Investing my Savings in a Halal Way

Muslims have a problem when it comes to investing their wealth.? There are too few investment products out there that cater to their specific needs.? As a result, when thinking about long-term investments (such as pensions), most of my Muslim family and friends do one of three things:

1.?????? They believe there’s no alternative to conventional finance and they leave the decision making to their employer’s pension scheme.? Many such schemes invest in companies that engage in vice industries like alcohol or arms manufacturing, and they invest in interest-bearing bonds which are explicitly forbidden in Islam;

2.?????? They invest in real estate;

3.?????? They tuck their money away in a savings or term deposit account at an “Islamic” bank.

That’s not a great menu of options.? They’re either ethically questionable or risky or a poor return on capital.? These solutions won’t pay for my retirement.? And because the investment I wanted didn’t yet exist, I worked with world class colleagues at CCM to create such a product. It’s a financial instrument that gives halal investors an excellent income without unacceptably high risk.? But before I explain how and what it is, let’s first explore the existing solutions.

“Islamic” Banking is an Oxymoron

Why did I write “Islamic” in quotation marks?? Because although Islamic banks offer investment products (like savings accounts) with contracts that have been vetted for Shari’a compliance by scholars, in fact an Islamic bank is just a bank at the end of the day.? This means it is regulated by a central bank to lend money in a process known as fractional reserve banking.? A bank’s capital reserves are a fraction of its loans: for every pound or dollar you deposit in a bank account, the bank is allowed to lend multiples more, thus creating new money from nothing.? This new money may be legal, but it is nevertheless morally fraudulent.? The creation of money from money is forbidden in Islamic law.

Islamic banks also have a tendency to use a particular type of contractual structure called “commodity murabaha”.? I have written and spoken about it extensively so I will not repeat myself here. ?Suffice to say, I see too many Islamic finance providers (not just banks) offer investments based on this dubious loan-like structure without exhausting all other possibilities first.

The other drawback of depositing money in an Islamic savings account or term deposit is that you get a low rate of profit.? At current market rates, you are typically earning 5% for a 12 month deposit which is below the current rate of inflation.

The big advantage of tucking your money away in a regulated bank is you are protected by the Financial Services Compensation Scheme: in the UK, up to ￡85,000 of your bank deposits are insured if the bank becomes insolvent.? In the US, the protection is even higher: the FDIC provides deposit insurance of $250,000 in the event of bank failure.

So Islamic banks offer low risk, low return investments.? My retirement won’t thank me for it.

Real Estate

Property is wonderful.? It’s real, you can touch it, you can hold direct legal title to it.? You can live in it, you can rent it, you can flip it.

It’s an essential part of any investment portfolio.? And Muslims love it.? They love the tangibility of it.? Perhaps it’s something cultural.? Perhaps the sanctity of individual property rights in Islam is a sort of subconscious driver of our affinity to it.? Whatever the reason, we seem to invest in this asset class a lot.

Is this a good thing?? Well, yes and no.? We make good returns, whether out of rental income or from selling the property in a rising market.? We have something real to fall back on if we need to use it or liquidate it.

But sometimes we have a tendency to put all our eggs in one basket. ??If the real estate market enters a downturn, were we foresighted enough to have invested in other, less risky asset classes to protect our overall wealth?? Sometimes people take large loans against property to make huge capital gains in a rising market.? Sometimes they lose it all when the market turns against them and the banks repossess the asset.? I’ve lived and worked through a number of economic cycles and, every cycle, ordinary investors get badly burnt when the market turns.

Sometimes we have a tendency to overstate the safety of property.? “As safe as houses”, goes the saying.? We might be tempted to invest in a less-than-perfect development site without planning permission, expecting to double or triple our capital, and are indignant when it all goes wrong.? We might allocate our capital to a professional fund manager to invest on our behalf.? I’ve done it, and then watched the fund manager lose all my capital.? I’ve learnt my lesson: real estate isn’t rocket science.? It’s easy to understand and manage myself, so I won’t pay someone else to manage it for me badly.

In summary, I view real estate as an element of my overall portfolio.? Something that can generate an income for me whilst providing a degree of protection as a “hard” asset class.? But it’s not without risk. ?To be on the safe side, I don’t allocate more than 15% of the total value of my retirement fund to property.

Where do I invest the other 85%?

Equities

Personally, at my stage in life, I’m looking to generate capital gains with medium risk in appreciating assets for the next decade or two and then (later) reallocate my portfolio to assets with predictable, repeatable returns to generate an income for when I retire.? So, today, I allocate a reasonable proportion of my portfolio to what professional investors term “large cap global equities”, meaning shares in well-known multinational firms listed on regulated stock exchanges. ?I typically make these investments in the form of exchange traded funds (ETFs).? ETFs are like buying a basket of stocks on an exchange in one simple security at low cost.

Equities or shares are high risk and they generate low dividends, which is why they’re not very useful for generating a meaningful retirement income.? I could lose all my money which is why I diversify across multiple industries and multiple geographies.? I am careful not to overallocate to this risky asset class.? People buy equities because they expect the price to rise, not for income.? The good news is over a sufficiently long period (say, 20 years), equities tend to outperform most other types of investment.

For most people who are not professional investors, it’s often best to let regulated fund managers decide what shares to buy through a fund.? My problem with this is there aren’t many fund managers who care about my values.? I won’t buy shares unless I know the underlying company is halal and ethical.

I don’t allocate my wealth to venture capital (VC) unless I personally do the due diligence on the underlying investments.? VC is typically investment in speculative, early-stage companies without any meaningful track record.? We live in an era of cheap money which has encouraged the proliferation of venture capital fund managers.? There are a small number of high quality firms but their investments remain disproportionately high risk and I prefer to stay away from this asset class despite its huge popularity.? Anyone promising returns which are multiples of your initial investment should be regarded with a healthy degree of cynicism.

Inflation Hedges

So where else to allocate my savings?

A part of my portfolio is invested in physical gold- and silver-backed funds, as well as bitcoin.? I treat these assets as a hedge against inflation and financial Armageddon.

I have written and spoken at length about the need for “sound money” and so I will not repeat myself here.? Suffice to say, I believe bitcoin is the global reserve currency of the future and the most Islamic form of money ever invented, which is why I treat it as a form of savings.

Notice I did not say “crypto”!? I believe 99% of crypto is straight-up gambling.

Equity Returns for Bond-Like Risks

I have one final secret weapon up my sleeve and I believe it’s going to change the way Muslims invest their wealth: PPNs or profit participating notes.? I couldn’t find an income-generating investment I actually wanted to invest in so my team at CCM built such a product.? But let me come to that in a second by first explaining an obvious omission from my portfolio.

You will note I have not mentioned sukuk (Islamic bonds).? Pension fund managers will tell you that a balanced pension portfolio must incorporate bonds, which are interest-bearing debt instruments typically listed on an exchange.? Bonds generate an ongoing income.? Bond holders are effectively lending money to a company, earning a regular interest payment, and then getting 100% of their capital back when the loan matures.? If the company goes bankrupt, bond holders tend to get most of their money back before other investors in the company.? A nice way to earn a low-risk passive income.

Obviously bonds are haram because they are a type of interest-bearing loan.? Muslims believe Allah wages war on those who devour riba (interest).? When lending with interest proliferates in society, the rich become richer merely through the act of owning money, and societal inequality rises.

The Islamic equivalent of bonds is called sukuk.? Sukuk are supposed to be asset-backed investments on which the investor is taking a “real economy” risk.? In other words, investors are participating in ?some underlying real business activity which generates a profit.? In real life, this is not the case: the underlying asset in a sukuk transaction is usually not what generates investor returns.? Anyone who tells you otherwise is not really the expert they think they are.

Even though the team I founded at Deutsche Bank invented many of the sukuk techniques in existence today, I don’t invest in them.? Why?? Because (1) I don’t believe sukuk generate a sufficiently attractive return for the relatively high risk the investor takes and (2) the Shari’a structures employed by these instruments have in some cases diverged from the original ethical principles.

Let’s examine that first point: most sukuk generate a paltry 4-5% income per annum.? For that, I must take the risk of the underlying company continuing to perform well even during a recession.? I consider the risk mitigation controls built into this financing instrument to be insufficient to justify such a small income.? The risk outweighs the reward.

Now to the second point: when I originally structured the first large “benchmark” sukuk in the early 2000s, I tried to use real economy structures like leases or investment partnerships, i.e. a link to real business activity that generated profits which were split between the company and the investors.? Unfortunately, in order to sell sukuk to large institutional investors, the investment ended up looking increasingly like a conventional bond, especially when it was tied to a contract called a “purchase undertaking”. ?This contract obliges the company issuing the bonds to buy it back from investors at maturity.? This is a sort of guarantee, which, as you probably recognise, is a bit weird from a Shari’a compliance perspective.? If you guarantee a loan, it’s not halal.? It’s a very technical subject and there may be some legitimate arguments in favour, but, on balance, I prefer to avoid any doubt.

So what’s the halal solution to financing companies?? At CCM we invented an investment product that generates double digit income for investors (typically paying 10-16% income every year) from real trade activities in high quality, mature companies.?

This financial instrument is called a profit participating note (PPN).? For investors who typically invest in “fixed income” investments (such as bonds, sukuk, private credit and trade finance), income from a PPN is typically 2-3 times higher than sukuk since PPNs participate directly in real trade and earn profits from this activity.

PPNs have tightly managed risks, are listed on an international exchange and are Shari'a compliant.? For medium-sized, high growth companies seeking working capital finance, PPNs represent a unique method of accessing the international capital markets without the restrictions of bank debt, without diluting equity and without the high costs of listing on?an?exchange.

Those tightly managed risks are key. ?Not only do we conduct extensive due diligence on the companies we finance to ensure they have an excellent trading record, strong management, audited accounts, world class operations and watertight internal governance processes, but in addition we have linked the PPN directly to an underlying hard commodity asset or trade activity.? The investor is getting the profits of that specific trade calculated according to a pre-agreed formula.? Your money is doing something “real”, like purchasing raw materials for processing in a factory.

PPNs are not shares in a company: investors are not exposed to all the risks of that company, only a specified trade activity that generates a consistent, measurable income.? There are capital controls in place so that if investor money cannot be deployed profitably into that specific activity, it will be held back in a segregated bank account under a legal trust.? This legal trust is an “orphanised” investment vehicle that exists solely for the benefit of PPN investors: the company cannot touch that money for any other purpose and the legal trust has no other shareholders to pay.

So although it’s not a “guaranteed” instrument (your capital is still at risk), the controls built into a PPN provide a type of protection that de-risks the investment.? That’s why we describe it as “equity returns for bond-like risks”.

This is an industry gamechanger that will become the go-to method for financing the real economy.? It not only addresses an enormous multi-trillion dollar gap in the supply of working capital to international companies but also a massive unrealised demand from investors seeking truly halal, high quality, repeatable income at very attractive yields.

Who can invest?

CCM’s investment platform is a protected cell company (PCC) in Jersey, a reputable international financial centre.? A PCC is an investment vehicle commonly used by professional investors and financial institutions to issue securities and manage investor risks in a cost-efficient and flexible way. ?It issues PPNs as bond-like securities, listed on a regulated exchange and governed by legal documents approved by the financial regulator, the Jersey Financial Services Commission.? Given the sophisticated nature of the instrument, only qualified investors with a minimum investment of USD 20,000 are eligible to invest.? We hope in the future PPNs will be approved for smaller retail investors as well.

For more information, visit www.ccmkts.com or email [email protected].

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