Islamic finance and the global Sukuk market

Mohieddine (Dino) Kronfol is a chief investment officer of Global Sukuk and MENA fixed income at Franklin Templeton Investments.

Islamic finance, a generic term for financial transactions that comply with Islamic principles, has been one of the fastest-growing areas of the financial services sector with an estimated asset value of over US$1.8 trillion as of April 2014 and continues to grow at an annualized rate of nearly 20%1. Since the 1990s, Islamic finance has grown from a focus on Shariah-compliant commercial banking and project finance to encompass a range of products and services that are now accessible by individual and institutional investors, chief among which are “Sukuk.”

Sukuk is the plural Arabic name for financial certificates, but commonly refers to the Islamic equivalent of bonds.

Sukuk are designed to meet Islamic Principles, but are catering to all investor types

Sukuk structures differ from conventional bonds in several ways, for example, Sukuk constitute partial ownership in real assets. Additionally, Sukuk prohibit interest and instead are structured so that profit rate payments are really lease, rental or profit payments that are passed through to Sukuk holders from an underlying asset. Furthermore, a separate purchase undertaking, by a third-party or the issuer in some cases, gives Sukuk holders the comfort that the principal will be repaid in full. Through such structuring, Sukuk are meant to meet both risk-sharing and asset-based standards that are of the utmost importance to Islamic investors.

Historically and prospectively, demand for Sukuk, which comes from Islamic and non-Islamic financial institutions and individuals alike, far outstrips supply, reflecting the fast growth of the Islamic banking industry and the increasing appetite for credible, Shariah-compliant and liquid securities. Global, investable Sukuk issued by corporations and sovereigns have been in excess of US$35 billion a year for the past four years now, with Malaysia, Indonesia and Gulf Cooperation Council (GCC) countries still accounting for the lion’s share of Sukuk issuance. While the quantum of issuances is gathering pace and has gained acceptance from international investors, the US$300 billion market hardly keeps up with the growth of Islamic finance assets.

Sukuk bring exposure to a growing and lowly-correlated asset class with ensuing diversification benefits

The asset class represents an interesting opportunity for investors, as global Sukuk issuance is growing rapidly with larger and more diversification by geography, sector and capital structure. In addition, global Sukuk provide diversification benefits due to historically low correlation in performance to other asset classes (including a three year correlation to oil at zero as at the end of 20143), helping investors build balanced portfolios.

Despite the growing concerns surrounding emerging markets, we expect countries with solid fundamentals and the appropriate policy mix, particularly in parts of Asia and the Gulf Cooperation Council, to perform better than others and see recent oil price weakness as an attractive buying opportunity. The global Sukuk market continues to benefit from a strong and stable demand base, a steady stream of new issuers, and an exciting growth and development story that supports increasing diversification and potentially competitive risk-adjusted financial performance.