An Islamic Structured Investment (or deposit) is an investment product which is linked to or benchmarked against a Shariah compliant underlying range of performance indicators such as equities, real estate or commodities. There are some Shariah compliant structured products in the market which is benchmarked against (Shariah compliant) indices, foreign exchange and even inter-bank offered rates. The returns from the structured investment are therefore dependant upon the performance of the underlying range of performance indicators.
A structured investment can either be principal protected or non-principal protected.
A Shariah compliant structured investment works the same way as their conventional counterpart, the only difference is in the nature of the underlying asset, it must not contravene Shariah principles.
The mechanics are as follows:
The promoter pool funds via the sales of the structured investment. The contract between the promoter and investor is usually that of a wakalah fi istithmar (investment agent).
For a principal protected structured investment, the promoter will split the funds into two, one portion will be invested in the Islamic money market or a fixed income instrument (zero coupon / discounted Sukuk) and a smaller portion will be utilised to purchase an option, applying the Urbun contract and referenced against the underlying.
The investment in the (Shariah compliant) fixed income instrument is for the purpose of reserving the principal investment and the option will provide the upside, if any.
The capital protection will only be enjoyed if the investment is held to maturity. Any premature withdrawal will result in the investment being valued at market and the investor will incur mark-to-market losses.
The maths is basically, allocate a portion based on the prevailing (profit?) rates that will ensure the capital is 100% preserved at the end of the investment tenure. The balance will be used to purchase an option. The participation rate (in the upside) of the option may not be 100% as it will depend on whether the balance after setting aside for the money market/fixed income Sukuk is sufficient. In some cases, the participation rate is less than 100% meaning the option holder is not entitled to all of the gains made from exercising the option.
Let’s dissect the structure.
Pooling of funds for investment purposes are perfectly fine and Shariah compliant.
Investing a portion to preserve capital – this would be done via the money market using Tawarruq. My stand on Tawarruq can be found here
A structured investment can either be principal protected or non-principal protected.
A Shariah compliant structured investment works the same way as their conventional counterpart, the only difference is in the nature of the underlying asset, it must not contravene Shariah principles.
The mechanics are as follows:
The promoter pool funds via the sales of the structured investment. The contract between the promoter and investor is usually that of a wakalah fi istithmar (investment agent).
For a principal protected structured investment, the promoter will split the funds into two, one portion will be invested in the Islamic money market or a fixed income instrument (zero coupon / discounted Sukuk) and a smaller portion will be utilised to purchase an option, applying the Urbun contract and referenced against the underlying.
The investment in the (Shariah compliant) fixed income instrument is for the purpose of reserving the principal investment and the option will provide the upside, if any.
The capital protection will only be enjoyed if the investment is held to maturity. Any premature withdrawal will result in the investment being valued at market and the investor will incur mark-to-market losses.
The maths is basically, allocate a portion based on the prevailing (profit?) rates that will ensure the capital is 100% preserved at the end of the investment tenure. The balance will be used to purchase an option. The participation rate (in the upside) of the option may not be 100% as it will depend on whether the balance after setting aside for the money market/fixed income Sukuk is sufficient. In some cases, the participation rate is less than 100% meaning the option holder is not entitled to all of the gains made from exercising the option.
Let’s dissect the structure.
Pooling of funds for investment purposes are perfectly fine and Shariah compliant.
Investing a portion to preserve capital – this would be done via the money market using Tawarruq. My stand on Tawarruq can be found here
Capital preservation is often a sticky issue with Shariah, if economic conditions go against the investment, what right does the investors have to demand full capital preservation? It becomes a zero sum game and there will be one party in the transaction who will lose out at the expense of the other. Shariah based finance is about justice and equity, sharing of profits and losses.
Buying an option using Urbun*, putting a deposit/downpayment to earn rights to purchase an asset – sounds compliant but are indices, foreign exchange and even inter-bank offered rates Shariah compliant assets? Does buying an intangible asset serve any economic purpose? I have no issues on Urbun for tangible assets like property or commodities.
My take on structured investment is it sort of looks and sounds like a mutual fund with a derivative (the option) and capital preservation elements. My views on derivatives can be found here and I’m of the opinion that capital should be positively correlated to the economy, preserving it would entail going against economic trends and causing some party somewhere to suffer more losses than necessary.
*Urbun is sometimes spelled Arboon
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