Filling a Need
For more than 30 years, Amana Mutual Funds have provided professionally managed and diversified investment portfolios serving the needs of our clients. Building upon our history of halal investing expertise, the Amana Participation Fund is designed to help clients meet their long-term financial needs through an investment objective of capital preservation emphasizing current income consistent with Islamic principles.
Investors following Islamic principles traditionally have found their asset allocation options limited to equities and cash to meet their financial planning needs. To help investors diversify, we created the Amana Participation Fund, the first non-equity, halal income fund offered in the US. The Amana Participation Fund presents an opportunity to gain access to a third asset class: a non-equity, income-producing asset with historically lower volatility compared to equities.
The name, Participation, describes the characteristics of sukuk – investment certificates which are structured so that investors share in their economic profits and losses. Sukuk comprise a non-equity asset class only recently available to mainstream US investors, broadly serving the financial needs of the Muslim community and beyond.
The Participation Fund is not a cash alternative or deposit account and is best suited for investors with an investment time horizon of at least two or more years. Please carefully review the Fund’s prospectus regarding risks and other disclosures, or consult your financial advisor, before investing.
The Amana Mutual Funds Family
The launch of the Participation Fund marks an important development for Muslim investors, broadening access to a third, essential leg of basic asset allocation: non-equity income.
One primary benefit of the Participation Fund is that formerly unproductive, uninvested cash can earn current income from a portfolio of investment securities that seeks to be more stable than investing for income from equities.
What are Sukuk?
Sukuk is the plural of sak, an Arabic word translated as deed, instrument, or legal document. Sukuk are financial certificates having characteristics similar to conventional bonds. Generally sukuk:
- have a stated maturity date;
- offer a stated annual investment income rate, similar to a coupon offered by a conventional bond; and
- may obtain a credit rating from well recognized credit rating agencies, such as Moody’s and Standard & Poor’s.
It is important to note that while sukuk may share similar features with conventional bonds, unlike conventional bonds, they typically reflect an undivided beneficial ownership interest in an underlying asset, similar to a stock. The returns of the underlying asset provide the investment return, and sukuk holders share in the underlying asset’s profits as well as potential losses.
Sukuk are a distinct asset class.1
|Underlying Asset||Proof of ownership in an asset||Debt obligation|
|Legal Structure||Holders each hold an undivided beneficial ownership in underlying assets||Issuer has a contractual obligation to pay bond holders interest and principal on certain specified dates|
|Halal considerations||The underlying assets are halal||n/a|
|Pricing||Pricing based upon value of underlying assets||Pricing based on credit rating of issue and issuer|
|Valuation||Buyers purchase assets that have value||Buyers act as creditors in implicit loan agreement|
|Investment rewards and risks||Holders receive a share of profits from the underlying assets (and accept a share of any loss incurred)||Holders receive regularly scheduled interest payment for the life of the bond, and the principal is returned at the bond's maturity date.|
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What makes Sukuk halal?
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), a not-for-profit Bahrain-based Islamic financial standards organization, defines sukuk as “certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity.” Sukuk may invest in a broad range of tangible assets including facilities, equipment, operating businesses, and real estate that generate a return (or a loss) from those assets. This contrasts with conventional bonds where the investor holds a debt instrument that generates income from the payment of interest (riba).
All aspects of sukuk are subject to review by appointed Islamic scholars who provide a fatwa that forms the basis for claims of compliance with Islamic tenets.3
A Condensed History of the Sukuk Markets
While sukuk have gained broader acceptance among investors over the past few decades, they are not new. Some of the earliest forms of sukuk date as far back as 634 CE. In1988, the International Islamic Fiqh Academy (a university in Jeddah, Saudi Arabia) of the Organisation of Islamic Conference helped to modernize sukuk by issuing a widely accepted framework.4 One of the first sukuk issued under the new framework came a few years later in 1990 from the Malaysian subsidiary of Shell Oil Company.5 The Government of Bahrain issued the first sovereign sukuk in September 2001.6
At the end of 2015, there were US$281 billion of sukuk outstanding.7
Annual sukuk issuance grew at a compound annual growth rate (CAGR) of 33% between 2001 and 2013,8 and more than US$60 billion of new sukuk were issued globally in 2015.9 Although this represents a slowdown from previous years (likely due in part to a drop in oil and other commodity prices), issuers include a wide array of industries and countries.
Types of Sukuk
In a typical structure, investors buy sukuk certificates from an issuer who then forms a special purpose vehicle (“SPV”) to manage the assets, any counterparties, and the beneficiary or lessee (sometimes referred to as the “originator”) who will use the assets. While this is not a complete list of the types of sukuk, we have provided brief descriptions of some commonly used structures.
Ijara / Lease
Sukuk al-ijara is similar to a lease program and is one of the most prevalent forms of sukuk. With this arrangement, investors finance the purchase of fixed assets (such as real estate or airplanes) in exchange for an amount of income generated by the business activities in which the assets are used. At the end of the agreement, the lessee has the option to buy the assets from the SPV.
Istisna’a / Exception
Sukuk al-istisna’a is a contract to financing an industrial development project (i.e., contruction or manufacturing). It differs from ijara in that the assets are not yet created and the developer agrees to deliver the assets by a certain date.
Mudaraba / Profit Sharing
Sukuk al-mudaraba are similar to business loans, but instead of a business paying interest on its loan, it pays a pre-determined percentage of its profits. In the case of loss (i.e., an unprofitable business), the losses are born solely by the provider of the funds.
Murabaha / Cost-Plus-Financing
Sukuk al-murabaha could also be described as a cost-plus-financing model. The issuer buys a particular asset or commodity at market value and sells it to the originator (who will use the asset). This structure is a common method of financing home loans, but typically the certficates are not traded because of the prohibition on trading in debt.
Musharaka / Participation
Sukuk al-musharaka are similar to mudaraba except that the repayment terms are flexible and both the originator and the issuer contribute funds, and consequently both would participate in any losses.
Wakala / Agency
Sukuk al-wakala share characteristics of mudaraba and musharaka, with a twist: the investors agree to a pre-determined ratio of profit, but should the profit exceed the agreed to amount, the issuer may keep the excess.
Making a Mindful Investment
The Amana Participation Fund aims to offer broader diversification opportunities for investors seeking capital preservation and current income consistent with Islamic principles. It is important to note that while the sukuk market has experienced favorable growth and broader acceptance among the investment community, it is still viewed as a newly developing and nascent market. As a result, these securities can be adversely affected by unexpected risks and as such, require a careful review of the prospectus.
1 International Monetary Fund (IMF), The IMF and Islamic Finance, March 2015.
2 Bhandari, Sunil. Islamic Finance, Association of Chartered Certified Accountants (ACCA), August 8, 2015.
3 Ali, Rahail and Lovelis, Hogan. Sukuk and Islamic Capital Markets: A Practical Guide, Globe Law and Business, March 2011.
4 International Islamic Financial Market (IIFM), Sukuk Report, 1st Edition, 2010. Page 7.
5 IIFM, Sukuk Report, 1st Edition, 2010. Page 7.
6 IIFM, Sukuk Report, 1st Edition, 2010. Page 8.
7 RAM Rating Services Berhad, Sukuk Snapshot (as at end of December 2015), February 10, 2016.
8 Augustine, Babu Das. Global sukuk issuance to gain momentum in 2015, Gulf News, March 15, 2015.
9 Tan, CK. Global sukuk issuance slides 43% in 2015, Nikkei Asian Review, April 6, 2016.
The value of the shares of the Amana Participation Fund rises and falls as the value of the securities in which the Fund invests go up and down. The Fund limits the securities it purchases to those consistent with Islamic principles. This limits opportunities and may affect performance. The Fund may invest in securities that are not traded in the United States. Investments in the securities of foreign issuers may involve risks in addition to those normally associated with investments in the securities of US issuers. These risks include currency and market fluctuations, and political or social instability. The risks of foreign investing are generally magnified in the smaller and more volatile securities markets of the developing world.
While the Participation Fund does not invest in conventional bonds, risks similar to those of conventional nondiversified fixed-income funds apply. These include: diversification and concentration risk, liquidity risk, interest rate risk, credit risk, and high-yield risk. The Participation Fund also includes risks specific to investments in Islamic fixed-income instruments. The structural complexity of sukuk, along with the weak infrastructure of the sukuk market, increases risk. Compared to rights of conventional bondholders, holders of sukuk may have limited ability to pursue legal recourse to enforce the terms of the sukuk or to restructure the sukuk in order to seek recovery of principal. ukuk are also subject to the risk that some Islamic scholars may deem certain sukuk as not meeting Islamic investment principles subsequent to the sukuk being issued.