Principles of Islamic banking and finance/PIBF203/Investment in stocks/Performance of Islamic indexes

Performance of Islamic stock indexes: Kia’s survey

The current literature concentrates on four aspects of Islamic stock markets:

Outperformance of Islamic stock markets over the traditional stock markets

For example, Wilson (1997) analyses Islamic equity indexes as ethical investment products and shows, in general, these indexes perform well relative to conventional indexes. Hussein and Omran (2005) find the Dow Jones Islamic Market Index (DJIMI) outperforms the traditional stock index. However, they found that, during the bear period, DJIMI underperforms the market and the reverse is true in the bull market. Tag El-Din and Hassan (2007) report studies that show DJIMI has done relatively well compared to the Dow Jones World (DJW) index, but underperformed in relation to the Dow Jones Sustainability World (DJS) index. They also report studies which show that the Islamic index performs as well as the Financial Times Stock Exchange (FTSE) All-World index . Al-Zoubi and Maghyereh (2007) examine the relative risk performance of the Dow Jones Islamic index (DJIS) with respect to the DJW index and find that the former outperforms the latter.

Abdul Rahim et al. (2008) examine the causality between the Islamic equity world –– Malaysia, the US, the UK, Canada, Japan, Europe, Asia Pacific (with and without Japan), the World Emerging, the World Developed, and the World (excluding the US). They found that Malaysia is a potential investment center capable of offering enormous returns and Malaysia, Asia Pacific (without Japan) and the World Emerging offer the lowest risk per unit of returns. Guyot (2011) finds Islamic indexes are as efficient and globally liquid as traditional indexes, but bring additional portfolio diversification benefits to investors. Furthermore, he finds DJW index exhibits higher levels of informational efficiency than its conventional counterpart.

Finally, the study found the terrorist attacks of September 11 and the invasion of Iraq in 2003 as well as the subprime US crisis affect the price dynamics of Islamic indexes, compared to conventional indexes, by accentuating the divergence of price patterns. Consequently, it concludes that, due to their particular nature, Islamic indexes are associated with specific risk factors, which are of interest for the purpose of the diversification of international portfolios. Al-Khazali et al. (2013) find during the 2007-2012 period the global, European, and US Islamic stock indexes dominate their conventional counterparts. However, the reverse is true in the earlier period, i.e., 2001-2006. Since the 2007-2012 period includes the recent financial crisis, they concluded Islamic indexes outperform their conventional counterpart during that meltdown period.

Correlation between Islamic and conventional stock indexes

Tag El-Din and Hassan (2007) conduct an extensive survey of the literature and report studies which examined the volatility of the DJIM index returns and those which found that the DJIMI is correlated with neither the Wilshire 5000 index nor the three-month Treasury bill. Abdul Rahim et al. (2008) find the Malaysian Islamic equity market to be weakly correlated with all the other markets, especially with the advanced markets. They also find returns of Islamic stocks traded in the Malaysian market are caused only by the US, Asia Pacific, World Emerging as well as World Developed stock returns.

Excessive speculative activities

Tag El-Din (1996) discusses the traditional concept of market efficiency in light of the theories of Keynes-Hicks-Samuelson. He proposes three conditions and asserts that under these conditions both operational and informational efficiencies can be achieved. He stresses the fact that there is an excessive speculative activity in the conventional stock markets and introduces a highly regulatory normative stock exchange which is needed in a competitive market in order to achieve an efficient stock market. Kia (2001) finds that excessive speculative activities do create wasteful information from the efficiency point of view. His empirical finding confirms Tag El-Din’s (1996) view that a highly regulatory normative stock exchange is needed in a competitive market. He also showed that the application of the Islamic law automatically guarantees stable and efficient stock markets.

Kia (2001) suggests the central bank and the government should ensure that the investors in stock markets have complete knowledge of the stock market mechanism which implies that the government facilitates the training of the existing as well as new investors in these markets. Such a policy leads participants in stock markets to have or acquire the knowledge of the market mechanism so that they conduct transparent transactions rather than over or under react to any information. Since he found, using Canadian data, the excessive speculative activities create inefficiency in the stock markets, Kia (2001) proposes a tax levy on short-horizon investment returns. Since short-horizon (at least up to a month) investment returns could purely be due to windfall gains and not to real investment opportunities - and in most cases these returns are the result of excessive speculative activities – he suggests a 20% Quranic tax may be appropriate. Tag El-Din and Hassan (2007) review speculation in the stock market from an Islamic point of view and raise the question of how much speculation is allowed in an Islamic stock exchange market.

The impact of the Shariah (Islamic law) on liquidity and the performance of individual stocks

Sadeghi (2008), using an event study methodology, analyses the impact of the Shariah-compliant index by the Bursa Malaysia on the liquidity and performance of each stock in the index. He found there is a positive relationship between the introduction of the Shariahcompliant index and the performance of each individual stock in it. Furthermore, he found a positive reaction of the market to the introduction of the Shariah. However, the bid-ask spread, as a measure of liquidity, increased after the introduction of the Shariah, which Sadeghi (2008) interprets as the reaction of market participants to the generated asymmetric information rather than the reduction in liquidity.

Performance of Islamic Indexes: Rana & Akhter’s Survey

Contrary to the literature of Islamic banks and Islamic mutual funds, Islamic indices have not received high level of empirical research due to their shorter histories (El Khamlichi and Laaradh 2012). In addition, the performance comparison of Islamic indices against conventional counterparts is also complicated owing to different factors such as differences in size and industry-weighting (Fowler and Hope 2007). Therefore, earlier studies such as Naughton and Naughton (2000) use qualitative approach to discuss the initial stage of Islamic stock indices in terms of regulations, financial principles, and market framework.

However, previous studies on the performance analysis of Islamic indices provide somewhat mixed results. This difference among the results can be attributed to different performance measures, sample data, and different benchmarks used by these studies. For example, Atta (2000) analyzed the performance of Dow Jones Islamic Index (DJIM) against market index and risk-free rate. He reports that DJIM has not only outperformed its conventional counterparts, but also offered more returns than risk-free rate.

Same results are reported by Hassan (2001) where he investigated the performance of 6 Dow Jones Islamic indices. His results also confirm superior efficiency of Islamic indices against counterparts. On the contrary, Girard and Hassan (2005) do not find any significant performance differences between of Dow Jones Islamic indices and 7 Morgan and Stanley conventional indices. They use different performance measures to check the robustness of the results. From single factor CAMP to four factor conditional CAMP; they report that results remain same for the period of 1996–2005. They also report that growth and small stocks are core drivers of the positive performance for Islamic indices. The same results are reported by Dabeerru (2006) about the performance of Saudi Arabian Islamic indices. He reports that Shari’ah screenings do not lead to good performance of Saudi Islamic indices. The family of Dow Jones Islamic Market Index got attention of most earlier empirical studies and include the work of Atta (2000), Hassan (2001), Tilva and Tuli (2002), Hakim and Rashidian (2002; 2004). , , , , These studies compared the performance of Dow Jones Islamic market index (DJIM) against a conventional benchmark. However, the choice of performance measures and benchmark remain different from one researcher to another. Atta (2000) used market conventional index and 3 month risk-free rate as benchmark against DJIM and concluded superior performance of DJIM than risk-free rate and conventional index. His results are further supported by Hassan (2001) who used same benchmark with different data set (1996–2000). He documents that 6 DJIM indices are more efficient than conventional index. On the other hand, Tilva and Tuli (2002) used different conventional benchmark (S&P 500) with different performance measure of Fama and French 3 factor model. His results show that Islamic and conventional indices are highly correlated and have no significant performance difference. Hakim and Rashidian (2000) analyzed the performance of DJIM with Wilshire 5000 and 3 moths T-Bill with weekly data set. They conclude less performance of Islamic index. Hakim and Rashidian (2004) again analyze the performance of DJIM but with different benchmark (Green Index, DJ World, Libor) with different data set (2000– 2004). Islamic index earned inferior returns as compared to Green index (socially responsible index). On the other hand, family of Financial Times Stock Exchange Islamic Index (FTSE Islamic Index) analyzed by Hussein (2004), Miglietta and Forte (2007), Girard and Hassan (2008) who also employed different empirical models, benchmarks and performance measures to examine the FTSE Islamic Index. , ,

Hussein (2004) uses FTSE all world and FTSE4- good as benchmark against FTSE Islamic Index to compare the performance difference. He comes up with somewhat complicated results. He analyzed performance of these indices over three different intervals; bullish, bearish and entire time horizon over the period of 1996–2003. During bullish period, Islamic index outperformed its conventional counterpart, whereas during whole time period both indices perform same. Since Islamic investing is a part of socially responsible investing (SRI), Elgari (1993) and Miglietta and Forte (2007) compared FTSE Global Islamic index to FTSE socially responsible index by employing Sharpe’s analysis (Sharpe, 1946) and co-integration techniques. . They report that although Islamic index looks similar to SRI, however both are quite unique in terms of both assets allocation and econometric profile. SRI indices are exposed financial sectors whereas Islamic indices are invested in Oil & Gas sectors. Also, there exists co-integration between 3 months Euribor and FTSE Islamic index. Another study (Hashim, 2008) compares FTSE Islamic index and SRI (FTSE 4 Good). By employing CAMP and other traditional performance measures such as Jensen’s Alpha, Sharpe, and Treynor, he concludes that FTSE Islamic index is more efficient, even though more riskier than the market, and yields positive abnormal returns as compared to SRI index.

The study of Girard and Hassan (2008) is considered as a gateway into the empirical literature of Islamic indices. By employing sharp Ratio, Treynor Ratio, and Jensen’s Alpha, they compared 5 FTSE Islamic indices and 5 conventional benchmarks MSCI. They also employ Fama’s selectivity, net selectivity, and diversification to examine the style and timing ability of fund managers. In addition, Charhart’s four-factor model is used to examine the performance persistence of Islamic indices. They report insignificant performance differences between FTSE Islamic indices and their counterparts due to style and timing ability of fund managers. The results remain same even after controlling for other factors like market risk, size, book-to-market, momentum, and local and global factors. Also, there exists co-integration between Islamic and non-Islamic indices for overall period.

Some studies have analyzed the performance of Islamic indices of particular countries instead of examining the performance of world’s famous Islamic indices. These studies include (Ahmad and Ibrahim 2002; Nishat 2004; Dabeerru 2006; Yusof and Majid 2007; Albaity and Ahmad 2008; and Fahmi et al. 2009). , , , . For example, in Malaysia, the performance of Kuala Lampur Shari’ah Index (KLSI) have been analyzed by Ahmad and Ibrahim (2002), Yusof and Majid (2007), and Albaity and Ahmad (2008). No significant performance differences between Islamic and Non-Islamic indices have been reported by Ahmad and Ibrahim (2002). Also, during the bull market period, Islamic index is less performing against its conventional counterparts. Albaity and Ahmad (2008) report similar results for Kuala Lampur Shari’ah Index (KLSI) and Kuala Lampur Composite index (KLCI). They also examined causality between both indices and find bidirectional causality. Recent studies on performance analysis of global Islamic indices include Guyot (2011), El Khamlichi and Sarkar (2012), Jouaber-Snoussi et al. (2012), and Arouri et al. (2013). , , , Guyot (2011) analyzes nine Dow Jones Islamic indices (DJIM) and finds no cointegration between Islamic and non-Islamic indices. He also reports that both indices have no performance difference and efficiency & liquidity of both indices is similar during the study period. Another study that examines efficiency of 4 Dow Jones Islamic indices is El Khamlichi and Sarkar (2012). These results about efficiency level of Islamic and non-Islamic indices are similar to those of Guyot (2011). They document that Islamic indices are as efficient as conventional MSCI and FTSE indices are. In addition, Dow Jones Islamic index and S&P Islamic index are not co-integrated with their conventional counterparts. Arouri et al. (2013) examines the impact of current global financial crisis on 3 Dow Jones Islamic indices to see whether Islamic finance constitute a potential solution in reassuring investors and stabilizing financial systems to escape from financial downturns. They employ Multivariate Vector Autoregressive (VAR) and Granger Causality test to test the interaction between Islamic and conventional financial products and specify the dependence orientation of feedback between screened and unscreened stock prices, respectively. Moreover, to ensure the best resource allocation, they develop portfolio simulation and optimal portfolio strategies (Proportional investment for both Islamic and conventional funds). They find that inverting in Islamic financial products yields higher returns and systemic risk of such portfolios, which includes Islamic financial products, is reduced significantly.