One area showing real potential in the Islamic finance sphere is private equity and as such is emerging as a key component of the industry. Ruth McKee reports
Islamic private equity seems to be able to be channeled into most sectors making it a valuable asset class for Islamic finance. A lot of activity in this sphere is being conducted out of the MENA region.
There is an increasing number Islamic private equity funds and a number of well known names who continue to pop up. They hail mainly from the GCC region and most notably include Arcapita Bank, Unicorn Investment Bank, Gulf Finance House, Kuwait Finance House, Al-Tawfeek, Abraaj, M'sharie, Injazat Capital, and Dubai Islamic Bank with its hefty $5 billion family of funds.
Dubai Islamic Bank is a regional force in Islamic banking and it is no surprise that it should put its strength and experience into plans for a $5 billion family of private equity funds.
Aref Kooheji, the CEO of the Investment Banking Group, says the seven funds it encompasses will be sector-specific, with $500 million allocated to industry, infrastructure, real estate and health and education, and $1 billion to power, oil and gas, and telecommunications and media. DIB and Dubai World, with Istithmar, the investment arm of Dubai World, will put in seed money, but Aref says it will be open to all investors from across the region and globally, and the rest will go into private placement. As with an increasing number of regional funds, the intention is to invest the funds into global opportunities.
Michael P. Lee, deputy chairman and managing director of the Emerging Markets Partnership, Bahrain, which is the manager of the IDB Infrastructure Fund, says private equity in infrastructure particularly lends itself to meeting the needs of Islamic investors "because infrastructure is very much an Islamically acceptable business line. It is very much something that attracts the interest of Islamic investors, and helps build up the economic and social structures within Muslim economies. The question has been, could Islamic finance, which was traditionally focused on a relatively shorter term maturities, play a central role in the financing of big infrastructure projects, particularly those that are being undertaken by the private sector?
He says private sector project risk was something Islamic banks only began to focus on recently, "In Muslim countries a lot of the economies have been dominated by the governments, so there wasn't much experience with medium term credit extension dependent upon private sector cash flows. Now, with the advent of private equity in infrastructure, private projects need longer term complementary financing, and there are proven, acceptable methods of financing in the Islamic mode that can provide that, such as Ijarah financing. There are also Sukuk. We are finding that, with the increasing entry of conventional banks into Islamic finance, the same sort of credits and maturities acceptable to conventional banks are becoming increasingly acceptable for Islamic financing. Conventional banks' participation in Shari'ah compliant transactions facilitates convergence between the effective costs and benefits of the conventional and Islamic financing modes."
Bahrain-based Unicorn Investment Bank has raised $150 million in capital for what it calls the world's first global Islamic private equity fund. While most funds in the GCC have focused on the GCC or Middle East, and others have launched US funds, Unicorn is looking at opportunities around the world. Tariq Al Refai, regional director for the bank, says global Islamic private equity growth is coming from the MENA region. "Islamic private equity didn't begin that long ago but the focus was always on outside the MENA region because the market wasn't developed at all and only now is it starting to develop. But private equity in general and Islamically is still at the early stages here."
Although there were earlier attempts, Tariq believes Islamic private equity was first noticed with the launch of First Islamic's (now Arcapita) investment fund. "The focus was previously really to team up with a partner and invest in private equity deals. These deals were almost entirely in Europe or the US, but when First Islamic was launched there was more focus in the bank building up its own capabilities instead of just looking to invest with a private equity partner. They were looking to build up their own capability and invest in private equity deals directly. Their focus from day one was the US market and a few years ago they added the European market to their list, and now because of the growth over the past three years in the GCC they're looking at the GCC market as well."
However, Tariq thinks the regional industry is at a crossroads. "I think it's stuck because a lot of money was raised both conventionally and Islamically for private equity deals in the Gulf, and whilst there is a lot of money going around, there are not enough deals. If you look at other parts of the world, such as South America, there is a lot of potential deals, but not enough money. The GCC has been very successful at raising money for private equity, but now everybody is looking for companies or deals to invest in, and that's going to be challenging because when you have too much cash chasing too many deals, you tend to overpay."
He adds, "Private equity here is in the early stages. The opportunity here is great if you start early, but we are not going to be seeing good returns for investors yet, and we need to invest in a diversified pool of assets. Obviously the US market is very developed and competitive. The European market is of interest to us, but we haven't got involved there yet, and in South East Asia there is tremendous growth and there is a lot of deals going on there."
From the launch of the first Islamic investment funds during the 1980s, debate rose amongst Islamic scholars regarding the Shari'ah compliance of equity investments. Tariq thinks the Islamic finance industry is looking to develop its own capabilities by building up its own private equity expertise and teams. "That's challenging because you really have to understand the companies you are investing in, the industry, and the market potential. Islamic investors should apply the model of private equity firms whose strategy revolves around taking majority stakes in privately held companies engaged in the real economy. This enables them to maintain control, which ensures the company's adherence to Shari'ah principles." He adds, "Private equity offers Islamic investors a better value proposition compared to other asset classes in terms of performance, diversification, higher long term returns, price stability and lucrative investment opportunities."
In the Middle East, a lot of Shari'ah compliant investment transactions concentrate heavily on real estate.
Hussein Rifai, chief executive officer of Dubai-based Injazat Capital, which focuses on key industries, says there are opportunities in the Middle East based on property development, but the Middle East has a lot of structural problems in its industry. It's improving, faster in some countries than in others, but is not going to become Europe, Australia, or the US overnight.
"Structurally the industries in the Middle East are flawed. All the industries are fragmented and they tend to be family businesses. Therein lies a huge opportunity. If you selectively start focusing on industry by industry and consolidate through mergers and acquisitions to create bigger entities, that in its own right gives a huge opportunity from a private equity perspective. It would make a lot of money, and have a great deal of benefit in terms of a knock-on effect. There is a huge opportunity for consolidation, and that's what I think is going to happen."
© Banker Middle East 2006
