Hedge funds are at the center of a debate among Islamic scholars over whether their practices are halal or not, particularly short-selling.
What Is a Hedge Fund?
A hedge fund is a wealth investor pooling their money together to get a nice profit. Professional fund managers often manage the hedge funds. They often use many non-traditional aggressive strategies. Their main goal is maximizing returns and mitigating risk.
A hedge fund may sound like an ETF or Mutual Funds. However, it is a wrong idea. Hedge funds are not constrained in the same way that mutual funds are. They are more likely to use aggressive investment tactics such as leverage, debt-based investing, and short-selling and they can buy assets that other funds can’t, such as real estate, art, and currencies.
How do Hedge Funds Work?
Hedge funds can invest capital anywhere in the market and employ virtually any strategy, making it impossible to define a “typical” hedge fund. However, there are some commonalities: a preference for public market investments (opposed to illiquid private equity investments) and a propensity to use uncommon trading tactics such as derivatives or short selling.
Are Hedge Funds Halal?
The main goal of a hedge fund does not contradict Shariah standards. As mentioned above, hedge funds are private companies that pool investors’ money and reinvest it into more complicated financial instruments. They aim to outperform the market. They need to be smart enough to create high returns regardless of the market conditions.
However, hedge funds usually employ an aggressive investment strategy. They often use leverage, debt-based investing, and short-selling to meet their investment objectives. According to AAOIFI (The Accounting and Auditing Organisation of Islamic Financial Institutions), short selling and leverage is not Shariah compliant.
Another problem with the traditional long/short equity strategy is the significant risk of investing in non-Shariah compliant equity and company. Before stock purchases become Shariah-compliant investments, they must pass a qualitative and quantitative Shariah screening with a continuous scholarly perspective.
Conclusion
Hedges funds are one of the fastest-growing financial sectors of our age. However, scholars strongly criticize them, stating that the hedge funds operate out of speculations and high risk. Despite the struggles, the sector has created Shariah-compliant Islamic hedge funds. The absence of harmony is the main difficulty facing Islamic hedge funds and the whole Islamic financial industry.
To read more about Islamic Finance related topics, please click here and visit our academy.
Also, feel free to sign up for our free stock screening services at musaffa.com.