Tuesday, October 16, 2007

Are sukuk the same as conventional bonds?

Although much has been written about the similarities between sukuk and conventional debt instrument, very little empirical work has been released. Some critics describe sukuk as nothing more than conventional debt with additional expense. A recent (October 1st) white paper by Selim Cakir (at the IMF) and Faezah Raei, a graduate student at the University of Texas, released on the IMF website by suggests that there may be important differences between sukuk and conventional debt.

The paper analyzed portfolios holding either only conventional debt or a mix of conventional debt and sukuk for soverign issues from Bahrain, Malaysia, Pakistan and Qatar (the countries with the best developed sovereign sukuk apart from Brunei which, despite its great oil wealth, does issue sukuk to help develop Islamic finance). When comparing the Value-at-Risk (VaR) of each portfolio at a 99% confidence level, each country's mixed sukuk-conventional portfolio had greatly lower VaR than a portfolio of just conventional debt. The percent decrease in VaR between the portfolios for each country was: 11% (Malaysia), 15% (Pakistan), 18% (Qatar), 32% (Bahrain).

In their conclusion, the authors write that they found "evidence that Sukuk—-contrary to our priors—-are different types of instruments than conventional bonds, as evidenced by their different price behavior. If an investor is ready to allocate certain amount of funds in the bonds of a certain issuer, diversification by including Sukuk in the investment portfolio could significantly reduce the portfolio’s VaR compared to a strategy of investing only in conventional bonds of that issuer."

The full paper is available in pdf format is available from the IMF website. An abstract is available here.


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