Bond Investing with a Conscience: Sukuk Bonds - dummies

Bond Investing with a Conscience: Sukuk Bonds

By Russell Wild

According to the classical laws of Islam, paying or charging interest is a forbidden. You’d think, therefore, that bond investing would be considered sinful. Well, it depends on the bond. Some very special bonds, called sukuk (pronounced soo-cook), actually allow for virtuous investing . . . at least according to some followers of Islam. Other followers see the sukuk as smoke and mirrors.

But while the controversy continues, there are likely at least $100 billion — some say considerably more — in sukuk floating around the world. In fact, you can even track their performance with the Dow Jones Sukuk Index.

Most of these bonds are being issued in Islamic countries and sold to Middle Eastern and European investors. But sukuk sales in the United States have begun to take hold. In June 2006, Houston-based East Cameron Partners, an oil development company, issued $166 million in sukuk. Most of the buyers were U.S.-based hedge funds. They didn’t buy the sukuk for religious reasons; these particular sukuk were paying 11.25 percent.

In late 2009, General Electric Capital Corp. issued $500 million in sukuk with five-year maturities. Buyers responded, in part because the issue, rated AA+, offered to pay 1.75 percent more than comparable Treasuries were paying at the time.

What are sukuk bonds?

Traditional bonds pay you a fixed interest amount over the life of the bond, and then you get your principal back upon maturity.

Sukuk may also pay you a fixed rate, but it isn’t called interest, and the money is said to come not from the lending itself but rather from the sale or leasing of certain tangible assets, such as property, or (in the case of East Cameron) oil profits, or (in the case of GE) aircraft assets.

A sukuk in full compliance with Islamic law also cannot guarantee your principal; the return of your initial investment, as with your share of profits, may depend on whatever returns are garnered from the assets backing the bond.

Note that Islamic law, like the law of many other religions (as well as governments, for that matter) is often subject to interpretation. Just ask the bankers at Goldman Sachs who announced a $2 billion sukuk deal in late 2011 that, months later, was still being widely debated, with some Islamic scholars blessing the proposed deal and others objecting to it.

The central tenet of Islamic law is that money cannot have any real value in and of itself, explains Eric Meyer, chairman and CEO of Shariah Capital, a Connecticut-based financial product development firm specializing in Islamic offerings. “Returns from an investment must stem from a hard asset that is both real and substantial,” he says.

Like a traditional bond, a sukuk has a maturity date and a certain rate of return, but that rate of return may be either fixed or floating and is always backed by some hard (“real and substantial,” as Meyer says) asset.

Should you invest in sukuk bonds?

So far, the sukuk market in the United States is pretty small. But keep your eyes and ears open; more will likely be coming. Do a lot of research before investing. If you are Muslim, you may want to check with your mullah to ascertain whether a particular offering meets your religious needs. The website of Shariah Capital should bring regular updates on the development of sukuk.