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The unconventional bond to back to ride the interest rate hike

The unconventional bond to back to ride the interest rate hike

Sukuk bonds, Sharia-compliant Islamic fixed income securities, will be less affected by a rise in interest rates than traditional fixed income instruments, according to Franklin Templeton’s MENA fixed income strategies CIO Mohieddine Kronfol.

In his latest commentary, Kronfol said the asset class will hold up better than US Treasuries and emerging market debt in a rising interest rate environment, offering an interesting opportunity to international investors.

‘Sukuk portfolios have a lower duration and thus less interest-rate sensitivity than major fixed income indexes. Not only are the returns attractive relative to traditional bonds, but also their volatility has historically been more subdued,’ he said.

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.

This is the reason why, according to Kronfol, they can provide a growing diversification to global investors’ portfolios.

'They also tend to be more insulated from market events and have lower correlations to other asset classes,’ he said.

From a geographical perspective, Sukuk bonds offer exposure to areas of the market that may not be captured in more traditional fixed income indexes, such as the Gulf Cooperation Council and Southeast Asia, the MENA fixed income strategies CIO said.

‘These areas’ credit ratings are currently relatively strong and economies have been expanding at a rapid clip. As a result, the securities’ credit risk profile has tended to be lower than high-yield debt,’ he added.

A growing (but still opaque) market

The Sukuk market has surged from just $121.5 billion outstanding in 2010 to $247.6 billion in 2013, according to data from the investment research company KFH Research.

Kronfol believes the increase still pales in comparison to the demand for these investments. 

‘Global consultants Ernst & Young predict that global demand for Sukuk will reach $900 billion by 2017. 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.’

In regards to asset class risks, the MENA CIO said that Sukuk are still largely over-the-counter instruments and access to information in some cases can be uneven.

‘We believe local expertise is crucial in finding suitable Sukuk investment opportunities. Thorough independent credit research, global investors can definitely uncover attractive opportunities.’

Since its launch two years ago, the Kronfol’s Franklin Templeton Global Sukuk fund returned 7.81%, 8.62 percentage points more than Dow Jones Sukuk index. Currently, Franklin Templeton manages approximately $2 billion in Shariah-compliant assets.

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