MALAYSIA has a long way to go when it comes to the Islamic private equity industry. It is still in the development stages and its growth, for various reasons, remains slow.

Acceptance among institutional investors for conventional private equity is low, says ACA Amanie CEO Mohamad Damshal Awang Damit. “So it is only natural that it is difficult to find [Islamic private equity],” he says.

The number of Islamic private equity players is very limited, and this is cause for concern, says Azam Azman, vice-chairman of Malaysia Venture Capital & Private Equity Association (MVCA) and managing director of CMS Opus Private Equity Sdn Bhd. However, he is unable to provide the exact numbers.

Azam says the lack of players might be due to the similarities between conventional and Islamic private equity. “The private equity investment itself [in the conventional sense] follows the concept of mudharabah and musharakah. Because of that, it is difficult to differentiate between [conventional and Islamic] private equity funds.”

In Malaysia, most of the private equity players are from the conventional side. There are no requirements in place for Islamic investors to invest in Islamic private equity funds, nor are Islamic companies required to seek funding from them. Hence, there are few of such funds.

“For the Islamic venture capital and private equity industry to prosper, there must be willingness by investors to invest in us,” Azam says. “Investors play a crucial role in the expansion of the industry.”

Rik Muilwijk, managing partner at Navis Capital, opines that there are probably a growing number of Islamic private equity players, but they might not be managing Islamic private equity funds exclusively. “You will have to distinguish between pure play Islamic private equity and those that operate within an Islamic private equity window, that is, investing in Islamic funds alongside conventional funds,” he says.

But Muilwijk attributes the slow development of shariah-compliant private equity investing to a lack of knowledge and human capital. “There is only a handful of general partners that have a proven track record in that regard,” he says, adding that human capital is a crucial element and is somewhat scarce in Asia.

Mohamad Damshal says it is not just about the Islamic label. “It’s about demand and supply. It is tough for emerging markets like Malaysia to really accept private equity as a whole, due to its perceived high risk nature.”

This is not a problem for listed equity or sukuk, because they are well-established, he adds. “The management of risk and return is easier because they have well-established benchmarks and markets, as well as good liquidity.”

“What type of benchmark [does it have]? What if liquidity is needed? How is liability managed?” All these questions are still unanswered for Islamic private equity, he says.

This will slowly change as awareness of Islamic finance increases, says Muilwijk. Awareness has increased since the introduction of the Islamic Financial Services Act (IFSA) in July last year.

The IFSA has indeed been a game-changer for the industry. Many governments in the region are looking to attract more shariah-compliant capital.

But where Malaysia really shines is the newly-introduced framework, as this gives it a greater advantage on top of having a sizeable Islamic community. “[The creation of] a regulatory framework that is conducive to Islamic finance, including clarity on accounting and tax treatment of Islamic finance instruments, may likely prompt more investing,” Muilwijk says.

The framework is important to reassure investors that the industry, though young, has the right risk-return profile. “Like other investors, Islamic investors are looking for the right risk/return profile. Islamic investors are likely to favour markets that are conducive to Islamic finance, both from a regulatory and human capital perspective,” he says. “Investors don’t like uncertainty, inefficiencies and transaction costs.”

Challenges aside, Mohamad Damshal, Azam and Muilwijk all agree on this: there is a lot of potential for Islamic private equity to take off in Malaysia. “Entrepreneurs are getting more sophisticated. Even Islamic private equity companies are starting to mature and show commitment to grow,” says Azam.

Companies in the manufacturing industry are starting to seek funding from them, he points out. The industry has seen a revival with rising costs in China and other issues in other parts of the world.

Family-owned businesses are starting to open up to the idea of getting outside investors into their companies, Azam adds. “Trends are changing and they are a positive for the industry.”

Times may be changing, he says, but Islamic private equity companies have to remember that there are still certain principles that have to be adhered to. These principles revolve around a central theme — the concept of “fairness”. Otherwise, Islamic private equity and its conventional counterpart are similar where risk-sharing in entrepreneurial ventures is concerned.

However, Azam says there are three main differences when it comes to shariah-compliant private equity. “First, the structure of the fund must be shariah-compliant when the money is raised, whether it is musharakah or mudharabah. Second, the company itself must be shariah-complaint. And third, its operations must also be shariah-complaint.

“The level of shariah-compliance in Islamic private equity is quite wholesome. At all levels, it follows the checklist.”

At the investment level, the guidelines include not investing in forbidden industries, such as hotels, gambling, liquor and tobacco. Also, companies have to use Islamic banking, takaful and other shariah-compliant components.

But the crux of it is that in shariah investment, everything is fair, Azam says. This comes with the shariah guidelines. For example, the principles in Islamic private equity are mainly about credibility and honesty.

“Globally, if you look at the terms of investment, it is environmental, social and corporate governance (ESG). In shariah, we cover this too,” he adds. “You cannot run away from these principles whether you are looking at conventional or Islamic.”

In Islamic finance as a whole, riba is considered a major sin. This also applies to Islamic private equity. “The key is to avoid exploitation by a party to a commercial transaction. Hence, the difficulty for Islamic investors to be exposed to conventional interest-bearing loans or purely speculative transactions,” Muilwijk explains, confirming that in all matters, Islamic finance follows the concept of “fairness”.

Otherwise, he says, Islamic and conventional private equity are not that far apart. “People realise that certain conventional investment models are very compatible with Islamic finance. And it has long been our experience that a significant number of non-Islamic investors, notably pension funds, excuse themselves from investing in industries such as weapon manufacturers, casinos or adult entertainment, which are also prohibited to Islamic investors. From that perspective, it would seem only natural that conventional and Islamic investors invest side by side.”

Apart from the forbidden industries, most Islamic private equity companies are sector-agnostic when it comes to investment. Some private equity firms agree that they avoid sectors that are cyclical, such as property. “Sometimes, we try very hard to manage, but the performance is due to market movements rather than management,” says Mohamad Damshal.

Can the industry flourish?

The Securities Commission Malaysia’s guidelines and Bank Negara Malaysia’s suppport for the Islamic banking industry have made the job a lot easier for Islamic private equity companies. “[Islamic banking and Islamic private equity] go hand in hand. When we invest in a company, support comes in the form of shariah-compliant [financial] products to complement the business,”Azam says.

However, certain products are still lacking in the industry. These are often not discovered until an Islamic private equity firm invests and finds gaps in a company. “We can either invest in a company and discover the gaps that need filling, or wait until they create the products that fill those gaps before going in to invest, so that it’ll make our job easier,” he explains.

Azam feels that such gaps should not be a hindrance to Islamic private equity firms. “This is where we can learn to get creative and truly understand the depth of Islamic finance,” he says.

When Azam encounters gaps, he sits down with shariah advisers to figure out a solution. “It is interesting to see how far you can go with Islamic finance,” he adds.

Muilwijk says for the industry to really grow, shariah-compliance must be an integral part of a fund manager’s investment process and structuring to resonate with Islamic investors.

Islamic private equity practitioners are also vital to the development of the industry. For Azam, being a Muslim himself, he feels that his work should be in line with his religious beliefs. He is also passionate about pushing Malaysia to the next level in Islamic private equity.

“We see Malaysia as the centre for Islamic finance. We have a lot of potential to be at the forefront of Islamic private equity,” he says. Sukuk was only a concept about 15 years ago, but Malaysia was at the forefront. There is no reason why Malaysia cannot be at the forefront of Islamic private equity as well, he adds.


This story first appeared in The Edge weekly edition of Sept 01-07, 2014.