Market perceptions of liquid sovereign Sukūk: a new asset class?

This paper aims to explore whether the market perceives liquid international sovereign sukūk as distinct from comparable bonds and as an asset class of their own that could shield investors against turbulences in the bond markets.

If sukūk and bonds belong to the same asset class, then basically the same supply and demand factors determine inverstors’ activities in both markets. This should lead to matching patterns of yield curves for sukūk and bonds comparable in terms of issuers, maturity, currency, size, liquidity and rating. Only a rough analysis of holding and trading patterns of conventional and Islamic sukūk investors was possible, as most sukūk market transactions are “over-the-counter” and not registered in the Bloomberg database. However, price information could be used for an analysis of yield curves of liquid sovereign sukūk and comparable bonds.

Conventional investors participate in the sukūk market, but their influence on prices is rather small, as they act primarily as intermediaries (i.e. market makers) as opposed to price setters. The yield curves of the selected bonds and sukūk widely match. This suggests that bonds and liquid sovereign sukūk belong to the same asset class. Furthermore, as turbulences in conventional markets are also reflected in the sukūk markets, Islamic investors themselves play a role in the transmission.

The study of holding patterns and of the market perception of sovereign sukūk and bonds required a focus on four countries with deep and (potentially) liquid sukūk markets (Malaysia, Turkey, Indonesia and Hong Kong) and US$-denominated international securities. Some suitable combinations of sukūk and bonds are relatively young issuances with time series data for two to three years only. Data on holding patterns are sketchy and require interpretations based on market knowledge.

Parallel yield curves indicate that conventional investors do not perceive international sovereign sukūk as an asset class of their own distinct from conventional government bonds. This market perception of liquid international sovereign sukūk could have an impact on other types of sukūk (e.g. on international corporate sukūk) if sovereign sukūk are taken as pricing and performance benchmarks.

The paper sheds light on institutional investor behavior in the bond and sukūk markets and outlines data availability issues that constrain quantitative analyses in over-the-counter markets.