Investing in private markets, otherwise known as ‘private alternatives’ is all about investing in assets that are not publicly traded, such as stocks and bonds. 

The easiest way to do so would be via an investment fund, which could specialise in private equity, real estate, credit or infrastructure. 

Instead of an investor purchasing securities directly, individuals invest their money into funds alongside each other and the fund manager invests the collective pool of money on their behalf. Each investor still retains ownership of their own shares and benefits from the reduced risk of investing as a group, the expertise from using the best fund managers and the prospect of lower transaction costs. Private markets have also historically achieved greater returns compared with public markets. 

At Mnaara, we’re only focused on investment funds that adhere to our values. As such, all funds that we select on our platform are structured and governed in line with Shariah principles.

What does this mean?

The key difference between conventional funds and Shariah-compliant funds lies in the guidelines set out at the outset. It is likely that the following will need to apply:

• The fund observes set screening criteria, in line with Shariah rules. Activities such as investment in alcohol, gambling, traditional finance and weapons manufacture aren’t allowed.
• Investments into companies or assets will also have certain limits or controls. This includes limits on leverage, the use of financial instruments such as derivatives and the prohibition of interest income. Other parameters in relation to financial ratios will also likely be in place.
• The level of risk must not be unacceptably high.
• The fund will be overseen by a Shariah board to administer compliance. 

What type of Shariah-compliant funds should you expect?

Private Equity Funds

Private equity is the investment of capital into private companies, where the fund will typically buy a part or all of these companies depending on his strategy. 

The private equity model fits well into the Shariah-compliant way of investing. This is because it is an investment in the form of “Musharakah”, where equity investors all share in the risks and returns – a key aspect of Islamic finance. Shariah-compliant private equity Funds would only invest in companies that do not contradict with Shariah guidelines, with a target of exiting at a higher price some years later standard practice. 

However, at that point, part of the profit earned from non-Shariah compliant activities, if there is any, will be determined and must be ‘purified’ i.e., donated to charity. 

To be fully aligned with Shariah values, focus is to be more concentrated on funds that derive value from business growth, as opposed to leverage. As such, venture and growth private equity funds are more likely to be singled out.

Private Income Funds

A private income fund raises money from investors and then uses this money to finance companies. Used as an alternative to bank lending, investors also receive steadier, lower risk returns more in-line with that received from bank deposits and fixed income securities. Given that the charging or paying of interest does not align with the Shariah guidelines, it should therefore not form part of a compliant investment portfolio. Accordingly, special focus would be on:

• Equipment Leasing Funds – the fund buys equipment and leases it to it’s clients.
• Trade Finance Funds – finances low-risk trade businesses, with income generated from gains on trades.

Private Real Estate Funds 

These funds invest in holdings relating to real estate assets. Different funds operate distinct strategies; some are income focused whereas others look for growth and capital gain. Depending on the strategy, properties owned vary, with exposure potentially including mixed-use schemes, new developments, property redevelopment or land holdings. 

To be Shariah compliant, if there are no available Islamic financing options, investments made by the fund manager will need to limit leverage to maximum acceptable levels. Other challenges with regard to leases can make the inclusion of assets tricky, but options remain for the Shariah-compliant fund manager.

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Author

Saad Adada, CFA