Islamic finance has witnessed tremendous growth over the past years, both in terms of the growth of the entire industry and in terms of the development of new and more sophisticated products that meet the increasing yet unmatched demand for structured products and comply with the principles of Shariah law. The global Islamic finance industry is valued today at approximately US$800 billion. Furthermore, there are a number of additional factors such as growth in the Muslim population (estimated to grow by over 20% within the next 8-10 years, to reach 1.6 billion, which represents 21% of the global population, against 19% as of today), an enormous increase in the wealth of this population (the wealth of high net worth individuals in the Middle East is estimated to grow at 8% per annum, to reach US$1.8 trillion by 2010), as well as a sharp rise in interest by international (non-Muslim) investors, governments, financial institutions and capital markets to enter the Islamic finance and investment space. This is documented by the value of Sukuk to be issued over the next three years, which is estimated to be worth US$30 billion, with global issuance totaling US$100 billion by 2010.
Islamic private equity focuses on acquiring majority stakes in privately-held Shariah-compliant companies. By doing so it enables investors to maintain control and ensure the company’s adherence to Shariah principles. Islamic private equity provides investors with an ethical investment product offering high performance, portfolio diversification, superior risk-adjusted returns and diverse investment opportunities. Private equity and Islamic investment share a lot of common principles: both of them are based on investment in the real economy, and on the principle of sharing risks and rewards through partnership. Private equity takes a long-term view on investments and aligns the interests of stakeholders, which are also among the key principles of Islamic investment.
At first sight Islamic private equity appears to be restrictive in comparison to conventional private equity, In fact, on the investment side, there are indeed some limitations in terms of industries (for example alcohol, tobacco and leisure-related activities are prohibited industries), as well as certain financial parameters such as the use of debt instruments and investing in companies with high leverage. However, such obstacles can in most cases be overcome by innovative structuring, for example through repaying a portfolio company’s conventional debt and refinancing it through Shariah-compliant structures such as Murabahah agreements, amongst other solutions.
Since Islamic investment adheres to high ethical standards, it has been attracting a growing number of non-Muslim investors, in addition to the 1.3 billion Muslims worldwide, thereby targeting a substantially larger investor base than conventional private equity. Recent research has found that a considerable number of private equity and venture capital funds have passed Shariah compliance tests, with only minor adjustments made to the investment policies of these funds.
Nevertheless, regional private equity in general and Islamic private equity in particular are still in their very early stages. Today, players in the industry face a lack of information and academic research, as available market data is often incomplete and inconsistent. Additionally, there is only a limited number of professionals who are well-trained in the principles of Shariah law and their application, especially when it comes to the development of new products and structures.
What is needed to accelerate the Islamic finance and the Islamic private equity industry’s development in particular is skilled and educated human capital, as well as a higher level of standardisation across countries, disciplines and products of the entire Islamic finance space. Critical success factors on the micro level include product development expertise, client relationship management and competitiveness, both in terms of quality and pricing, among others. In this context, innovation is the key, as it enables individual players and the industry as a whole to draw the link between conventional and Islamic financial products by structuring the former in adherence to Shariah principles.
Islamic private equity promises to be one of the fastest-growing areas both within the private equity and the Islamic finance space over the coming years. To date, there are only a few Islamic private equity funds in the market. However, the popularity of these funds is growing tremendously; over the last year alone, Islamic private equity funds announced exceeded US$4 billion, demonstrating a strong and yet unmet investor demand. Considering the growth in assets of global and GCC Islamic banks and financial institutions, it is estimated that the Islamic private equity industry in the region will be worth US$41 billion by 2011.
The author is a senior financial analyst at CORECAP, which is a Dubai-based investment and advisory firm that offers a spectrum of compelling investment opportunities in alternative asset classes in the MENA region to sophisticated institutional and high net worth investors. She is involved in all aspects of the investment cycle, including deal sourcing, execution, post-acquisition management and realization. With over six years’ experience in the financial and consulting industries, she was formerly actively involved in the preparation and execution of two highly complex transactions worth €2.6 billion (US$3.46 billion) out of the €36 billion (US$47.87 billion) portfolio of non-performing loans and non-strategic assets at the Institutional Restructuring Unit, a specialized task force in Dresdner Bank, Frankfurt.