Very few Westerners are aware that much of the written knowledge of the Ancient world was saved from destruction then copied and enhanced by Islamic scholars. An academic powerhouse of the day known as the House of Wisdom was established during Europe’s Dark Ages. Much of the groundwork for modern medical, mathematical and scientific advancement can be credited with this institution. There is now a real possibility that the ancient wisdom embedded in Islam will ascend once more, ironically to save the West from self-destruction.
Since the break-up of the Gold Exchange Standard forty years ago, the perceived wisdom has been that never-ending growth could be funded by an ever-expanding money supply. Once free from the restraint of precious metals, governments in tandem with banks could fund military expansion and a merry-go-round of populist policies for the baby boom generation. It was convenient to treat the resulting appreciation of asset prices as a ‘boom’ and to nurse the myth that one’s house was a pension pot. There was however a catch to the process; the dual devilment of interest and inflation. The mathematical genii (or even djinni) that work in financial markets overlooked the juggernaut of compound interest that snowballs debt into an avalanche of liabilities. Creating yet more interest-bearing bonds is the surest form of financial suicide yet this is the same solution served out for every crisis; to buy more time. We cling to a failed financial system through want of familiarity combined with a fear of the unknown.
While it is popular to demonise bankers they are simply symptoms and servants of a philosophy that is widespread in the West. Its tenets dictate that mankind is master of the Universe, unconstrained by greater forces that operate around us. The concept of economies lying fallow for a period of respite is an intolerable. We should instead accept and appreciate the cyclicality and seasonality that are an indelible tapestry of our being. Whether it is our own lifecycle or the recurrence of Fibonacci numbers, there is clearly ebb and flow all around us. Anyone who studies chart patterns will be familiar with the expansion and contraction of volatility as seen in Bollinger Band analysis. Reversion to mean is a powerful force that regulates and restrains many excesses that would otherwise engulf us. The beauty of the credit crisis is that it has shown that mankind is not in control and that the growth-at-any-cost model has been exposed as a sham. Recent years have been needlessly wasted in an attempt to resurrect a flawed financial system, with unintended consequences of spiralling food prices as the US dollar devalues.
Such ponderings may seem alien or even irrelevant to an article request for Islamic hedge funds. Rather than indulging in the tired debate whether such funds are an oxymoron or innovation one can instead ask more fundamental questions about the role of money. Hedge funds have been subject to a witch-trial by the media and by European politicians accusing them of causing the credit crisis. One can sense a whiff of jealousy in targeting a group of wealthy people who apparently made fortunes as others suffered. Headline examples of hedge fund folk raking it in were very much the exception as many suffered crippling losses and major outflows of capital. After all, unlike investment banks, hedge funds were not the beneficiaries of the public purse.
Nevertheless, speculation is not a guilt-free pastime, nor is leverage a zero sum game. The lame euphemisms about ‘price discovery’ and ‘liquidity’ seem heavy price to pay for their de-stabilising effect on financial markets. As highlighted in Dr Sami Suwailem’s book ‘Hedging in Islamic Finance’ the use of derivatives increases systemic risk as investors take ever-bigger bets because they think they are protected. In practice, the risks accumulate in the hands of those who cannot afford to take them and the liabilities end up with the government by way of bail-outs. Instead, Dr Suwailem proposes risk sharing which goes back to the fundamentals of the Islamic approach to trade, money and community. This cannot be brushed aside as Muslim propaganda against speculation, which is of course forbidden. In ‘A Demon of Our Own Design’ Wall Street risk manager Richard Bookstaber makes a similar case. In the study of both industrial disasters and financial crises, common themes emerge. Speed, complexity and over-regulation lead to tight coupling that in turn increases the vulnerability and volatility of the system. In the case of financial markets we have high frequency trading, excess leverage and ever-more complicated algorithms which increase correlation; the ‘flash crash’ will become a regular event.
It then begs the question as to why Muslims would want to buy hedge funds, even if they brandish a scholar’s stamp of approval. Is it just a case of seeking the best return and reducing risk or is something more fundamental at play? For one thing it is hard to find out the facts on how large or popular these funds are. The opaque world Islamic fund statistics is a stumbling block as they are only available to paid subscribers. For now we shall overlook the irony of a financial industry based on principles of transparency that fails to share data freely available for conventional funds. One suspects that Islamic hedge funds are being promoted and purchased because they appear to be glamorous, sophisticated and Western. If there is indeed a desire for such funds then it may well be a symptom of human behaviour that has been prevalent for centuries. When dominant nations form empires, the conquered countries often adopt the fashions, architecture and lifestyles of the leading power. In the case of America, the empire is a financial one with the US Dollar as a form of tribute which everyone must buy for commodity transactions. The IMF in turn has used debt as a conduit of Colonial power to extract cheap raw materials from developing countries. Sovereign Wealth Funds of many Muslim nations accumulate interest-bearing debt seemingly without question, as though Islamic principles need not apply to institutions. However there is also a practical aspect in that there is little outside of conventional bond markets than can cater for the size of such investments. As ever, the wisdom of the Prophet echoes down the ages when he informed his companions of a time “when not a single person remains except that he consumes riba” or at the very least “its dust will reach him” (reported by al-Hakim and others from Abu Huraira).
It is easy to become despondent when looking at history but there is also scope for optimism. Maturing empires have a tendency to import ideas as well as impose them. In the Roman era what was once deemed Barbaric became fashionable as beards festooned previously clean-shaven faces and togas were discarded for trousers. Christianity likewise became the State religion having been suppressed on pain of death in earlier centuries. While the chance of the West converting wholesale to Islam is rather unlikely, the power of its financial principles may well take root. After all, the spread of Islam was not necessarily about conquest but about the respect gained when dealing with Muslim traders, renowned for their honesty and dependability, if not for their hard-bargaining. We may now be on the verge of a new era where the mutual risk/reward of equity topples the iniquity and imbalance of interest-bearing debt. The first rumblings of such an approach have been proposed by the world-renowned economist Professor Kotlikoff who has recommended that European banks convert to mutual funds.
The famous Victorian-era playwright and one-time Guernsey resident Victor Hugo said ‘There is nothing more powerful than an idea whose time has come.’ The fundamental message of Islamic economics is that of recycling capital into real assets for productive, communal improvement. The hoarding of wealth (in the form gold and silver in the time of the Prophet) was viewed as selfish and destructive. Scholars liken money to water; only useful when flowing, otherwise stagnating if uncirculated. Zakat is of course the charity tax on liquid assets that are not invested in productive ventures, acting as a form of negative interest rate; a case of use it or lose it. Many investors are sensibly buying bullion as a means of protecting themselves against the devaluation of mainstream currencies. However, gold is simply a measure of the malaise of modern money, like mercury in a thermometer. Other than boosting the profitability of mining companies and bullion dealers, there is little benefit to humankind, let alone the environment, as prices surge. Commodity appreciation is feeding a frenzy of resource depletion and associated pollution we will later come to regret. Swathes of capital are being allocated to passive lumps of metal locked underground, which could otherwise fund industries starved of finance.
In the meantime, we are failing to see the wood for the trees concerning the on-going credit crisis. Investors face greater threats from a range of natural and man-made disasters. We believe that population growth, environmental degradation and the mutation of financial markets are closely correlated. We are witnessing an unprecedented confluence of factors caused by climate change and resource scarcity, exacerbated by currency devaluation. The public face severe inflationary pressures from diminishing supplies of raw materials combined with an exponential escalation in demand. As investment managers we see our roles in a more holistic light than many of our counterparts. We have gone beyond the tedium of money making for its own sake and now seek to benefit our clients as well as the companies we invest into by following the recycling approach to capital. We are therefore launching a multi-asset fund called Gaia Opportunities investing in 5 themes from our proprietary ‘Gaia Filter’:
• Natural Resources: commodities, rare earth metals, forestry, water
• Food Chain Disruption: fertiliser, agriculture, soft commodities, infrastructure
• Population Growth: healthcare, biotech, waste management, emerging markets
• Currency Devaluation: precious metals & mining stocks to offset currency dilution
• Green Revolution: clean technology, renewable energy and strategic assets
Inevitably we could be accused of hypocrisy by purchasing futures contracts to gain exposure to food and other commodities. Likewise the holding of precious metals may well be exacerbating the upward price trend. Where we seek to be different is that we will be donating a portion of our performance fee to promoting sustainable communities in developing countries. This is not the same as charity but an attempt to promote the work ethic through interest-free loans. We would also welcome the opportunity to create a Sharia’a compliant version which would be difficult but not impossible with the correct guidance. The challenge is to find a willing Islamic bank to form a partnership and a scholar who will share the risk and reward without charging a large, flat fee. Great change happens through small episodes of leadership by example. At the risk of sounding naïve we hope that an investment fund which helps investors escape the effects of inflation while promoting sustainability can be a catalyst for financial reformation.
Toby Birch is the Managing Director of Oppenheim & Co Limited in Guernsey. He is author of one of the most prescient predictions of the credit crisis called The Final Crash: Addictive Debt and the Deformation of the World Economy, published in 2007. He has been a fund manager for 20 years and is a Chartered Fellow of the Chartered Institute for Securities & Investment and holds the Islamic Finance Qualification. Oppenheim & Co Limited is the investment manager of the Gaia Opportunities Fund, a Luxembourg Specialised Investment Fund suitable for Well-Informed investors with a minimum investment of €125,000 or currency equivalent.