Sukuk bonds: Where the smart money is headed? Originally published (8/16/16)
In today’s upside-down economic environment, tepid stock markets and negative interest rates in parts of Europe and Asia mean that neither equities nor bonds has provided the kind of performance many would like. Where can one look for an acceptable return? The answer may be sukuk bonds. Global dollar sales of sukuk climbed to $14 billion this year, a record for the period. Issuance over the past several years has grown to meet the demands of not only Muslim investors in Gulf Cooperation Council (GCC) nations and parts of Asia, but also institutional investors in the developed world. This unconventional instrument, which behaves in ways similar to a conventional bond in terms of payment priority but has an Islamic structure, is now basking in the spotlight as more conventional players start to pile in.
Commodities help sukuk issuances:
Increased attention paid to sukuk can be traced back to the recent drop in commodity prices. Export-oriented countries in need of U.S. currency to manage widening current account balances are often forced to borrow in dollars. That means more dollar-denominated sukuk issuances from those countries. Because of a flood of sales, yields have climbed in recent months to entice buyers. According to JP Morgan, the average yield on sukuk from the Middle East climbed to a five-year high of 5.25% in January.
The higher cost of borrowing hasn’t deterred commodity-producing governments, however. Data from Bloomberg show that Indonesia, a major palm oil and rubber exporter, paid nearly a quarter of a percentage point more than it did a year ago on its 10-year sovereign sukuk bonds issued in March, bringing the current yield to 4.55%.
In addition to slumping commodity prices, limited investor participation relative to the larger bond universe has led to liquidity issues and wider yield spreads. But the era of higher borrowing costs compared to conventional bonds may be nearing an end if certain factors play out. Chief among those is reported interest by JP Morgan to include sukuk instruments in its suite of emerging market indices. Such a decision would likely mean not only tighter spreads but an even larger investor base since many emerging market investors abstain from bonds not included in indices.
This is especially the case for sovereign credits. Analysts expect that emerging market sovereign sukuk would benefit most from inclusion in an index. An estimated $300 billion in assets track emerging market bond indices, and $120 billion is earmarked for sovereign or quasi-sovereign bonds. A sizeable portion of this subtotal could be allocated to sukuk should JP Morgan choose to move forward.
According to strategists at Standard Chartered bank, those Indonesian sovereign sukuk bonds mentioned earlier would likely benefit most from inclusion in the JP Morgan indices. The country currently has $9.5 billion outstanding, which translates into a full percentage point increase in index weight in both the EMBI Global and JACI, two widely followed indices focused on emerging markets.
Analysts also expect GCC countries to benefit from index-eligible sukuk bonds, where a third of dollar-denominated sales originate, but Southeast Asia, they say, stands to see the biggest gains.
Today, sukuk investors enjoy the advantage of a maturing asset class that is drawing attention from big money players. And prospects for the future could mean even greater demand and exposure for the instrument. In an era in which global central bank policies have distorted markets and stymied investors for what could turn out to be a significant time, sukuk bonds have the potential to outlast short-lived publicity and thrive longer term courtesy of growth-conscious investors in the global marketplace.
Joshua Brockwell is Investment Communications Director at Azzad Asset Management, a socially responsible registered investment advisor located in Falls Church, Virginia. Azzad is the sponsor of the Azzad Wise Capital Fund, a sukuk-oriented emerging market fixed income fund sub-advised by Federated Investment Management Company.
The views expressed are those of Azzad Asset Management. These views are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security or the markets generally, nor are they intended to predict the future performance of any Azzad account, strategy or fund.
Diversification, asset allocation and rebalancing cannot assure or guarantee better performance and cannot eliminate the risk of investment losses.
The information provided is for general information purposes only and should not be considered an individualized recommendation or advice. Azzad Asset Management makes no representations or warranties with respect to the accuracy or completeness of the information provided. Any illustrations are for hypothetical purposes only. Holdings are subject to change.
We strongly recommend you consult with your tax advisor for more information about your particular tax situation.
Before investing, carefully consider the Fund’s investment goals, risks, charges, and expenses. For a prospectus or summary prospectus containing this and other information, contact your financial advisor or download them from our literature center. Read them carefully before investing.
Investments carry risks, including possible loss of principal. Portfolios investing in sukuk have the same interest rate, inflation, and credit risks that are associated with bonds. The value of sukuk will fluctuate relative to changes in interest rates, decreasing when interest rates rise. Unlike sukuk, sukuk funds have ongoing fees and expenses. Investments in the Fund are not FDIC insured, nor are they bank deposits or guaranteed by a bank or any other entity. Investments in equity securities are subject to additional risks, such as greater market fluctuations. Additional risks may be associated with investments outside the United States, especially in emerging markets, including currency fluctuations, illiquidity, volatility, and political and economic risks.
Credit quality ratings for Azzad Wise Capital Fund used ratings from Moody’s Investors Service. Where Moody’s ratings are not available, we have used Standard & Poor’s ratings. Where neither rating is available, we have used ratings from other NRSROs.
A bond credit rating assesses the financial ability of a debt issuer to make timely payments of principal and interest. Ratings of AAA (the highest), AA, A, and BBB are investment-grade quality. Ratings of BB, B, CCC, CC, C and D (the lowest) are considered below investment grade, speculative grade, or junk bonds.
There is no guarantee that the Fund will meet its investment objectives. Funds invested in a limited number of holdings may expose an investor to greater volatility.
Please see our glossary for a definition of terms.
Azzad Asset Management is the investment advisor to the Azzad Funds. The Azzad Funds are self-distributed.