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Perfect Partners: Private Equity and Islamic Finance

Written by Amjad Khan Suri

This past decade has witnessed private equity funds playing a major role in pushing the financial markets forward. At the offset of this decade, the Economist magazine captured this phenomenon aptly by labeling Private equity funds as “Capitalisms new kings”. The Economist Magazine from 2004 was commenting on the sheer size of these fund pools. It is without a doubt that Islamic Finance will tread the private equity path before anyone starts looking.

In recent times, global investments have been characterized by high risk and no investment class better illustrates the importance of managing risks than Private equity. Over the past 25 years, private equity has led to big investment deals, propelled companies onto the global stage, and created opportunities for good businesses.

Private equity investments are investments that provide the long-term equity base for a company that is not listed on any exchange and consequently does not have the ability to raise capital in the public stock market. Private equity invests in underperforming companies that demonstrate the potential for high growth. Private equity growth is delivered by working with the company’s management team to improve performance, provide strategic advise, making complimentary investments and driving operational improvements as stated by the British Venture Capital Association. One of the pioneering big private-equity firms, Warburg Pincus, was formed in the late 1960s, and had to raise money from investors one deal at a time. By the late 1980s private equity had grown big enough for the general public to notice and today, the private-equity industry has moved from the sidelines to the centre of the capitalist action, writes the Economist.

According to a new report from Bain & Company, private equity firms were sitting on more than $1 trillion in available capital at the end of 2013,

Private Equity Performance
Private Equity firms are typically structured as partnerships where outside investors are Limited Partners (LPs) and the private equity firm, which may manage a number of funds, is the general partner. Private Equity delivers significant benefits to its investors and has a proven track record of outperforming other traditional asset classes. As of June 2013, private equity outperformed the S&P 500 index by 1.2 percentage points and 6.8 percentage points for the five to 10 year period, writes Private Equity Growth capital council. Harvard Business School Professor Josh Lerner, together with researchers with researchers from the Stockholm School & Columbia University analyzed 20 industries in more than 2 dozen countries between 1991 and 2007 and discovered that those with private equity activity grew 20 percent faster than other business.

Why Islamic Private Equity?
Islamic private equity funds are well known and respected in the Western world and will gain more market share moving into the future. Given the global success of Islamic finance, many private equity sponsors will continue launching Shariah compliant funds over the coming years. Islam encourages Muslims to invest their money and become not creditors but partners in business. This encourages entrepreneurs who, having then developed a successful business in partnership with the financier, are then themselves in a position to supply financial capital and knowledge to other entrepreneurs. This tends to encourage higher-risk investments that can stimulate the economy while encouraging both the entrepreneur and the investor to have oversight of the business that can mitigate risks. The returns generated from such a venture are then reinvested and continues the cycle. There is an abundance of resources for Islamic private equity transactions in the GCC. A report by the Gulf Venture Capital Association (GVCA) indicated that USD 7.1 billion had been raised in private equity funds in 2006, up from USD 4.3bn in 2005.

Investing in Shariah Compliant Private Equity
In Malaysia, the Securities Commission issued guidelines and best practices for Islamic venture Capital in March 2008. The guidelines specify the core requirements for establishing an Islamic venture capital corporation or an Islamic venture capital management corporation, and set out the best practices intended to assist such corporations in carrying out Islamic venture capital activities. Investors who seek to abide by the tenets of Shari’ah law must comply with certain principles when investing. Money must be invested in businesses that offer ethically acceptable products or services, and returns must be earned through active participation in the relevant business risks. The investment strategies of Islamic funds must comply with these principles to be acceptable to Shari’ah investors. In particular, as certain haram (improper) industry sectors (e.g., the production or distribution of alcohol and pork-related products, arms, hotels, casinos, and even conventional banks) are prohibited, investment opportunities are tighter for Islamic funds.

The Future
There is an ever growing number of Islamic Venture Capital/Private Equity funds in the Middle East today looking for Shariah compliant investments. Consequently, private equity firms have rushed to accommodate the demand for Shariah-compliant investment opportunities wanted by their Middle Eastern investors. GCC country firms like Unicorn, Arcapita and Millenium Private Equity are major players in this industry and others like Gulf Finance House and Rasmala will make gains in market share moving into the future. Fund management firms from other parts of the world such as HSBC Amanah or UK house Prosperitus Capital are also successfully raising money from investors who stick to the tenets of Shariah law. There is a need for an more efficient intermediaries of new found wealth and affluence which will offer tremendous opportunities for markets offering Shariah compliant investments.

Islamic finance private equity investments confirm a social commitment to the real economy in the real, tangible sense of the word. The money will help creative entrepreneurs develop optimal businesses. The global success of the industry will depend on the continued attractiveness of Islamic funds to conventional investors familiar with western banking practices in order to reach critical mass. The current financial crisis has perhaps shown that ethically orientated finance products, such as Islamic finance offer and may represent a potentially safer investment for investors. Islamic Finance could be viewed as an alternative investment that could avoid the current instabilities of the conventional financial market. It is a direct cooperation between money and labor on a fair and equitable foundation. This is exactly what Islamic Finance, private equity, partnerships, entrepreneurship encapsulate and strive for.

–Edited by R.M.

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