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Shariah money close to hedge
Hedge funds have been considered one of the great taboos of Shariah compliant investing, since they tend to carry a large amount of risk and involve selling assets before they are purchased, but this could be about to change.
Deutsche Bank has released a white paper to the industry which gives details of a way in which Islamic investors can gain exposure to hedge funds while adhering to Shariah principles.
Geert Bossuyt is managing director, regional head of Middle East structuring, global markets, Deutsche Bank. His job is to come up with new spins on existing financial products and find ways to open asset classes to new investors.
"The academic paper talks about one of the issues the industry had, and that issue was getting away from the traditional asset classes that Islamic finance was about, being real estate, equity or murabaha deposits," says Bossuyt.
"That's non-diversified. What we wanted to do was in an Islamic way, a Shariah compliant way, give investors exposure to alternative asset classes."
The investment bank developed a technique which achieved this, based on a credit swap that means an Islamic investor is distanced from alternative assets but can still benefit from their revenue.
"It is an Islamic compliant total return swap," says Bossuyt. "To give you an example, an Islamic investor who wants to have exposure - not invest into, but get exposure - to hedge funds, gives us US$100. That $100 we put into Shariah compliant assets.
"Then on top of that we do a total return swap. We give away the return on those Shariah compliant assets to a counterpart. That counterpart in return gives us exposure to hedge fund returns."
This way, the cash is kept in Shariah compliant assets and the swap is conducted in a Shariah compliant way. "We cannot allow Islamic investors to invest in non Shariah compliant assets, but we have created an exposure to non Shariah compliant assets in a Shariah compliant way," says Bossuyt. "That may sound strange to you, but if you look at the sukuk market, 80% of Islamic bonds are linked to LIBOR (London Inter Bank Offered Rate). LIBOR itself is a non-Shariah compliant index."
He stresses that Deutsche Bank just provides the products and leaves it up to individuals to make their own choices.
"We make the most aggressive Shariah compliant structures to the most conservative Shariah compliant structures," says Bossuyt. "At the end of the day, it's the scholars or the client or the distributor of the product that says how far they want to take it. We will not make that judgment for you, you have to make it for yourself."
Deutsche Bank has used the technique for some time, but it only made the details available to its clients, who had to sign a confidentiality agreement. Around one year ago, it was decided to make the paper public - partly because some banks were releasing similar products, or even imitations, and because Deutsche Bank felt that making its development public might inspire innovation in the industry to benefit everyone.
"We can only hope that that paper brings other players, first of all to copy that structure, which we have no problem with any more, and secondly that it's an inspiration for them to do similar things: talking to academics and trying together to find new ways to solve issues with regards to Islamic structuring," says Bossuyt.
Bossuyt's next project is even more challenging. "We are also working on Shariah compliant hedge funds where everything within the hedge fund is Shariah compliant," he says. "There's a solution for everything - the question sometimes is, is it an economically feasible solution?"
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