1. Does Islamic Equity Investment Offer Hedging Benefits
Dawood Ashraf PhD CFA®
Islamic Research & Training Institute, KSA
Mohsin Khawaja
King Fahad University of Petroleum & Minerals, KSA

2. Background – Performance Evaluation Issues
Recent Empirical findings: Investments based on Islamic Shari’ah principles provided a hedging benefit during the downturn of capital markets (Abdullah et al., 2007, Ashraf, 2012, Saiti et al., 2014, Ashraf and Mohammad, 2014)
However, the outperformance depends the time period chosen for performance evaluation and the benchmark used for the performance evaluation (Elfakhani et al.; 2007)
literature documenting the hedging benefit, authors identified a specific period as ‘crisis period’ and draw their conclusion based on that period. However, such an approach lacks the rigor as market fluctuations are common and often we observe rising (bull phase) and declining (bear phase) trends.

3. Efficient frontier risk-return comparison – S&P 500
MVP are better for Islamic
Islamic portfolio are less efficient

4. Efficient frontier risk-return comparison – S&P TSX 60
MVPs are better yet inefficient for higher risk level

5. Efficient frontier risk-return comparison – S&P Europe 350
Less effiecient

6. Efficient frontier risk-return comparison – S&P GCC

7. Efficient frontier risk-return comparison – S&P JAPAN

8. Main Findings
Islamic equity portfolios are generally less risky but not efficient
Minimum Variance portfolios of Islamic equities are usually better
Question: How is the risk adjusted performance of IEPs as compared with conventional benchmark index?

9. Background - Performance Evaluation Issues
Islamic mutual funds
Fund management – Active Management
Stock selection,
market timing
Islamic equity indices
Different index construction methodologies
Multiple Shari’ah screening standards
Rebalancing frequency

10. Data sources Time Period: 2008 -2013 monthly data
Portfolio Based approach following major Shari'ah screening standards: AAOIFI, Dow Jones, MSCI
Self generated Indices & Benchmarks
S&P Mathematics Methodology
Portfolio based on 5 Markets: USA, Canada, Europe, GCC and Japan (1,712 equities)
15 Portfolios: 3 for each market
5 Benchmarks: 1 for each market
Time Period: monthly data
Financial data from Bloomberg

11. Research Questions
Return of Shari’ah Compliant Indices does not fall as much as that of Benchmark Indices during the downfall of capital markets
Shari’ah Compliant Indices following the Market Value approach provide better hedging opportunities as compared to those following Book Value approach

12. Proportion Shari’ah compliant companies
Regions
Criteria
2008
2009
2010
2011
2012
2013
Total
USA
MSCI
46.8%
42.6%
44.4%
45.2%
46.4%
44.8%
500
AAOIFI
50.2%
41.2%
43.8%
44.2% DJ
52.8%
47.6%
45.8%
45.6%
Canada
63.3%
61.7%
60.0% 60
53.3%
46.7%
56.7%
50.0%
45.0%
55.0%
51.7%
58.3%
48.3%
Europe
44.3%
43.7%
44.6%
46.6%
49.4%
50.6%
350
36.6%
23.7%
29.1%
33.4%
33.1%
34.6%
39.1%
29.4%
35.7%
36.3%
GCC
34.1%
36.8%
42.7%
302
38.1%
34.8%
32.8%
36.1%
41.1%
37.1%
40.1%
Japan
42.2%
36.0%
36.2%
35.8%
37.8%
23.2%
22.0%
20.2%
19.4%
25.8%
39.4%
31.0%
22.6%
20.6%
22.4%
27.8%

13. Descriptive Statistics
No two SCIs have the same number of constituents
More companies pass the filter in book value based screening (MSCI)
AAOIFI is the strictest standard
More sensitive with the market
GCC SCIs have a financial sector which makes them more diverse than other SCIs
Finance stocks are screened out in other regions

14. Descriptive Statistics (cont’d)
SCIs generally lag behind BMIs
SCI returns deviate from the benchmark returns during the upsurge in capital markets

15. Empirical Methodology
Constant Risk Model
beta coefficient is stable over the investment horizon and under different market conditions such as `bull' and `bear' markets.
Conversely, the assumption of stable beta is very restrictive and it is often found that beta coefficients diverge over time under different market conditions
Logistic smooth transition autoregressive (LSTAR) Model
Time varying risk (DCC – GARCH is preferred)
Allows for a smooth transition between the states of market rather an abrupt jump as in the case of ‘dual beta models’

16. Empirical Results – Constant Risk
No evidence of abnormal return except from Canada and GCC where alpha is –ve  SCIs usually end up with stocks which lag benchmark performance (BMIs)
Systematic risk coefficient β is significant  performance deviation of SCIs can be explained by the relative riskiness with BMIs
Canadian SCIs exhibit higher systematic risk, while European report lowest risk

17. Empirical Results - LSTAR
Abnormal return coefficient (α) is insignificant (different from CRM results)
SCIs do not drift considerably from BMIs
General shrinkage of β coefficient
Significant shrinkage in GCC
Bearish market trend (Down market beta) - Generally insignificant except
USA & Japan (MSCI) – negative significant
USA – AAOIFI – positive significant  hedging benefit

18. Robustness check Four factor model – Fama & French and Carhart models
Factors are created from the same set of equities as that of SCIs and BMIs
To the best of authors’ knowledge, there is no study on performance attribution of Islamic equity portfolios that used actual data for computation of additional factors from benchmark indices.
Results are same as from LSTAR model
Alpha insignificant
Beta significant
Down market beta – significant for US- AAOIFI and Europe-DJ

19. Conclusion
SCIs following any Shari’ah screening criteria does not result in any performance deviation as compared to the BMI despite lower diversification.
SCIs generally reflect a lower systematic risk as compared with the BMIs.
The claimed benefit of hedging is not obvious in most of the SCIs
Partial evidence that SCIs investing in the US and following MVE based Shari’ah screening criteria do offer the hedging benefits.
Shari’ah compliant indices do not necessarily offer hedging benefits during a down market