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Sunday, 19 October 2014

Sukuk: An asset class goes mainstream

Dubai: Islamic finance, particularly fixed income instruments known as Sukuk, has come of age and is now an integral component of the mainstream global financial system. A decade ago, the Sukuk market was valued at $9.6 billion, issues were generally small in nature, and the market was concentrated amongst a handful of issuers; in 2013, the market topped US$269.4 billion, with an exponential growth in the number of large deals and increasing diversification of issuers. The Islamic finance industry is expected to continue growing at nearly 20 per cent per year, and the pool of investors interested in Shariah-compliant securities is expected to rise along with it. And while Islamic investors are the natural buyers of Sukuk, the appeal of Sukuk now extends far beyond the Islamic world. Some estimates suggest that conventional investors may account for as much as 40% to 60% of any individual Sukuk offering.
In our view, Sukuk may be attractive options for both Islamic and non-Islamic investors seeking to diversify their investment portfolios. Not only are the returns attractive relative to traditional fixed income assets, the volatility of Sukuk has historically been more subdued—something that could prove important in a rising interest-rate environment. Moreover, Sukuk provide exposure to some of the fast-growing and most financially sound economies in the Gulf Cooperation Council (GCC) and Southeast Asia, countries that are often underrepresented in many traditional bond indexes and funds. Due to their unique structure and market dynamics, Sukuk returns also tend to be less correlated with other parts of the global fixed income market. All of these factors, we believe, may make Sukuk an appropriate complement to investors’ existing equity or global bond allocations.
Innovation and Growth
In essence, Sukuk combine religious law dating back some 1,500 years with the latest developments in modern structured finance. Sukuk are fixed income securities that comply with Islamic law’s prohibition of paying or charging interest. Instead of basing payments on interest, payments are based on either profit sharing or rental or lease income—and they are typically backed by a tangible asset. The Sukuk market has surged from just US$121.5 billion outstanding in 2010 to US$247.6 billion in 2013, according to data from KFH Research. Impressive as that increase has been, it still pales in comparison to the demand for these investments.
New Sukuk issues are often many times oversubscribed, and given the growing acceptance of Sukuk outside of traditional Islamic markets and issuers, the asset class is reaching critical mass. Global consultants Ernst & Young predict that global demand for Sukuk will reach US$900 billion by 2017. The strong demand stems partly from the massive expansion in the assets of Islamic investors, and the relatively limited supply of Sharia-compliant investment alternatives. Islamic financial assets currently total more than US$1.8 trillion, and continue to grow at an annualised rate of nearly 20%. Furthermore, the strength of the asset class during the global financial crisis and Eurozone sovereign debt crisis, as well as the growth of the asset class beyond the Islamic world, is fuelling demand.
Sukuk market goes global
The bulk of Sukuk issuance still comes from Malaysia and the oil-rich Gulf States, but an increasingly wide array of countries and companies in other parts of Asia, Africa and Europe are seizing the opportunity to tap the Islamic debt markets to take advantage of the vigorous demand. Indeed, in June 2014, the United Kingdom (UK) became the first Western government to issue Islamic bonds. The yield offered was comparable to what the UK government pays on its conventional Gilts, with investors receiving rental income based on three government-owned properties.
We expect this trend to continue as a range of issuers looks to tap the large pools of Muslim wealth and liquidity around the world and policymakers see the benefits of complementing their financial architecture with Shariah-compliant securities and services.
Tangible progress is being made across the globe to support Islamic finance and further Sukuk issuance. Sixteen governments around the world have issued Sukuk since 2001, and more are likely to follow suit in the next few years. These deals, we believe, will further help to diversify primary market activity and improve secondary market liquidity.
(Gulfnews.Com / 18 October 2014)
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