The Islamic bond market has surged over the first half of this year as issuers take advantage of the demand for sukuk. We predict that 2012 will be a record-breaking year for sukuk issuance with levels hitting in excess of USD 120 billion.
Sukuk has become a more attractive investment opportunity for a variety of reasons. The Eurozone crisis has forced investors to broaden their asset allocation models and target different markets, with sukuk being high on their list of attractive investment opportunities. Additionally, many sukuk are issued from the GCC and GCC investors are investing in sukuk as they return to their domestic market attracted by the relative economic stability, massive wealth reserves and lack of sovereign debt.
With demand for sukuk increasing, issuers are looking to capitalize on this opportunity. In the first half of 2012, there has been sovereign issuance from State of Qatar, issuance from banks such as First Gulf and Emirates Islamic, and corporate sukuk including Majid Al Futtaim. After the summer hiatus we expect to see more banks and corporates issuing sukuk toward the end of the year.
Despite the increase in issuance and demand the sukuk market is still less than 2% of the global bond market. However, we expect to see sukuk's market share continue to grow over the medium term as more conventional issuers and investors move into the sukuk market. As longer dated US dollar swap rates fall, the sukuk market will continue to out-perform many conventional bonds.
Conventional investors are also attracted by the fact that Shariah-compliant Islamic financial institutions are less exposed to highly leveraged organizations and their balance sheets are based on traditional lending and trade business, rather than on derivatives and structured products.
Due to this investor appetite, there is a strong market for actively managed funds that invest in sukuk and Shariah-compliant assets. BLME has two income funds that invest in sukuk: the US Dollar Income Fund and the High Yield Fund.
The US dollar fund provides investors with the optimum mix of return via active investment, liquidity and security. It has met its performance objectives and has consistently and significantly exceeded its target return. The fund is 60% invested in sukuk and is in the top percentile of its peer group - comprising 730 conventional income funds - since launch, as ranked by Reuters' fund ranking service, Lipper Hindsight.
The High Yield Fund offers higher returns than the US Dollar Income Fund and predominantly invests in sukuk. As at July 2012 this was the top performing sukuk fund ranked by Zawya. This fund comprises 90% sukuk.
In the past there have been concerns regarding the liquidity of the sukuk market. However, over the past three years, the secondary market has grown in depth and breadth and now US dollar-denominated sukuk are freely traded.
The current level of sukuk issuance is not meeting investor appetite with most sukuk being significantly oversubscribed. The State of Qatar Sukuk was 20 times oversubscribed. We expect that this demand will continue to grow and that investors will continue to look for ways to access the sukuk market either via funds or direct investment.
Jason Kabel is head of fixed income at BLME. Jason has more than 15 years of asset management experience focusing on money markets and fixed income products at various companies including BNP Paribas, Novartis and F&C Asset Management.
© Zawya 2012
