Developing Sukuk ETFs – a new asset class for investors

The successful issuance and listing of Pakistan’s first sovereign Sukuk at the PSX worth Rs30 billion and overwhelming demand from investors reaching close to Rs400 billion has opened the door for regular issuance of Shariah-compliant instruments and it could stimulate the development of new Islamic capital market instruments like Sukuk Exchange-traded Fund (ETF) and Sukuk tokenisation.

It is expected that the Ministry of Finance will now aggressively offer Sukuk (Islamic bonds) of different tenures through the PSX and will be able to benefit from the liquidity available with the investors looking for Shariah-compliant returns at much more attractive rates as compared to conventional offerings.

During 2023, the government issued Sukuk of over Rs1.7 trillion and is looking to convert a significant share of its sovereign debt to Islamic modes.

According to the IIFM Sukuk Report 2023, on the international front, Sukuk as an asset class has gained prominence and it holds a substantial share in Islamic financing assets globally. The investment in Sukuk is estimated to be over $794 billion and in 2022 the global Sukuk issuance reached $182.715 billion, marking their significant presence in the financial landscape.

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Following the Shariah court ruling, there is an expected shift from conventional financing to an Islamic financial system within five years. This directive prompts the issuance of new Sukuk for conversion purposes, both at sovereign and corporate levels. Investors seeking Shariah-compliant options in the Islamic capital markets now have access to mutual funds and Sukuk listed at the Pakistan stock market. With increased issuance of sovereign Sukuk at the PSX of different tenures, the potential to develop Sukuk ETF seems promising, offering investors a mechanism to invest in a portfolio of Sukuk of different maturities and rates while managing their risk and return expectations.

An ETF, a relatively new product in the Pakistani market, was first launched in 2020. It is a pooled investment, comprising a collection of assets like stocks, bonds, or commodities. It trades on stock exchanges, offering investors exposure to diversified portfolios mirroring an index or specific market sectors. ETFs combine features of stocks and mutual funds, providing liquidity, diversification, and flexibility. They track market performance, allowing investors to buy or sell securities throughout the trading day.

ETFs offer accessibility to various markets, catering to different investment strategies and preferences, making them popular investment tools for both individual and institutional investors. Sukuk ETFs provide investors with exposure to a variety of Sukuk, promoting portfolio diversification within Islamic finance. They facilitate convenient trading on stock exchanges, allowing investors to buy or sell Sukuk ETF shares, catering to those seeking ethical and Shariah-compliant investment opportunities within the global financial markets. SP Funds Dow Jones Global Sukuk ETFs is one of the Sukuk ETFs launched in December 2019 in the US with total net assets of $157.74 million as of December 31, 2023. The portfolio of the SP Fund includes exposure of 50.7% sovereign Sukuk and 47.8% corporate Sukuk. From an investor point of view, investing in Sukuk ETF offers additional advantages as compared to directly investing in Sukuk in the following manner:

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Risk and portfolio diversification: Investing directly in Sukuk typically involves purchasing specific Sukuk issues, limiting diversification. Sukuk ETFs offer diversification by pooling various Sukuk issues into one investment.

Accessibility: Direct Sukuk investments often require larger capital amounts and may have higher entry barriers compared to Sukuk ETFs, which offer accessibility to retail investors with lower investment thresholds.

Costs: Sukuk ETFs might have lower transaction costs compared to direct Sukuk purchases due to economies of scale and reduced brokerage fees associated with ETF trading.

Flexibility: Investing directly in Sukuk allows investors to choose specific Sukuk issues based on their preferences or investment criteria, while Sukuk ETFs offer flexibility to invest in a pre-selected diversified portfolio managed by the ETF issuer. Liquidity and trading ease: ETF unit holders can liquidate their investment without waiting for maturity and can also trade a diverse Sukuk portfolio on stock exchanges.

Sukuk ETFs in Pakistan represent a promising avenue, fostering Shariah-compliant investment opportunities in the country’s financial markets. Offering diversified portfolios aligned with Islamic finance principles, these instruments cater to both retail and institutional investors, promoting accessibility and ethical investment choices.

Read Shariah-compliant counter at PSX

They contribute to market development, enhancing liquidity and credibility while supporting the country’s growing Sukuk market. As an innovative financial instrument, Sukuk ETFs pave the way for broader investor participation, aiding in portfolio diversification and reflecting Pakistan’s commitment to fostering Islamic finance, thus bolstering its position as an emerging market for Shariah-compliant investment products.

It is the right time for market participants along with the key capital market infrastructure institutions start exploring the concept of Sukuk ETFs to add yet another Shariah-compliant instrument for the local investor.

Ahmed Ali Siddiqui is the Director IBA Centre for Excellence in Islamic Finance. Annie Ahmad is a faculty member of IBA Karachi. Zahra Nakhoda is a faculty member of IBA Karachi.

Published in The Express Tribune, January 15^th, 2024.

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