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MANAMA, Dec 11 (Reuters) - Demand for sukuk, or Islamic bonds, is expected to almost double in value over the next four years, driven by strong economic growth in the Middle East and Asia and their spread to new markets, according to a report by Thomson Reuters.
Sukuk are Islamic investment certificates that pay returns on money invested, instead of interest, to obey Islam's ban on interest. They are a major funding tool for both banks and corporates in the Islamic finance industry, which has its core markets in the Middle East and southeast Asia.
Global demand for sukuk is expected to reach $421 billion by 2016 from $240 billion in 2012, according to a Thomson Reuters survey of 169 investors and sukuk arrangers, mainly from the Gulf region and Asia, conducted in August and September.
Supply is also forecast to grow, but not as quickly as demand with the gap widening to more than $280 billion over the next four years from around $160 billion now, the report said.
On average, investors expect to allocate $200 million into Islamic investments, or 50 percent of their portfolios, next year, with sukuk representing 35 percent to 40 percent of this.
The report highlighted concerns over liquidity of sukuk in the secondary markets. Only 19.2 percent of investors expect to hold sukuk for less than a year for trading purposes.
Investors' preference is to hold sukuk for longer, with 42.4 percent saying they would hold sukuk between one to three years, and more than a quarter expecting to hold sukuk to maturity.
Arrangers, however, expect the liquidity of the secondary market to improve in coming years. Both arrangers and investors see the emergence of a mega Islamic bank as a way to boost liquidity, as well as dedicated sukuk traders.
Sukuk issuance is expected to remain anchored in core markets such as Malaysia and Saudi Arabia, with investors also showing appetite for Omani sukuk. Arrangers also favour Egypt and Kazakhstan outside of core markets.
Despite agreeing on the growth potential of sukuk, investors and arrangers have differing views on several key features.
There is greater demand by investors, for example, for dollar-denominated international sukuk, while arrangers see a more even split with domestic-currency issuance.
Investors are also seeking an even split between fixed and variable profit rates on their sukuk, while most arrangers expect fixed rates to be offered in the next two years.
Investors prefer tenors of three to five years, compared with the longer terms expected by arrangers. And asset-backed sukuk are preferred by a majority of investors, whereas arrangers see these accounting for only a third of issuance in the coming two years. (Editing by Mark Potter)