Asset classes in Islamic capital markets

THE spectacular growth of Islamic finance has been one of the defining trends in Arab finance in the past two decades. With $275 billion in assets and a growth rate of 15 per cent, Islamic institutions represent a significant, growing pool of multinational capital. Islamic investment and development funds, such as Jeddah's IDB, have been instrumental in the design of multi-billion dollar capital markets instruments to assist the economic development of the Muslim world. Islamic capital markets instruments such as Sukuk and Arboun have emerged as innovative alternatives to conventional Western financial instruments such as bonds and options. Yet, despite its exciting intellectual ferment, the arena of Islamic investments is still replete with lack of uniform standards, ambiguity about the Sharia compliance across institutions and a hostile environment in the United States after September 11.

By Gulf Money By Matein Khalid

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Published: Sun 5 Oct 2003, 12:25 PM

Last updated: Wed 1 Apr 2015, 9:32 PM

The problem manifests itself most clearly in the area of Islamic investments. It is easy enough to list conventional Western financial tools, that would be considered impermissible by most Sharia scholars. These would include short selling futures/options or indeed all derivatives, leveraged speculation, forward foreign exchange, hedge funds of almost all conceivable variety. However, innovative bankers have created Islamic investment funds that are based on asset classes where there is no obvious Sharia compliance issue.

Take for instance, real estate structured Islamic transactions in real estate have become almost a staple, flagship product for the various Islamic investment banks in the Gulf.

With the havoc in the world financial markets in the past three years, the intrinsic attraction of real estate to the Middle East investor is not hard to understand.

Real estate has proven to generate excellent returns with lower volatility and, in countries plagued by high inflation or geopolitical uncertainty, a hedge against currency devaluation. Morever, the institutional architecture for real estate investing is so well developed in countries like Britain and the United States - where pension funds and insurance companies literally dominate the trillion dollar real estate market - that it was possible even for new Islamic investment banks to graft "best of breed" practices in their structured Islamic real estate funds.

The second area where Sharia compliant principles have been used to design innovative product has been in private equity. In fact, First Islamic Investment Bank and a few other banks in Bahrain and Kuwait, have written the book on corporate acquisitions using Islamic principles. This, in turn, led to the creation and distribution of private equity funds using Islamic principles. Unfortunately, technology investing became the craze in the late 1990, both because of the Silicon Valley bubble and also because private technology companies did not violate the debt/equity or obvious prohibitions. Unfortunately, the collapse of the technology bubble has hit Islamic private equity funds disproportionately hard and soured the appetite for investors in this asset class, even though valuations are extraordinarily attractive in such private equity areas as retailing or health care.

The creation of the Dow Jones Islamic indices suggests that portfolio management expertise based on Sharia principles is a growth area in the Middle East. A number of Gulf banks, such as Saudi Arabia's NCB have actually created entire menus of Islamic investment products, that include both equities and other fixed income alternative products such as leasing and trade receivables.

In fact, Saudi Arabia has been leading the innovation curve in Islamic investment products. This is due to the fact that it has the largest and oldest mutual fund industry in the region and that all the major Saudi banks have Islamic investment products subsidiaries. In Islamic investing, supply of innovative products creates its own demand.

Morever, themes such as regional real estate or trade finance can also be profitably incorporated in a Islamic investment product menu. With the evolution of the Arab equity and capital markets a given in the decade ahead, the challenge for investment bankers is to source, structure and manage investment, not just for sophisticated investors but for the millions of Muslims who seek Sharia compliant wealth management products.

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