Opportunities For Sukuk Exchange-Traded Funds In Malaysian Market Jan 21, 2021 This article was first published in IFN Volume 17 Issue 44 dated the 4th November 2020. Exchange-traded funds (ETFs) are open-ended investment funds traded on an exchange. The ETF consists of baskets of assets such as stocks, bonds and commodities, and tracks or replicates the performance of an index with similar underlying assets. At the time of writing, there are 19 ETFs listed on Bursa Malaysia, with five of them Shariah compliant equities ETFs. As of August 2020, the total market capitalization for Islamic ETFs in Malaysia stood at RM559.2 million (US$134.49 million) and the number of units outstanding stood at 404.76 million. A Sukuk ETF is an ETF which tracks the performance of a basket of Sukuk. The development of Sukuk ETFx is still at a nascent phase with the first-ever Sukuk ETF, SP Funds Dow Jones Global Sukuk ETF (SPSK), issued in December 2019. The SPSK is traded on the New York Stock Exchange and it seeks to track the performance of the Dow Jones Sukuk Total Return Index, which consists of global US dollar-denominated investment grade Sukuk. As of June 2020, the market price of annualized returns and the fund net asset value (NAV) since inception stood at 0.56% and 0.41% respectively. Another recently issued Sukuk ETF was the Alinma Short Maturity Sukuk Bond ETF by Alinma Investment based in Saudi Arabia. The ETF was created to give exposure to short maturity Sukuk issued by the Saudi government and it is linked to the iBoxx Tadawul Sovereign Index Short-term. The index consists of Sukuk issued by the Saudi central government or central bank that have at least SAR100 million (US$26.66 million) outstanding and the remaining time to maturity of less than five years. As of the second quarter in 2020, the Alinma Short Maturity Sukuk Bond ETF has yielded a 3.7% return since its inception in February 2020. There is an opportunity for Malaysia to follow suit in constructing an ETF with Sukuk as the underlying asset given the growing demand for Islamic investment products, the performance of Sukuk over the past years and the attractive features of ETFs which suit the retail market. The demand for Islamic unit trusts has increased over the past years. The number of units in circulation and the number of accounts of Shariah compliant unit trusts have grown by 52.3% and 8.3% respectively since 2017 and this shows a growing market for Islamic investment products. As of August 2020, the NAV of Islamic unit trusts stood at RM125.2 billion (US$33.38 billion) compared with the NAV in August 2017 which was at RM71.5 billion (US$19.06 billion). Furthermore, the performance of Sukuk has overtaken that of conventional bonds in Malaysia. Based on a Bond Pricing Agency Malaysia (BPAM) report, as of August 2020, the three-year annualized return of the BPAM Sukuk Index was 7.22%. On the other hand, for its conventional counterpart, the BPAM All Bond Index, the three-year annualized return was 6.82%. The issuance of Sukuk in Malaysia also surpassed that of conventional bonds. The good performance in the market leads to a higher demand for fixed income products which, unfortunately, retail investors have almost no access to. Moreover, the issuance amount of corporate Sukuk stood at RM102.39 billion (US$27.3 billion) in 2019, RM71.96 billion (US$19.18 billion) higher than the issuance amount of conventional corporate bonds. This places Malaysia in a strategic position to create a basket of corporate Islamic bonds due to a bigger pool of Sukuk issuances in the market. Investing in ETFs offers some advantages which are not available in other investment vehicles. Firstly, investors can diversify their portfolio at a low cost as an ETF represents a basket of assets, where investors do not need to buy many individual assets for diversification. Secondly, investors can also easily buy and sell the ETF on an exchange similar to buying and selling shares. For some ETFs, there are market makers who provide a competitive bid/ask price throughout the trading day. ETF providers often disclose the individual assets invested within the ETF, hence providing transparency to investors. All the aforementioned advantages make ETFs one of the best asset classes for retail investors to access the bond and Sukuk market which has been enjoyed by institutional investors. Furthermore, investing directly in individual Sukuk in Malaysia is costly for retail investors, hence, a Sukuk-based ETF will be an attractive asset to get exposure to Sukuk at a lower cost. The options of ETF products in Malaysia are limited as many of them are based on equities. There is only one fixed income ETF, the ABF Malaysia Bond Index Fund, that gives exposure to both conventional and Shariah compliant ringgit-denominated government and quasi-government debt securities which include Malaysia Government Securities and Malaysia Government Investment Issues. It tracks the performance of the Markit iBoxx ABF Malaysia Bond Index. A Sukuk-based ETF can fill the supply gap and can attract conservative investors into the ETF market. Given the demand for Islamic investment products, the performance of the Sukuk market and the attractive features of ETFs, there is great potential for Sukuk-based ETFs in Malaysia. Disclaimer This report has been prepared and issued by Bond and Sukuk Information Platform Sdn Bhd (“the Company”). The information provided in this report is of a general nature and has been prepared for information purposes only. It is not intended to constitute research or as advice for any investor. 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