds products to be offered under offer structured products referenced with assets dripping in rather than ents,” confirms Gerhard. the Dubai Shariah Asset Manage- to Shariah compliant hedge funds. flowing. There were some Shariah com- ment (DSAM) brand. Citi is believed to be developing an While significant assets from pliant products, but collectively they Al Safi is a comprehensive Sha- Islamic hedge fund platform. Islamic investors have gone into did not offer wide diversification riah compliant platform comprised Despite these various initiatives, alternative funds and hedge funds, across instruments or portfolios. The initially of single strategy alterna- little progress has been made. How- there is a growing demand for Sha- team at Barclays Capital sat down tive investment managers with Sha- ever, Barclays Capital hopes that as riah compliant hedge funds. With a and the result was the idea to create riah Capital as the Shariah advisor investors become more comfortable, serious alternative to non-Shariah a one-stop-shop solution that would and Barclays Capital as the prime high-profile allocations by entities compliant investing in existence allow hedge funds to carry on with broker and eventually the structured such as the DMCC could persuade through the Al Safi platform, Islamic their lucrative strategies but within product distributor. other Islamic investors to follow suit, investors and institutions can begin a Shariah compliant framework that Barclays Capital was not the first in turn causing assets under man- to diversify portfolios and add alter- did not add unnecessary burdens to to try to find a solution. Newedge, agement to slowly inflate. native investment strategies that the hedge fund or impose punitive jointly owned by Calyon and Société “It is possible that some Islamic conform to the principles and ideals charges on investors. Générale, launched its Shariah institutional investors may wait of the Islamic faith. Factors that in the past restricted TARGET ASSET CLASSES OF SHARIAH COMPLIANT FUND UNIVERSE the growth of Shariah compliant hedge fund investing – such as Proportion of funds targeting asset class (as a % of total) 100 increased fees, restricted investment 10 11 10 Other 18 universe and lack of world-class 29 27 6 26 80 10 Money market managers – have been solved by the 27 13 20 15 Balanced 7 8 Al Safi platform. By tackling these 14 60 10 Fixed income 8 13 7 7 obstacles the Al Safi platform has 1 22 5 Equity 40 opened the floodgates to a new era 67 63 52 of liquid, profitable Shariah com- 54 49 51 20 42 pliant hedge fund investing. While the number of funds signed 0 up to Shariah compliant platforms Global Europe North Middle Asia Shariah Conventional America East Paci c compliant mutual remains small, the prospects for fund fund Shariah compliant funds by geographical mandate universe universe growth are positive. The potential demand for Islamic hedge funds is Source: Eurekahedge Islamic Funds Database, Investment Company Institute, Ernst Young Analysis huge, say many market observers, 10 | Access to IslAmIc Hedge Funds supplement | November 2008
  10. 10. success of al safi number of enquiries are coming it’s also good to have the lead with TyPICAL ASSET ALLOCATIONS from equity long short managers,” a reliable, credible and transparent says Gerhard. Shariah solution,” notes Gerhard. Alternatives Fixed income Once investors and hedge fund The future of the platform is hard Equity Real estate managers have been introduced to predict. While Gerhard believes its Cash/Deposits 20% to the notion of Al Safi as a “new capacity is huge, it is also necessary 15% 10% Allocation across the instrument”, the feedback from them to start small and grow. “We need to private equity and real Limited investment in Exposure to cash/deposits estate asset classes but real estate and xed inc largely is extremely positive. “Once man- walk before we can run. We’re still focused internationally through balanced funds 30% 5% 15% agers appreciate the concept they are in the ramping-up phase of the plat- 80% keen. They see the platform as a sen- form. We are getting the initial funds Cash/deposits allocations 5% required to meet short- sible way of approaching the chal- up and running and broadening dis- 5% term obligations 60% 60% lenge of delivering Shariah governed cussions with seed investors. As we hedge funds,” Gerhard notes. grow the platform, we need to make Typical Middle Eastern investors sure the funds and infrastructure already have significant experience stay within the Shariah requirements Equities dominate in alternative investments so they are and that we are offering more and asset allocation due to ease-of-access and Equity allocation split familiar with the concept of hedge more diversification across man- Regional listed equities availability through between local and dominate allocation mutual funds international funds. “At the moment we are seeing agers. Then we can branch out into HNWI/UHNWI Mass a uent investors a very strong move towards Shariah structured products where we may Takaful operators governed solutions. If we can pro- address the need for cash substitutes Source: Industry Interviews, Ernst Young Analysis vide generally attractive returns in and introduce derivative instruments. the Shariah space compared with That’s very much stages three and until they see others getting involved could become a standard for future non-Shariah, there is appetite. But four, after diversification is achieved.” before they start investing in hedge Shariah compliant hedge fund plat- we have to offer both: attractive Addressing what some may see funds themselves,” notes Shaykh forms and products. returns and a credible solution,” as a delay in launching more funds Yusuf Talal DeLorenzo, the chief According to Gerhard, roadshows declares Gerhard. on the platform, Gerhard answers Shariah officer at Shariah Capital, throughout the region by Barclays Middle Eastern investors are simply. “It is about timing. Actually one of the companies involved with Capital aimed at assessing and already one of the most important our timing was very fortunate. In the Al Safi platform. attracting investor interest in seeding alternative investors globally. The this space returns in commodity and “There is potential for Al Safi more funds has shown “significant high net worth and ultra high net equities have not been encouraging. to attract billions in investment,” interest from corporate treasuries, but worth individuals as well as large By delaying we feel we have given a declares Eric Meyer, chairman and also from banks. We also have some institutional investors and banks better choice, from an investor’s per- chief executive of Shariah Capital. players in the wealth management are interested in alternatives. “We spective,” he says. “Based on this assumption, we have space who are interested in seeding. already see strong interest for the Barclays Capital was also keen to been willing to undergo significant There is interest in using the plat- ethical investment aspect across the ensure the platform did not penalise time and expense to get the platform form as an open architecture means board. Investors are already begin- investors on the fee side or on any right,” he says. of creating and launching their own ning to migrate portfolios to Shariah other economic parameters for The success of Al Safi, Barclays products,” explains Gerhard. compliant vehicles. It depends how choosing a Shariah-governed solu- Capital believes, will come from its Barclays Capital expects to have a much of the allocations they can tion. “It was quite important from entirely different approach, basing its commitment from at least one wealth move and on the ability of a man- the beginning not to have to say to short selling mechanism on the con- manager in the region to go ahead ager to generate returns in the Sha- an investor choose one or the other. cept of arboon. An arboon contract and start seeding funds, probably riah compliant space. We see Al Safi Ethical investors are also seeking entitles the investor to purchase an by the end of 2008. The investment, as providing a solid environment for returns. It won’t work if the eco- asset at an agreed price at any time although relatively small at the start, Shariah governed hedge funds,” con- nomics are not right. The solution up to the maturity of the contract. is expected to overtake the $250 mil- cludes Gerhard. has to be sustainable. There is no The investor provides a deposit to lion seed captial put up by DMCC. question in our minds regarding Having the competitive edge the counterparty, which is forfeited Gerhard believes there was initial this,” he declares. if the investor decides not to proceed scepticism about the idea. However, Gerhard believes Barclays Capital Looking at the platform, Gerhard with the purchase (article, page 12). once investors understand the detail through Al Safi has a competitive sees success in simply getting the “With the capital support of a of the operation and how Barclays edge. He points to the months of project up and working. He says sovereign government and the prime Capital through DSAM ensures Sha- negotiation needed to hammer out they are at the beginning of the broker and structuring expertise of riah compliance, they are keen to prime brokerage documentation that process. “On the one hand we are Barclays Capital, the Al Safi Trust become involved. Barclays Capital was acceptable not only to the bank very pleased and thrilled that we’ve Platform is a historic development has also made a significant invest- but also to the Shariah scholars. got the pilot off to such a good start that unites modern investment strat- ment in both time and money – as “Yes, the arboon structure has been where other competitors have failed. egies with Shariah,” adds Meyer. well as in part staking its reputation available for five or seven years as a We are enjoying that,” says Gerhard. David Rutledge, chief executive on the success of the platform – in theoretical solution to this specfic “We have had very positive feed- of DMCC, agrees. “It [the platform] providing its prime brokerage serv- problem. But implementation and back from the industry. Over time enables us to access exceptional ices to the platform. delivery was the challenging part. We we will provide further innovations managers with strong track records He points to the blue chip fund had to make sure it met all the require- available within the same rigorous in order to achieve our goal of deliv- managers the platform is attracting. ments to provide a proper arboon scrutiny. But at the moment we want ering diversified exposure across a “There is real appetite from invest- structure and that we could imple- to make sure the confidence of inves- range of commodity sectors to both ment managers to find a way to ment the solution reliably in the prime tors in this product is justified; that institutional and individual inves- access the alternative investment services context,” Gerhard says. they see a transparent platform that tors interested in Shariah compliant space in the Middle Eastern region. Having now found a solution, is guided by Shariah principles. Time investment products and solutions.” Multi-billion funds with an average he says Barclays may have a small will tell if the platform becomes the While there is still a lot of scepti- size of $2–$3 billion in assets under window where it will lead the market. Shariah standard. At the moment cism, not least from the media, those management (AUM) are approaching But he also believes “it is important we want to give the market a trans- involved in the Al Safi platform are us and want to market themselves to have competitors in the market. It parent, credible solution,” concludes convinced the solution it presents through the platform. The largest helps make the market efficient. But Gerhard. n November 2008 | Access to IslAmIc Hedge Funds supplement | 11