Sukuk: An Asset Class Goes Mainstream

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Islamic finance, once of interest only to a niche market of Muslim investors, has been going mainstream. Fixed income investments within the space known as Sukuk have attracted the attention of investors across the globe who see the potential this unique asset class can offer.

Mohieddine Kronfol (pictured), chief investment officer, Franklin Templeton Global Sukuk and MENA Fixed Income Strategies, explains how Islamic finance has been growing over the past decade, and why a growing number of investors are crossing the borders—and boundaries—of traditional fixed income to add Sukuk to their portfolios.

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 US$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 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.

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