At US$930 billion ($1.18 billion) in size, the market for sukuk — the Islamic world's answer to bonds — is becoming harder for mainstream investors to ignore, according to Morningstar. Funds investing in sukuk — Islamic securities that mimic bonds in their cash flow and risk characteristics — represent a “small but growing market” with appeal for Muslim investors otherwise barred from owning conventional bonds, reads a Morningstar report released June 26.
According to Fitch Ratings, the sukuk market grew 7.7% y-o-y in outstanding securities at the end of 2024, but the market for funds investing in sukuk is tiny by comparison, at just US$5.8 billion in assets under management (AUM) over 98 individual vehicles.
While small, the AUM of sukuk funds worldwide was up 16% y-o-y as of May and 66% over five years. Fees for passive sukuk exchange-traded funds (ETFs), which largely focus on the investment-grade market, range from 0.35% to 0.50%. This is “reasonable, though higher than comparable bond options”, adds Morningstar.
Meanwhile, fees for US dollar-denominated actively-managed sukuk funds average 1.34%, which is “pricey compared with conventional global diversified or emerging market bond funds”, say the analysts.
See also: US Treasuries get vote of confidence from Korea’s wealth fund
Only two individual funds boasted asset volumes greater than US$500 million: market leader Franklin Global Sukuk (US$848 million) and runner-up Azimut Global Sukuk (US$582 million). Meanwhile, the Malaysian fund market, investing primarily in local currency sukuk and aimed at local investors, accounted for roughly one-third of global sukuk fund assets (approximately US$2.0 billion).
That market was dominated by one key player: Principal Asset Management Berhad boasted a 56% market share as of May.
See also: S’pore bonds beat developed peers on liquidity, scarcity
According to Morningstar, active sukuk funds often have more room to boost yields by investing in riskier, below-investment-grade issuers.
However, Islamic banks dominate sukuk ownership, resulting in a market characterised by shallow trading and low liquidity. The sukuk market’s “infrequent” trading and “largely buy-and-hold investor base” mean lower price volatility compared with conventional bonds, add analysts. “However, this feature could diminish if funds become a more meaningful portion of the market, and it should not be mistaken for a lack of credit risk.”
Despite its lower price volatility, the sukuk market remains highly concentrated geographically. According to an August 2024 report by Global Finance, Iran and Saudi Arabia account for over half of global Islamic finance assets, with market shares of 30% and 25% respectively, followed by Malaysia with 12% and United Arab Emirates with 10%. “However, for Muslim investors otherwise unable to tap fixed income funds, the sukuk market offers a compelling solution,” says Morningstar.
Adding sukuk to your portfolio
Built using a set of traditional Islamic contracts, sukuk allow issuers to raise capital from investors in exchange for a stream of predictable cash flows.
Unlike bonds, sukuk involve the temporary transfer of ownership of an asset from the issuer to the investor, providing income through shared rents or profits rather than paying interest on borrowed debt, which many believe violates Islam’s prohibition on usury, write Morningstar’s analysts.
To stay ahead of Singapore and the region’s corporate and economic trends, click here for Latest Section
Modern-day sukuk transactions are “typically quite complex”, says Morningstar. “Most rely on special-purpose vehicles (SPVs) as intermediaries to warehouse the assets in question, with sukuk investors acquiring beneficial ownership in the SPV rather than directly in the assets themselves.”
Hybrid structures — combining two or more sukuk contracts into a single issuance — have proliferated in recent years as a means of enhancing trading flexibility, they add.
As more governments and companies issue sukuk, the market is becoming deeper; at the same time, increased competition between funds should gradually bring fees down for investors, says Morningstar.
“Outside of investors specifically seeking Shariah-compliant options, however, the case for adding sukuk to a conventional bond portfolio is not compelling,” write the analysts. “Although the market's particular ownership structure and higher-quality tilt have historically given it a defensive shine, its high concentration means that geographic, regulatory and idiosyncratic risks remain considerable.”
Investors willing to step out of the comfort of developed market bonds have a wide array of emerging market bond funds to choose from, write the analysts. “Over long periods, the added diversification provided by those funds — including access to other regions of the world not represented in the sukuk space (such as Latin America or parts of Asia) — has proved to be a more reliable combination.”
Charts and tables: Morningstar
