Treasury puts faith in $500m Islamic debt

Sharia-compliant product is tailored to Mideast investors

THE National Treasury has issued a $500-million (R5.5-billion) Islamic sukuk bond to tap alternative sources of capital.

Those who work with the sharia-compliant products say this is just the beginning of Islamic finance offerings in South Africa.

According to Saliegh Salaam, portfolio manager for Old Mutual Investment Group’s Quantitative boutique, the order book was four times oversubscribed, despite criticism on the basis that South Africa does not have strong Islamic ties.

“The motivation behind this issuance . . . is not based on the country’s Islamic ties, but on an economic argument. As a cashflush region, the Middle East and Gulf countries are consid- ered one of the wealthiest regions in the world, with some of the largest sovereign wealth funds and one of the highest GDP per capita rankings.”

He said the economic fundamentals of the region were good, with low population growth relative to huge oil and energy reserve surpluses.

“Global investors are seeing significant opportunities and are keen to tap into the growth in this surplus liquidity.”

With sharia compliance a must for tapping capital in the region, Salaam said it was pragmatic for South Africa to create a product tailored to the Middle East’s Muslim investor base.

“It comes at a critical time for South Africa, with the Treasury in need of refinancing $14.4-billion of debt over three years.

“Considering that investors are bracing for the end of the US Fed’s quantitative easing programme, and that emerging market banks are raising interest rates again to protect against inflation and floundering currencies, the consequent rising bond yields mean that the Treasury needs to look at alternative instruments to raise funds to refinance its debt.”

Salaam said South Africa wanted to position itself as the gateway for Islamic finance into Africa. This status was backed up by Franklin Templeton’s introduction of three sharia-compliant funds, based in Luxembourg but aimed at local investors in South Africa.

Mohieddine Kronfol, chief investment officer for Franklin Templeton Investments’ Middle East and North Africa fixed income and global sukuk, disagreed with criticism that South Africa was an inappropriate issuer of Islamic paper.

We’d like our products to be bought by Muslims and non-Muslims

“Islamic finance lends itself to infrastructure finance and Africa needs a lot of that to unlock its potential. It’s been ahead of the curve with a sovereign issue, usually a precursor for banks and other companies coming to the market. In that respect we’re optimistic about Africa’s investment opportunities.

“From a business perspective, we’re happy to see that the regulator has approved our funds for distribution in South Africa . . . The demand for sharia-compliant financial products is increasing slowly. We’d like our products to be bought and in demand by Muslims and nonMuslims.”

Kronfol said the three funds — a global sukuk fund, a global equity fund and an Asian growth fund — were deliberately given a lot of flexibility in terms of the assets they could hold, resulting in a low degree of correlation or overlap with the portfolios most non-Muslim investors would hold.

For non-Muslim investors, Kronfol said, there was a good argument to be made that a global sukuk fund complemented emerging market and global bond portfolios, offering competitive historical returns.

“Conventional strategies don’t invest in the Gulf Co-operation Council (GCC) states or Southeast Asia. There’s little overlap, so you get diversification and the benefits of l ow correlation.

“It’s a different investable universe, with a core allocation to the GCC, which is underrepresented in fixed income.”

He backed up Salaam’s con- tention that the GCC region has some of the strongest credit and debt metrics in the world. “Compared with developed markets, it has the strong ratings, high GDP per capita and accumulated reserves but without ... low growth and high debt.”

Kronfol said 16 sovereign states had issued sukuk paper and more countries were seeing the benefit of complementing their financial markets with sharia-compliant alternatives. “We see the portfolios of tomorrow being even more diversified by geography, sector and capital structure.”

Franklin Templeton uses software to screen potential investments.

“For equity funds you need to eliminate companies that don’t meet certain qualitative or quantitative criteria. For exam- ple, regular financial services companies, those involved in pork, alcohol, gambling or weapons. Then, for the remaining companies, you need to screen out those that are excessively leveraged. Consensus has been reached on what constitutes a sharia-compliant company, and it includes not having a ratio of debt to equity of above 33%, not having cash above a certain amount and not having more than 5% of its activities in forbidden sectors.

“These filters are applied so that portfolio managers can select companies from an acceptable pool,” Kronfol said.