How costly is investors’ compliance with sharia?

Abstract EN

The rapid proliferation of Islamic-oriented investments has placed an added urgency on better understanding their risk profile.

With respect to Islamic stock market indexes, this concern is more pertinent to the extent that indexes could be subject to manipulation, and because they are often used as a benchmark for Islamic mutual funds.

Using the Capital Asset Pricing Model as the basis, the paper places the most popular Islamic index under analytical scrutiny, and asks (1) how has the Sharia selection restriction affected its performance? (2) what is the competitive risk-return tradeoff of a Sharia-compliant index and (3) to what extent is a Sharia-compliant index correlated with the broad stock market.

Using a ranking based on Treynor’s ratio, the results reveal that the most popular index is competitive relative to the world stock market index but underperforms when compared to another morally restricted and non-Islamic index.

The paper concludes that investors in the Muslim index are not suffering a discernible cost for complying with the Sharia restriction.

Results add muchneeded guidance to Islamic investments in general and help assuage concerns that Islamic indexes have received insufficient investigation.