How Does Sukuk Fit In Your Investment Portfolio?
A bond is a loan issued by governments or corporations in order to raise money. Bonds are a great low-risk investment that delivers consistent income through interest payments.
Bonds however, are not Shariah-compliant because they involve interest payments, which are prohibited in Islamic law. So, what is the alternative for those who want to invest in Shariah-compliant assets?
Here’s where sukuk comes in.
What is sukuk?
A sukuk is an Islamic equivalent of a bond. It’s a financial certificate that represents ownership of certain assets. When companies or governments aim to raise money for certain projects, they’ll issue a sukuk and use the investment proceedings to buy assets. In return, investors will receive periodic payments and principal investment when the sukuk matures.
Sukuk are considered Shariah-compliant because they don’t involve interest payments (as conventional bonds do). Instead, the payments come from profit-sharing or rental of the assets.
Should you include sukuk in your portfolio?
A sukuk is a low-risk investment that provides stable returns. Investing in it can be a good idea if the following applies to you:
1. You want consistent income
A sukuk provides regular payments (i.e. on a yearly, semi-annually or quarterly basis) to its investors. These payments are fixed and pre-determined, which makes sukuk a good investment if you need predictable income on a regular basis.
If you invest in a sukuk fund, the fund manager may distribute these payments to you in the form of monthly, quarterly, semi-annual or annual dividends.
2. You need to lower the risk in your portfolio
As you grow older, you may need to lower your risk by increasing the proportion of low-risk investments in your portfolio. That’s because older investors have less time to recover if their portfolios experience huge losses. Investing in sukuk can help you lower the risk in your portfolio, as sukuk are less volatile than other asset classes like equities. This helps to protect your portfolio when markets are volatile.
3. You need to preserve your capital
If you need to cash out your investments soon – say, you’re expecting to retire in a few years – you should focus on capital preservation. This means preserving your investments and avoiding losses.
Investing in sukuk is a good way to preserve your capital. Unlike equities, where prices can go up or down, the value of a sukuk will not change, unless you sell it on the secondary market (i.e. to other investors) for a different price. If you wait for the sukuk to mature, you will receive your principal investment.
How much returns can sukuk deliver?
A sukuk’s returns can depend on its credit rating. A sukuk with a lower rating is deemed to be riskier, but will offer higher payouts. A sukuk with higher ratings is less risky, but will offer lower payouts.
If you invest in a sukuk unit trust fund – that is, a fund that pools together money from many investors to buy a group of sukuk – the fund may manage its yield and volatility by buying sukuk with different ratings and maturities.
For example, the Principal Islamic Lifetime Sukuk Fund by Principal Asset Management aims to gain a higher-than-average income over the medium to long-term. To do so, it invests in a diversified portfolio of sukuk and other Shariah-compliant investments. Here’s how the fund has performed since its inception:
(October 2004 – September 2020)
Disclaimer: We recommend that investors read and understand the contents of the funds’ prospectus and PHS available on Principal website which have been duly registered with the Securities Commission Malaysia. Unit prices and income distributions, if any, may fall or rise. Investments in funds are exposed to an array of risks. There are fees and charges involved in investing in the funds. Past performance is not reflective of future performance.
An annual return of 5.9% means that if you invested RM1,000, you would have received RM59 in returns that year. However, it is important to keep in mind that past performance is not necessarily an indicator of future performance.
Are sukuk funds a good investment during economic volatility?
Investing in sukuk is suitable for all market conditions, as it helps to manage your portfolio risk and provide diversification.
But in times of economic volatility – such as the present – having sukuk in your portfolio can be especially useful. That’s because sukuk pay a fixed rate of return, which doesn’t increase or decrease based on market conditions. This gives you stable income even when times are uncertain.
During uncertain markets, having a portion of low-risk investments like sukuk can also help minimise the effect of equity losses in your portfolio. For example, the FBM KLCI, an index that tracks the 30 largest companies in the Malaysian stock market, experienced a loss of 5.9% from the start of the year until October 21 (source: http://www.bloomberg.com/quote/FBMKLCI:IND). By contrast, the Principal Islamic Lifetime Sukuk Fund gained 5.02% in the same period (source: https://www.bloomberg.com/quote/SBBHFIZ:MK).
How to invest in sukuk
It used to be hard for regular investors to invest in sukuk – you’d need at least RM250,000 to invest directly through a bank.
But these days, you can invest in sukuk unit trust funds. They’re much more accessible than buying sukuk directly, due to low minimum investment requirements. For example, the Principal Islamic Lifetime Sukuk Fund has a minimum initial investment of only RM2,000, while each subsequent investment requires as little as RM500.
If you’re interested in investing, consider how much of your portfolio should be allocated to sukuk. This involves determining your risk profile, and then setting a portfolio allocation. For investors with low to moderate risk profiles, sukuk can be a great way to manage your risk, diversify your portfolio and provide stable returns – all while investing in a socially responsible manner.