Dubai Taps Fund Talent

By JOANNA SLATER

In the latest effort to meld Wall Street with Islamic law, an arm of the Dubai government is investing in five well-known U.S. hedge-fund managers that will employ trading strategies conforming to religious strictures.

The five managers will evenly split $250 million to make investments that comply with shariah, or Islamic law. They will invest in commodity-related stock strategies ranging from gold to agriculture.

The announcement underscores the race to tap the burgeoning oil wealth of the Persian Gulf, and in particular, that of observant Muslim investors. Globally, the Islamic finance industry has more than $700 billion in assets, and is estimated to be growing at 15% a year, according to Moody's Investors Service.

The hedge-fund investment is being made by the Dubai Multi Commodities Centre, which is part of Dubai World, the government-controlled holding company credited with turning the city from a sleepy port into today's boom town.

The investments are part of a plan by the Dubai unit to create a "fund of funds," which is an investment vehicle that spreads money across several hedge funds.

The $250 million will be seed capital for this fund of funds, which will take money from other investors interested in shariah-compliant activity.

"I see this as a toehold for us to build our business in that part of the world, which is obviously attractive," says John Hathaway of Tocqueville Asset Management, one of the five hedge-fund managers involved in the project. The others are BlackRock Inc., Zweig-DiMenna International Managers, Ospraie Management, and Lucas Capital Management.

Marrying the strictures of Islamic law with hedge-fund tactics has proven an enormous challenge. In Islamic finance, investors aren't permitted to invest in companies involved in alcohol, for example, or that carry high levels of debt. Short selling -- or betting on a stock's decline by selling borrowed shares -- is equally problematic, since Islamic investors aren't allowed to sell what they don't own.

The five hedge funds will operate using a trading system developed by Shariah Capital, a Connecticut-based firm, and Barclays Capital, a unit of Barclays PLC that will act as the prime broker to clear and finance trades.

Dubbed "Al Safi," or "the pure," the platform screens out companies considered unacceptable. It also permits managers to replicate short sales of stocks by using what is known in Islamic law as an "arboon" structure, which operates much like a down payment.

In a short sale, investors borrow shares and sell them, hoping to buy an equal number of shares at a lower price and return them to the lender, pocketing the difference as profit. An arboon structure allows investors to avoid formal borrowing.

Such methods still spark controversy among Muslim investors. Eric Meyer, chief executive of Shariah Capital, likens the situation to the one that prevailed several years ago for Islamic bonds, then highly contentious but now widely accepted.

"There's always a healthy degree of skepticism" of new products, he says. He adds that all the shariah scholars who approved the hedge fund platform are part of an association in Bahrain that serves as the informal authority for Islamic financial institutions.

There are ambitious plans to expand the venture from here.

"Not only are we prepared to say we have confidence, but we are prepared to demonstrate" by having the Dubai Multi Commodities Centre invest its own money, says David Rutledge, the group's chief executive.

Newedge, a joint venture between Société Générale SA and Crédit Agricole SA's Calyon unit, also has a shariah-compliant trading system that hedge funds can use, which employs a somewhat different approach.

Five hedge funds currently use it to manage just less than $100 million, according to Philippe Teilhard de Chardin of Newedge.