Higher yields spur sukuk rally

Islamic bonds have rallied in the UAE in recent weeks, spurred on by low yields of corporate and treasury bonds around the world and returning demand from global investors for Sharia-compliant finance. Analysts said investors were looking to high-yield alternatives to corporate bonds in the US and Europe, where markets have sunk on traders fears over deflation and a possible double-dip recession.

Demand for Islamic bonds, or sukuk, fell sharply following Dubai World's restructuring, but is now recovering. "Bonds have been recovering nicely post the Nakheel restructuring," Skander Chabbi, a fund manager at DWS Investments in Frankfurt, told Bloomberg. Two of the strongest performers have been Aldar Properties and Dana Gas, both of which have seen increased demand for their convertible Islamic bonds.

Dana Gas's 7.5 per cent bonds due in October 2012 yielded 10.78 per cent yesterday, down from a yield of 13.6 per cent on June 30. Meanwhile, yields on 5.767 per cent sukuk issued byAldar Propertiesdue for repayment in November next year fell to 7.339 per cent. Bond prices are inversely correlated to yields, meaning that the total percentage or "yield" received on an investment rises when the price of a bond falls.

A decrease in yields tends to indicate increased demand from investors. Interest payments are prohibited under Sharia law, so sukuk are instead backed by assets. This lack of interest payments is a key concern to bond investors in developed markets, who are wary of incurring heavy losses when central banks in the US and Europe raise interest rates, currently at historic lows. Ten-year US treasury bonds, traditionally seen as a haven by investors, are currently yielding 2.64 per cent.

Meanwhile, the average redemption yield of the FINRA-Bloomberg Investment Grade US Corporate Bond Index currently stands at 4.43 per cent, which analysts attribute to continuing uncertainty about the strength of economic recovery. "Are we seeing a compression of yields because everyone is pricing in slow growth or a double-dip recession? The answer is yes," said Ahmad Alanani, a fixed-income specialist at Exotix, a London-based boutique investment firm. While corporate bond returns have dwindled, yields on debt sold by Aldar Properties have soared on speculation that the Abu Dhabi Government will step in to repay the company's mounting debts.

Aldar is expected to announce how it will finance a Dh6 billion (US$1.63bn) funding gap. Majed Azzam, an analyst at HC Securities, said a consensus had emerged that despite Aldar's credit rating having been cut to junk status, its bonds were still a safe bet. "At the end of the day, everyone knows that this is a quasi-governmental company and you should fairly assume that similar support should come forward," he said.

Having bailed out Dubai World, "Abu Dhabi isn't going to allow its corporates to default", he said. "It's logical that they'll do the same for their own companies." He said the fall in the value of Aldar's debt was an "overreaction by the market" after the Dubai World crisis. Dana Gas had also been "unfairly punished" by markets after the Dubai World restructuring, Mr Alanani said. "We've started to see demand in Dana Gas increase quite substantially."

gregor.hunter@thenational.ae