Sukuk, bond prices maintain consistent correlation

September 18, 2024 (MLN): Prices of comparable sukuk and bonds analysed by Fitch maintained high correlation over 1H 2024, continuing the pattern observed over the previous five years, although there are sometimes brief instances of price volatility when correlation falls, Fitch Ratings says.

Fitch expects this trend to continue in 2H 2024 and 2025. However, additional complexities due to macro developments or sharia-related issues could affect this trend. Similar pricing trends were also observed in certain global bond and sukuk indices analyzed by Fitch.

About 81% of Fitch-rated sukuk are investment-grade. Most are senior unsecured obligations of the issuer and rank pari passu with other senior unsecured obligations, including bonds.

However, sukuk are structurally more complex than bonds, with extra dissolution triggers, such as tangibility event, total loss event, and others.

The agency examined the pricing of over 50 sukuk and bonds issued by the same entities from the Gulf Cooperation Council (GCC), Indonesia and Turkiye.

Sukuk and bonds showed a high average pricing correlation between 2019 until August 2024, with a yield-to-maturity correlation of about 0.9 (on a scale of 0 to 1).

There is still a scarcity of directly comparable sukuk and bonds in terms of payment priority, issuance dates, maturity and currency denomination from the same issuer, but it believes these metrics at least partially capture investors' perceptions of relative credit risk for sukuk and bonds.

Fitch also analyzed the yield-to-maturity (YTM) of the S&P MENA Sukuk Index and the S&P MENA Bonds Index.

These indices showed a high correlation of 0.99 over the five years to end-August 2024. The difference in the YTM averaged only -26bp over the past five years, with the YTM of sukuk generally lower than that of bonds. In 1H 2024, the YTM differential narrowed, and it has averaged -10bp year-to-date.

However, the sukuk-bond spread has widened abruptly during periods of market stress before reverting to the mean.

These stresses might reflect broader financial market volatility around interest rates or oil prices, or geopolitical events. But they have also been caused by sharia-related uncertainties that are specific to sukuk.

For example, the average YTM differential widened to -64bp in 2021, partly due to the implementation of AAOIFI Sharia Standard No. 59 and resulting uncertainty over potential differences in sukuk and bondholder treatment in some markets.

A more sudden widening occurred on the onset of the coronavirus pandemic, when the YTM differential peaked close to -100bp in March 2020 before normalising rapidly.

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