Gulf sukuk funds grow but liquidity is problem
* Gulf-based sukuk funds grow 31 pct in 2011
* But half of them account for 91 pct of assets
* Aggregate size tiny compared to sukuk market
* Funds' turnover ratios generally low
* Industry still lacks firm that originates and underwrites
By Bernardo Vizcaino
SYDNEY, June 21 (Reuters) - Gulf investment funds dedicated to sukuk are increasing in size and number, but the growth spurt may not be enough to solve the concentration and liquidity issues facing the Islamic bonds market.
Assets of sukuk funds based in the Gulf now exceed $500 million, a 31 percent increase since last year, according to Reuters calculations based on data from fund companies. This remains small compared to the total Islamic bonds market; global sukuk issuance was $86 billion in 2011, and $43 billion in the first quarter of this year, according to Thomson Reuters data.
The growth of sukuk funds is partly because investors are becoming more sophisticated in their asset allocation decisions, and searching aggressively for yield, said Mark Watts, head of fixed income at National Bank of Abu Dhabi.
"As the market institutionalises, there is recognition that investments are not all about equities," Watts said. Classic asset allocation models suggest investors should put 60 percent of their money into fixed income, while currently that proportion is in equities or cash for Gulf investors, he added.
A reallocation towards sukuk is now underway but it faces a shortage of sukuk funds. This prompted NBAD to launch its own sukuk fund in May, alongside those announced this year by HSBC and Gulf institutions Al Hilal Bank and Rasmala Investment Bank.
The new launches join a small club of Gulf-based sukuk funds. There are a total of 17 such funds, with half of them accounting for some 91 percent of assets, according to the Reuters calculations.
The sukuk fund of QIB UK, a Qatar Islamic Bank subsidiary , by itself accounts for a huge proportion of the assets; launched in 2009, it now has $213 million in assets, of which $100 million was raised last year, Anouar Adham, head of asset management at QIB UK, told Reuters.
"A key differentiator for us is that we are a pure sukuk player...Some of the competition puts a lot of different instruments, not only sukuk, in their funds," Adham said.
Some funds allocate a large portion of their portfolios - 25 percent or more - to short-term instruments in order to manage their liquidity needs, because most sukuk holdings are not traded often.
Many funds are unable to accomodate retail investors, which are left out because of minimum investment restrictions. The investor base of QIB UK's sukuk fund is approximately 80 percent institutional, according to Adham, and comprises mostly takaful and re-takaful institutions (Islamic insurance and re-insurance). He said that three years ago, the fund attracted individual investments of $3 million in size, but some were now as large as $20 million.
The takaful sector's growth rates and profitability are under pressure, increasing the need for products with yields higher than cash.
This has encouraged customised investment mandates, some of which range from $60 million to $200 million, according to Adham.
"Discretionary mandates dwarf mutual funds," Watts said, citing one $350 million investment portfolio which allocates over half of that amount to sukuk. Precise figures remain elusive, but conservative estimates for the discretionary business range from one to three times the size of the sukuk fund industry.
Investors in sukuk include Islamic banks investing on their own accounts, which adds to the institutional and stable nature of the sukuk market, said David Marshall, head of product and distribution at Emirates NBD Asset Management.
"There is a normalisation of sukuk as an asset class," Marshall said, noting net inflows of $30 million last year into the sukuk fund of Emirates NBD, which was launched in 2010 and now has $44 million in assets.
But not all sukuk funds have enjoyed such interest, and distribution channels for funds have a strong influence on the make-up of investors in them, Marshall said.
"Not that many have a sustainable size, and in time, some will fall by the wayside," said Eric Swats, head of asset management at Rasmala Investment Bank. "Expect the industry to contract, with more money to be held by institutional players."
Rasmala, which manages $650 million in assets, announced its own sukuk fund in April with seed capital of $25 million. Swats says he expects it to grow to between $60 million and $75 million by year-end.
While many analysts expect the sukuk fund industry to continue growing in the long term, poor liquidity in the secondary sukuk market and a relatively narrow range of sukuk issuers threatens to slow the expansion.
Because of their small aggregate size, sukuk funds have not contributed much trading liquidity to the secondary market. Furthermore, sukuk issuance is dominated by sovereign and state-linked entities, which are estimated to account for as much as 78 percent of global issuance; funds and other investors tend to hold these high-grade instruments to maturity, without trading them.
This explains the low turnover ratios in sukuk funds. The funds trade as little as 40 percent of their assets in a single year, according to Marshall. "We are not day traders," Swats said.
In 2011 the global sukuk market saw just 15 U.S. dollar-denominated issuers, according to The Bank of London and Middle East, which launched its first sukuk fund in 2009 and another in May of last year.
There is one element missing in the market altogether: a firm that both originates and underwrites sukuk, and which could encourage more corporate issuance.
"What you need is to increase issuance in the primary market. Supply will drive sukukholders to start trading," said Abdul Rahman Mohammed Al Baker, executive director of financial institutions supervision at Bahrain's central bank.
Bid-offer spreads reflect the lack of a liquid market, he added. "You constantly hear sukuk oversubscribed five times," Al Baker said. "But what happens next? Nothing." (Editing by Andrew Torchia)
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