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Saturday, 1 September 2007

Are hedge funds permissible?

By Christina Gondokusumo
Brunei - There is one thing for sure, the markets are driven by fear and greed, and this is something that will outlast any of us, said a speaker during the Brunei Roundtable 2007 held recently at The Empire Hotel & Country Club. This is an oft-heard saying, and few would think twice about it. So when an Islamic banker mentioned hedge funds as part of Islamic investment products and tools, a puzzled participant asked how this works in relation to Syariah principles. The underlying motivation of Islamic investing is that it is "a mutually beneficial financial relationship that should equally reward both parties in any transaction", Wafik Grais, senior advisor of the World Bank, said at the beginning of the conference. I had been aware that Islamic institutions would only invest in Syariah- compliant instruments. And hedge funds could invite questions concerning its acceptability in Islamic investing. Many hedge funds in the last decade have collapsed and there is the familiar story of how over-leveraged speculative investments had resulted in the inability to hold investments in times of crisis, which serve as constant reminders of the consequences of irresponsible investing. In 1998, Long Term Capital Management (LTCM), founded by a group that included two Nobel price-winning economists, collapsed. It began trading in 1994 with over US$1 billion of investor capital, attracting investors with the promise of an arbitrage strategy that could take advantage of temporary changes in market behaviour. The strategy was very successful, and at the beginning of 1998, the firm had equity of US$4.72 billion and had borrowed over US$124.5 billion with assets of around US$129 billion. However, the strategy that depended heavily on the diversified nature of their bets suffered immense losses during the turbulent 1997-1998 period which included the Asian and Russian financial crises. The company, which had annual returns of almost 40 per cent up to this point, experienced a flight to liquidity. Within less than four months LTCM lost US$4.6 billion and became the most prominent example of the risk potential in the hedge fund industry. These risks are still very real today. Over the last few months, two prominent hedge funds run by US investment bank Bear Stearns collapsed after their highly leveraged positions in the US sub-prime mortgages turned against them. These put a big dent on Bear Stearn's reputation, which has been known for its expertise in the mortgage markets. In finance, as in all things in life, we have a choice. If we choose to use the financial markets wisely, they will provide liquidity and necessary facilities that go a long way in helping you and I earn an honest dollar. Otherwise, we can choose to speculate, play passing the parcel, and gamble with little regard as to whoever might end up with the exploding parcel, as long as it's someone else. The truth is, the markets are used for both purposes, and unfortunately, the sheep and wolves play the same game. It is not surprising therefore that during the conference, a participant who noticed that hedge funds were part of investment instruments offered by CIMB Islamic Bank asked Suryono Damor, the bank's director and head of asset management, and how this worked. Damor replied that hedging was not against Islamic beliefs, therefore, as long as the strategy was truly used to hedge risks, and not to make profit at the expense of others, they were acceptable. This was in line with the "mutually beneficial" and "non-exploitative" motivation of Islamic investments. The answer was simple, although in reality it would definitely be easier said than done. If any of the hedge funds that collapsed had adhered to this simple principle, they would not have suffered such massive losses. In my heart, I found myself respecting the ideals that Islamic investing strives to adhere to in the midst of the increasingly speculative and greed-driven financial markets. While I regret that I am no expert in Islamic investing, I think at the very least its motivations are sound, and can serve as an inspiration to all who seek an alternative to the fear and greed-driven markets. I sincerely hope that there will be a growth in such responsible investments, and that more and more will be committed to be socially and ethically responsible investors. The views expressed in this article are those of the author and do not represent the views of this news organisation.-- (Courtesy of The Brunei Times, 1 Sep 07)

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