Islamic hedge funds

I have no claim to any expertise in Islamic finance. What little I do know about Islamic financing has impressed me. There is a principle against usury. This underlies the principle of Islamic financing that is characterised by partnership and common venture between the lender and borrower.

Islamic finance is principles-based and values-based. 

So, when I hear that the Securities Commission (SC) is working on a plan to establish Islamic hedge funds, I am rather perplexed. Here's an interesting extract from the NST Online report:

Speakers at the forum (on Islamic capital market) said there is a growing number of investors in the world who require alternative Islamic investments such as hedge funds. 

The problem, however, is that there hasn’t been broad acceptance for hedge funds among syariah scholars and investors. “They are saying, ‘Do we need to go down this route at all?,” said Iqbal Asaria, a director of UK-based Amiri Capital Services Ltd, an Islamic asset manager.

Good question. Does Islamic financing need to go down the route of creating hedge funds?

These guys can say anything they like and create whatever legal fiction that is possible to squeeze conventional notions of hedge funds to become Islam-compliant. But I don't think the key principles of hedge funds will be any different. Read this:

A hedge fund is a private investment fund open to a limited range of investors that is permitted by regulators to undertake a wider range of activities than other investment funds and also pays a Performance fee to its investment manager. Although each fund will have its own strategy which determines the type of investments and the methods of investment it undertakes, hedge funds as a class invest in a broad range of investments, from shares, debt and commodities to works of art.

As the name implies, hedge funds often seek to offset potential losses in the principal markets they invest in by their investments using a variety of methods, most notably the term "hedge fund" has come to be applied to many funds that do not actually hedge their investments, and in particular to funds using short selling and other "hedging" methods to increase rather than reduce risk, with the expectation of increasing return.

Hedge funds are typically open only to a limited range of professional or wealthy investors. This provides them with an exemption in many jurisdictions from regulations governing short selling of interests in the fund. A hedge fund will nevertheless commit itself to a particular investment strategy, and therefore often particular investment types and leverage levels, via statements in its offering documentation, thereby giving investors some certainty regarding the nature of the fund.

Hedge funds dominate certain specialty markets such as trading within derivatives with high-yield ratings and distressed debt.

Now, I ask again, does Islamic finance REALLY need hedge funds?

The scary thing comes from this part of the same NST Online report:

While risky, it is an opportune time to launch Islamic hedge funds now as many conventional hedge fund companies have ceased to exist after being badly hit by global credit crisis.

Following the logic of that deadpan observation, the SC is considering Islamic hedge funds AND the timing is perfect because the conventional hedge funds ARE DEAD.

And, WHY are the conventional hedge funds dead? The obvious answer is that the hedge funds took on too much risk to the point where they could not figure out how much risk they had taken on. So, when the underlying assets started to drop in value, the entire unwieldy edifice of hedge funds started to crack and tumble like a house of cards. It was a flimsy asset foundation to start of with.

I think it is surreal to hear that the SC is actually considering Islamic hedge funds. Hedge funds are no different from derivatives, both of which are the principal causes of the current global financial turmoil.

No matter how you dress it in Islamic verbiage, a hedge fund is a hedge fund. It is an instrument designed to play with chance but instead of calling it chance, they call it risk. It means the same thing.

I say to the SC, go forth on Islamic hedge funds and run the risk that when the Islamic hedge funds get implemented and played out and crash in the next cycle (Oh Yes! There WILL be another cycle as surely as the seasons change) the credibility of Islamic finance will be severely damaged.

Go back to the core principles of Islamic financing. Stick to the core principles and do not deviate too far from it. This has been the underlying strength and proven resilience of Islamic financing. 

Mark my words, Islamic hedge funds are the proverbial Trojan horse that will mortally wound the nascent Islamic finance industry.