How you can get a return and do some good at the same time
Imagine you’re running a business with tons of potential. You know that it could be profitable — as soon as you have your finished product, you’re able to sell it. The problem is that you don’t have enough capital to buy your raw materials.
That was life before Islamic trade finance at PT Angels, an Indonesian company on the island of Java. PT Angels had processed raw sugar since 2002, but getting favorable terms to purchase supplies and sell the refined product to the food and beverage industry was never easy. Things changed, however, in 2009 when the firm signed an agreement to finance its raw inputs with $25 million from the International Islamic Trade Finance Corporation, or ITFC.
The ITFC is part of the Islamic Development Bank (IsDB) Group and was created to advance trade to improve the economic conditions and livelihoods of people across the developing world. It does this by helping small and medium-sized businesses compete successfully in the global market. In the case of PT Angels, that meant making capital available for sugar purchases on more favorable terms, specifically interest-free. It also meant stepping in as a buyer of quantities large enough to reduce costs and improve economies of scale.
How it works
The agreement between the ITFC and PT Angels is called “murabaha.” It’s a type of credit sale different from the interest-bearing loans common in trade finance. With the murabaha contract, the ITFC buys a sugar shipment from a third party vendor, free and clear. It then sells the sugar to PT Angels, adding a small mark-up, or profit, that was agreed upon in advance. The resulting transaction means that PT Angels can leverage the ITFC’s capital and reputation to secure raw goods at prices they could not get otherwise.
Investing in trade finance
The ITFC allows others who want to invest in deals like the one with PT Angels to do so through so-called syndicated trade finance deals. Investors are able to share in any gains from the transaction while making an impact on companies in the ITFC network through their capital contributions.
From a risk/return perspective, murabaha trade finance deals are an attractive option for fixed income investors; they can plan for an expected, though not guaranteed, rate of return, because pledged capital is drawn down orderly and incrementally. They can also help protect themselves from higher interest rate risk common with other credit instruments. According to Federated Hermes, which invests in ITFC-syndicated deals for the Azzad Wise Capital Fund, Islamic trade finance offers some of the best risk-adjusted returns in the space.
“You can earn superior yield with a quarter of the interest rate risk,” says Ihab Salib, portfolio manager of the Azzad Wise Capital Fund, which owned shares in the PT Angels trade finance deal. “There is much lower volatility because it’s secured by the ITFC.”
The Jeddah-based IsDB, parent of the ITFC, has never had a default on its trade finance deals, owing to the creditworthiness of the transactions the IsDB underwrites. The IsDB itself boasts a triple-A credit rating.
Adding to the investment appeal of Islamic trade finance is the fact that those syndicated deals have been insulated from the recent rise in global interest rates. That’s because profits are reset on a floating basis to reflect changes in the underlying rate environment, according to Federated Hermes.
Making an impact
The story of PT Angels prior to its relationship with the ITFC is not unusual in parts of the world. For many small businesses in emerging markets, the cycle of debt, repayment, and more debt can be impossible to overcome.
But Islamic trade finance has emerged as one of the most effective ways to directly help create jobs and grow businesses in an environment where access to capital is limited. From cotton deals in Burkina Faso to wheat exports from Kazakhstan, the ITFC syndicates deals that help both entrepreneurs and investors alike. With the additional capital contributed by the socially conscious, investors from all walks of life can help make a positive impact.
To learn more about Islamic trade finance and the Azzad Wise Capital Fund, read the summary prospectus.