In fact, over the last 6 years we’ve seen a pell-mell rush into the sale of derivative-based structured products with a fatwa wrap. These products are by and large toxic waste, and the recent meltdown in global markets only magnified the underlying mistruth about their application in nearly all institutional and private client portfolios. Don’t blame the sharia scholars for these time bombs. They are hired only to say whether the investment violates the rules and norms of Islamic ethics. The responsibility for such wasteful investment schemes lays entirely on the shoulders of bankers.
Unlike the claims of our friends at the Frankfurt conference, structured products are not a substitute for MPT allocations. They never have been and never will be. Like Warren Buffet famously said, derivatives are weapons of financial mass destruction.
Yet that didn’t stop many western banks and equally Islamic banks operating in the Middle East from pushing hundreds of millions, if not billions, of dollars worth of these products onto unsuspecting Arab clients. Muslim investors were coaxed into thinking they were getting a responsive product with fatwa, yet in fact were being peddled irresponsible trash that no professional would ever buy himself.
During the same period we saw an overwhelming consumption of regional and international private equity, including private equity for real estate, by investors in Saudi Arabia and the Gulf region. Why did this occur? Well, firstly there was in fact a real need for professional venture capital to be introduced into the developing economies of the GCC. But, what should have been the normal evolution of a new, high-risk investment industry became instead a stampede. From only two private equity houses in Arabia at the beginning of the decade, we saw over 100 established by 2008.
The abundance of so many private equity houses in the region, plus a big push from foreign banks to sell their own private equity deals, was too much for less-sophisticated investors. They consumed them in vast amounts, in the process tilting the balance of MPT allocations far too deeply into risky, illiquid assets.
Now the chicken has come home to roost. Investors everywhere—and not just in Arabia—indulged themselves in the fantasy that somehow private equity provided less risk and more reward than MPT. The cost is high. It hurt the biggest investors the most, where private equity cash calls dried up liquidity. Now we have seen that an overly amorous approach to this dangerous zone of the investment universe is best taken in extreme moderation. It may be another generation before we see the kind of over-investment in private equity that occurred during the last five or six years.
The great shame of today’s so-called Islamic asset management industry is that there really is no such industry. Many claims being made about the applicability of most Islamic products are generally false. No single major bank or investment company has delivered a credible lineup of professionally developed products that also meet the standards of sharia. Perhaps greed, perhaps inertia, and perhaps ignorance are reasons for this unhealthy situation. Certainly it is not a lack of resources. If major international and regional banks dedicated themselves to MPT with fatwa, the situation could change dramatically in short order.