Investors that follow the principles of Islamic finance often find hedge funds difficult to access as the funds’ strategies typically contradict Sharia principles. For example, short selling, receiving interest and speculating are all prohibited. The Al Safi platform claims to provide a framework for providing the same economic outcomes as investing in hedge funds while maintaining Sharia principles, through legal structures approved by Islamic scholars.
“We started creating the Al Safi platform 18 months ago because we saw there was demand for Sharia-compliant alternative investments among Islamic institutional investors,” said Frank Gerhard, head of fund-linked derivatives strategy at Barclays Capital in London.
Initially there will be five hedge funds listed on the platform, providing exposure to different types of commodities: Tocqueville Asset Management covering gold; Lucas Capital Management focussing on energy, oil and gas; Zweig-DiMenna International Managers covering natural resources, Ospraie Management dedicated to agriculture; and Blackrock investing in global resources and mining. In accordance with the requirements of the platform, these funds can execute both long and short trades for equities of firms in the various commodity markets. They cannot trade derivatives because these instruments are seen as speculative, according to Islamic finance rules. Barclays Capital plans to launch other types of long/short equity hedge fund managers soon.
The hedge funds on the platform can long equities using any equity broker. However, under the terms of using the platform, they can only short equities through Barclays Capital’s prime brokerage. The bank has developed a method for short selling in a Sharia-compliant way under the guidance and approval of Al Safi’s Sharia supervisory board, which includes four Islamic finance scholars from Bahrain, Malaysia, the US and United Arab Emirates.
The method used for short selling is called the 'Aboon' sale. When a hedge fund manager wants to short a stock on Al Safi, the trader puts an order through the Barclays Capital’s prime brokerage in much the same way as the trader would normally place such an order. The difference is that, on Al Safi, the bank facilitates the transaction as a purchase, not as a loan. While the mechanics of the sale are different, the bank claims the economics of the transaction are the same as a conventional short sale.
The platform has initially attracted investment from the Dubai government through its agency created to establish a commodity market place in Dubai, the Dubai Multi Commodities Centre Authority. This has committed to provide seed capital of $50 million to each of the five hedge funds on the platform totalling a $250 million investment. Those involved with Al Safi see Islamic investment as a large, rapidly expanding market. Dan Rice, portfolio manager at Blackrock said: “The Middle East is a fast-growing market, with estimated investment assets of more than $3 trillion.”
“There is potential for Al Safi to attract billions in investment. Al Safi cost a significant amount of money in legal fees to set up and we expect to make up the costs through processing a high volume of business,” said Eric Meyer, chairman and chief executive of Connecticut-based Shariah Capital, which is acting as Sharia advisor for the Al Safi platform.
Barclays Capital will use the hedge funds on Al Safi as underlyings for structured products and will be the sole distributor for them.
Another brokerage has been running a Sharia-compliant platform for access to hedge funds for over 18 months. The merged brokerages of Société Générale and Calyon, Newedge Group, launched its prime brokerage platform servicing Sharia-compliant equity long/short funds in October 2005.
The platform was designed to accommodate funds that employ equity long/short strategies. At the time of launch there was one fund on the platform and this number has risen to five hedge funds. NewEdge said a further five funds plan to be launched by September.
Through NewEdge, the hedge funds carry out equity trades, foreign exchange trades for currency conversions, murabaha (cost-plus financing) for cash management purposes and salam trades. NewEdge trades salam contracts for the hedge funds as a way round the issue of short selling. These are bilateral contracts between two parties, under which the owner of the salam contract is obligated to deliver the goods specified in the contract, (in this case equities), to the salam counterparty at a predetermined future date in exchange for cash paid up front. Through this arrangement the fund can gain economic exposure similar to shorting a stock.
Current funds under management for NewEdge’s platform total just under $100 million.
“Expansion speed of the product has been slower than hoped. There is interest for the product in the Middle East and Asia. Product organisers in these regions are waiting for a critical mass of funds for diversification. We anticipate that with the next wave of funds launch, the diversification will be such that it will allow for more capital inflows,” said Philippe Teilhard de Chardin, global head of prime brokerage at NewEdge in London.
He also noted one of the main challenges to attracting further investment is the broad acceptance of hedge funds as a viable asset class for Sharia-compliant investors, as the reputation of innovative Sharia-compliant investments has been tarnished in the past by the release of products that have not stood up to the test of the most conservative of Sharia principles.