Looking for assets to manage? Billions of dollars are potentially available to hedge fund managers willing to abide by shari’a, the set of Islamic laws that guide Muslims in all aspects of life — from religious practices to politics to the creation of wealth and its distribution. Shari’a-compliant hedge fund managers must let religious scholars supervise all of their funds’ transactions, be prepared to give excess profits to charity as a way of purifying their portfolios and refrain from using leverage or making big, speculative bets on such things as currency swings or derivatives. George Soros–style managers need not apply.
There’s more. Shari’a-compliant hedge funds also cannot own shares in companies that sell alcohol, pork, tobacco, drugs, pornography, weapons or gambling products, or that operate movie theaters, make films or run cable TV channels. They are also forbidden from profiting from interest-bearing products — effectively eliminating financial institutions as investments — as well as trading in futures, options and swaps. Short-selling, arguably the defining element of hedge fund investing, also violates shari’a, at least in the way most traders engage in it.
Nonetheless, demand for shari’a-compliant investments has been slowly building for two decades and surged in the aftermath of the September 11 terrorist attacks and the subsequent U.S. invasion of Iraq. Some investors from the Middle East, fearful that their assets would be seized, repatriated funds to their homelands. Most Muslim-controlled assets are in the Middle East, where oil riches have created one of the highest concentrations of high-net-worth individuals, and where a wave of young, conservative investors are pressuring their families to adhere to shari’a.
“Sophisticated investors are driving the demand for shari’a-compliant investments,” says Omar Bassal, a portfolio manager at Azzad Asset Management, a shari’a-compliant investment management firm in Falls Church, Virginia. “Western financial models are blending with Middle Eastern sensibilities.”
Earlier in his career Bassal opened one of the first shari’a-compliant hedge funds in the U.S. He closed it after only two years, in 2003, when would-be investors were concerned about whether the fund’s short-selling method conformed to shari’a.
Still, Muslims have deposited $700 billion to $1 trillion in Islamic financial institutions, and some assets have already found their way to the roughly 200 investment funds worldwide that adhere to shari’a principles. Most are mutual funds, like those offered by Azzad, and only a few are registered in the U.S.
All this could change if a small New Canaan, Connecticut, outfit called Shariah Capital delivers on its claim that it has devised a shari’a-compliant way to run hedge funds, including short-selling. The method has received a fatwa, or religious ruling, from Sheikh Yusuf Talal DeLorenzo, a leading Islamic scholar who joined the firm in October 2006 as its shari’a compliance officer. Two other scholars supported him in issuing the fatwa.
Instead of managing hedge funds itself, Shariah Capital plans to make money by supplying hedge funds with software that identifies compliant companies. Once portfolios are assembled, Shariah Capital will run them past Sheikh Yusuf for a compliance audit and then offer them primarily to Muslim investors.
“We are giving these hedge funds the seal of approval,” says Shariah Capital’s founder, Eric Meyer, who earlier in his career served as a research director of a family office where he developed screens for socially responsible institutional investors like the Boy Scouts of America and the Archdiocese of New York.
Two U.S. hedge fund firms, Rye, New York–based Gabelli Asset Management and GRT Capital Partners in Boston, are using Shariah Capital’s products. Meanwhile, in London, the city outside the Middle East catering most heavily to Muslim investors, Milwaukee-based Stark Investments has launched the Stark Al-Noor fund through Fimat, the prime brokerage arm of French bank Société Générale. The Stark fund, along with two other hedge funds, is being seeded with $60 million from a large Middle Eastern bank.
Timothy Krochuk, a partner and fund manager at GRT Capital, had once considered offering a shari’a-compliant hedge fund but says his interest flagged because it took too long to find appropriate companies. Krochuk says the Internet has enabled Shariah Capital to mine vast amounts of financial data and identify hundreds of companies.
“Basically, the idea is to tilt away from companies with a lot of leverage and interest, so all the banks get taken out,” says Krochuk. “It gets a little tricky.”
Among the unique challenges of running a shari’a-compliant fund is the lack of scholars who understand both finance and Islamic law. Meyer says one of his biggest concerns was finding and compensating a full-time scholar.
And for market-neutral funds like GRT Capital’s, which aim to eliminate market risk, shari’a offers an intriguing problem. “Under shari’a, you can’t have a riskless trade because only Allah knows anything for sure,” says Krochuk.
