Does a held-to-maturity strategy impede effective portfolio diversification for Islamic bond (sukuk) portfolios? A multi-scale continuous wavelet correlation analysis

Abstract

The Islamic bonds or sukuk market is one of the fastest growing segments of the nearly US$2trillion global Islamic finance industry. However, lack of trading in secondary sukuk markets is a peculiar feature in this sector and both institutional and retail sukuk investors are known to adopt a held-to-maturity investment strategy. Consequently, there is a critical gap in literature in studying the portfolio diversification opportunities available to sukuk investors and evaluating these in the light of held-to-maturity strategies. This paper (using recently available data and continuous wavelet transform methodologies) has made an initial attempt to study the portfolio diversification strategies for Islamic bond (sukuk) portfolios across heterogeneous investment horizons using the Malaysian and the Gulf Cooperation Council (GCC) sukuk markets as a case study. Our findings critically indicate that returns between local currency sukuk in different markets have low levels of long-term correlations, thus enabling portfolio diversification benefits. However, international currency sukuk issued in different markets exhibit high levels of long-term correlations which impede portfolio diversification benefits for held-to-maturity investments. A similar impediment is also witnessed in the domestic market context where diversification is intended by investing in different types of domestic sukuk. Overall, our findings critically highlight the feasibility of held-to-maturity sukuk investment strategies from a portfolio diversification perspective