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Here are reasons why sukuk is a great alternative

Ahmad Yousuf/Dubai
Filed on May 27, 2017 | Last updated on May 27, 2017 at 05.35 pm
Here are reasons why sukuk is a great alternative
The UAE is ranked third globally in sukuk issuances, behind Saudi Arabia and Malaysia.

It's not without risks though, so ask for expert advice

The latest bonds, loans and sukuk Middle East conference provided us with many insights into the latest trends surrounding the capital markets.

Recent data compiled by the International Islamic Financial Market (IIFM) has revealed that the total sukuk issued globally between 2001 and 2015 reached a staggering $767 billion (Dh2.82 trillion). Around 96 per cent of the issuances originated in the GCC region and Asia, with the two regions contributing 22 per cent and 74 per cent, respectively. Malaysia led the global list of countries for the highest outstanding sukuk issuances (57 per cent), followed by Saudi Arabia (16 per cent), the UAE (10 per cent) and Indonesia (six per cent).

Given the context, why are sukuk issuances becoming more popular in our region? And of what benefit is sukuk to investors?

 

Understanding sukuk

Essentially, sukuk is a Shariah-compliant debt instrument that is in line with Shariah principles and guidelines set forth by governing Islamic scholars. Sukuk serves as an alternative to conventional bonds for Muslim and non-Muslim investors. These Islamic certificates are structured to generate returns for investors without infringing Islamic law. Rather than offering the prohibited riba or interest, sukuk instruments offer depositors a stake in the actual investments instead. As such, they are very attractive to a broad range of investors, especially individuals and institutions with a strict mandate to invest in Shariah-compliant instruments.

Sukuk securities are especially attractive to investors who wish to diversify their investment portfolios seeking exposure in a different asset class, to achieve portfolio diversification. In sukuk, fixed income profit is paid to investors at predefined regular intervals, ensuring investors enjoy a steady cash flow. Sukuk securities provide exposure to some of the fastest-growing economies in the GCC region and Southeast Asia - which are often less-represented in many traditional bond indexes and funds.

There is no lock-in period for sukuk as with other investments; this means an investor who is squeezed for cash can easily redeem his sukuk holdings for money almost instantly. According to the aforementioned data by the IIFM, 61 per cent of all sukuk securities issued between 2001 and 2015 were linked to governments. This makes sukuk much safer than conventional bonds, since governments typically enjoy better credit health and control, in most cases.

 

Weighing advantages and risks

Sukuks enjoy greater liquidity than their conventional equivalents. This is mainly due to the demand that influences the sukuk markets; while demand is international, supply is currently limited to the GCC and Asia regions. This factor lowers liquidity risks when investors wish to sell their holdings.

Another critical factor favouring sukuk is that as securities, they are anchored in actual assets - ownership in particular projects, properties or special investments - while bonds are more or less debt instruments.

Perhaps most importantly for investors, sukuk securities are becoming the preferred choice over fixed deposits. This is mainly because of the profit rates that each instrument offers. Sukuk securities can offer on average a return of five per cent per annum, while fixed deposits for the same period and currency (usually US dollar) pay 1.75 per cent per annum at best.

As with any other investment, sukuk is not without risk. Some of the more inherent ones are the price risk, interest rate risk, credit risk, default risk and liquidity risk. All these risks are somewhat interrelated - in the sense that they complement each other in practice.

 

Adding sukuk to investment portfolio

Even though sukuk securities come with a measure of risks, they are outweighed by the rewards. Furthermore, the probability of these risks transpiring is very low. Thus, it is no surprise that sukuk is growing in popularity, especially given its link to the rapidly growing Islamic economy.

In most cases, it is important to remember the old rule of thumb while investing: 'The greater the risks, the higher the returns.' However, to counter the risk argument, there are many intangibles that play a crucial role in the quality of sukuk, especially in the GCC.

Ultimately, it's important for investors to assess their appetite and ability to bear market-related risks and carefully analyse available options.

In summary, the popularity of sukuk as an attractive investment option is growing worldwide. Sukuk securities appeal to a broad range of investors - institutional and individual, Muslim and non-Muslim alike. They are a safer alternative to conventional bonds because they are backed up by actual underlying assets. As such, they can be part of a vibrant investment portfolio, yielding attractive returns.

The writer is head of investment solutions - treasury sales at Noor Bank. Views expressed are his own and do not reflect the newspaper's policy.


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