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2004 Overview: Key Trends in Islamic Hedge Funds

The modern Islamic fund management industry was born in the 1970s, when a new class of Arab investors, rich from oil profits and celebrating the 15th century of the Islamic calendar (Hijra) in 1976, sought a culturally-aware alternative to the "profit at all costs" mentality of western investing, particularly in interest-dealings. The industry has been growing ever since: Islamic banking is active in 75 countries and is growing at 15% globally, with an estimated $1 trillion waiting to be managed.

The primary characteristic that distinguishes Islamic fund management from conventional investing is its compliance with Shariah law. Fund managers who are Shariah compliant must adhere to moral economic activity and invest only in companies that have an ethical purpose. In addition, the investors cannot deal with conventional banks that trade in fixed rate interest, or Riba, but instead would depend on Ijara, an Islamic method of financing. Investments must also be screened for companies that trade items restricted in Islamic laws, such as alcohol, tobacco, pork, gambling or pornography. While limiting investment strategy might seem a hindrance, there are advantages to this "ethical" investing. For instance, Islamic funds were little affected by the scandals afflicting companies such as Enron and WorldCom several years ago, as these companies' highly leveraged balance sheets restricted Shariah funds from buying them. In fact, some conventional managers have adopted Shariah law for strategic purposes.

Today, there are over 250 Islamic financial institutions with assets around $230 billion. However, the vast wealth of Islamic funds under management is not well-diversified; Saudi Arabia controls 70% of all assets under management. The primary fund management companies that cater to these investors are Citibank (Saudi American Bank), HSBC (Saudi British Bank/Al Amanah), Al Rahji and Al Ahli. Outside the Muslim world, London is the world's hub of Islamic banking activity; however, its banks offer few retail products to the Muslim community.

In Southeast Asia, Malaysia is the aggressive force, holding 9% of Muslim finances. Reciprocally, Islamic banking comprises 10% of Malaysian finances. With a dominant force like Saudi Arabia in the mix, Malaysia's goal of being the number one player in the Islamic fund industry remains a daunting challenge. However, with industry liberalisation following the 9-11 attacks, its efforts to woo rich Saudis have given it a decisive regional advantage.

One of the key factors towards propelling Islamic investment management into the mainstream is to acquire non-Muslim funds and clients, a trend which has already materialised in Malaysia: 70% of Malaysia's Islamic banking customers are Chinese. However, this trend may owe more to the distribution of wealth in Malaysia than to demographic preferences. Singapore also intends to throw its hat into the ring, according to the MAS' new chairman, Goh Chok Tong (Singapore's ex Prime Minister), who plans to attract more Islamic businesses to the country. In addition, OCBC, DBS and UOB - Singapore's three principal banks - which manage Islamic funds are exploring opportunities in Malaysia and, to a lesser extent, the Middle East.

The world of Islamic finance extends far beyond basic fund management, particularly in Sukuk (Islamic bonds) and hedge funds. In fact, the first Shariah-compliant hedge fund - the Shariah Equity Opportunity Fund - was launched on October 10 in the Gulf, although the Shariah restrictions reduce its risk and speculative structure. Given the recent surges in oil prices, private wealth in the Middle East is expanding at unprecedented rates, and currently stands at about $1.5 trillion, much of which is more inclined to invest domestically, as long as there is supporting infrastructure. To the victor who can capitalise on these investment opportunities, the spoils will undoubtedly be tremendous.