Do Sukuk provide diversification benefits to conventional bond investors? Evidence from Turkey

We investigate the contribution of Sukuk in diversification of bond portfolios. We do so by comparing Turkish bond funds that invest exclusively in conventional bonds (pure conventional bond funds), in Sukuk (pure Islamic bond funds), and in both (mixed bond funds) among each other for the period of 2014-2019. We employ tests of differences in means and variances of various risk-return measures as well as mean-variance spanning and intersection tests in order to uncover the diversification potentials of Sukuk in the portfolio management industry. Our results suggest that bond funds, of which the portfolios are composed of a combination of Sukuk and conventional bonds (i.e. mixed bond funds), have a relatively "lower risk-higher return" profile. Moreover, including Sukuk to conventional bond portfolios theoretically offers significant diversification opportunities for investors, particularly when the economy worsens.