What is “sukuk,” and what does this concept have to do with investing?

Short answer: They’re considered an Islamic-based fixed-income alternative to traditional bonds.

Longer answer: Sukuk are Shariah-compliant fixed-income instruments structured to avoid the Islamic prohibition on “riba,” or interest. Shariah is the body of Islamic law governing religious rituals and daily life based on the Quran and the teachings of the prophet Muhammad. It includes certain restrictions regarding finance and commercial activities. 

Sukuk is the plural form of the Arabic word “sakk,” which means certificate, legal instrument, deed or check.

Like with conventional bonds, sukuk investors receive regular income over a stated period and a final payment at the maturity date. And as with bonds, sukuk credit quality are rated by recognized rating organizations.

But unlike conventional bonds that promise to pay interest, sukuk are based on various contracts to create financial obligations, and investor returns are considered to be profit sharing, not interest. Under Shariah law, investors aren’t allowed to profit simply from using money to make money. Investor returns must be tied to profits from a business activity and should come from the commercial risk taken by an investor.

Sukuk can invest in a range of tangible assets such as equipment, real estate, infrastructure or other operating assets such as docks. A sukuk holder is granted an ownership interest in the assets or business being financed, and returns are tied to the performance of the underlying assets. If those assets run into trouble, investors might not get back their entire principal at maturity.

“Sukuk is a bit of a hybrid with an equity-esque flavoring along with all of the attributes and structure of a fixed-income instrument,” said Patrick Drum, portfolio manager of the Amana Participation Fund (AMAPX), which invests in sukuk as part of its mandate of capital preservation.

That fund, along with the Azzad Wise Capital Fund (WISEX ) from Azzad Asset Management, are sukuk-focused U.S.-listed mutual funds. The SP Funds Dow Jones Global Sukuk ETF (SPSK) is the lone U.S. exchange-traded fund with a sukuk focus.

Sukuk typically originate from Islamic issuers in the Middle East or from Southeast Asian countries such as Malaysia and Indonesia. They are issued by international financial institutions, foreign governments and foreign government agencies.

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