Islamic Investments. An Overview and Comparison of Islamic Indices

by Arthur Ritter (Author)

Research Paper (postgraduate) 2015 25 Pages

Business economics - Investment and Finance



The following industry and market analysis is primarily based on the most recent Islamic Financial Services Industry Stability Report (2014) provided by the Islamic Financial Services Board.

The total amount of assets in the Islamic financial industry was approximately $1.8 trillion by the end of 2013. The Islamic financial industry includes 4 major subcategories, Islamic banking, Sukuk (Islamic capital markets), Takaful (Islamic insurance) and Islamic Microfinance. By far the largest subcategory is Islamic banking with an estimate of 80% of all assets. The remaining 20% split up to Sukuk $245.3 billion, Islamic funds $68.9 billion and Takaful $18.3 billion. The Islamic financial industry is still very small in comparison to the traditional industry, however it is one of the fastest growing sectors with an Compound Annual Growth Rate (CAGR) of 17,04% between the years of 2009 and 2013. The growth in the Islamic banking industry was, on average, 20% after the recovery of the global financial crisis in 2009. Most of the assets are concentrated in Islamic countries like Gulf Cooperation Council and Malaysia. Beside these major players, other countries in the Middle East or North Africa showed a rapid growth or entered the market. Further growth, mentioned by Iqbal and Tsubota (2006), is also expected because of the increasing demand of Sharia compliant investments and financing due to the growth of “oiladollars” and the immigration of Muslim people all over the world.

The specialty of the regulatory framework for Islamic investments is that they all have to be Shariah confirm. The main principals for Islamic investments are (AlaSuwailem, 2006):

- It is not allowed to invest money only for the sole purpose of profit.
- The concept of interest (Riba) is not allowed
- It is only allowed to invest in companies, which are Shariah confirm (alcohol, weapons, pornography, gambling, etc. are prohibited by the Shariah)
- Gambling as it self is not allowed
- No high uncertainty/risk (Gharar) can be taken
- And the risk must always be shared between the lender and the borrower

One of the important differences between conventional finance and Islamic finance, as far as risk is concerned, is that in Islamic finance the risk must be split between borrower and lender and very high risk investments like short selling and high leverage is not allowed.

“Conventional finance can be likened to a spectator’s game where few skilled players stay in the playground and a big crowd is watching from outside. Islamic finance, meanwhile, is similar to participatory sports, where everyone is playing and no one is mere watching.” (Ala Jarhi (2004), p.17).

In other words, an investor faces the traditional sources of risk, however it is split up between the borrower and the lender and it is not Shariah compliant to take additional risk just for additional profit (high leverage, short selling, etc.). The fee structure of Islamic investment funds is comparable with conventional funds.

Moisseron, et al. (2014) state that in most Islamic countries the complete financial system is aligned with Islamic law. However, in most western countries Islamic banking institutions do not benefit from the conventional financial regime. Islamic financial institutions therefore stay inadequately developed and are not in a net borrower situation to the Central Bank or the financial system. Consequently they stay outside the normal refinancing process. Current literature stresses that a global Islamic regulation system is absent.


This literature review will give an overview of the scientific literature regarding Islamic finance, however will focus on Islamic equity with emphasis on the performance of Islamic indices in comparison to conventional indices.

The two most studied topics are the performance of Islamic (mutual) funds and on Islamic indices.

Islamic mutual funds are substantially different form conventional funds for the reasons mentioned above (Shari’ah compliance). Hence, it is of interest to analyse if Islamic funds substantially underperform their conventional equivalent. Abdullah et al. (2007) examined the Jensen alpha of a portfolio of 14 Malaysian Islamic funds between the years 1992 to 2001 and where able to show that the Islamic portfolio significantly underperformed its market benchmark. This finding is confirmed by Kraeussl & Hayat (2008), who also find the underperformance of Islamic equity funds. However, Walkshäusl et al. (2012) find no significant difference in the performance of Islamic portflios.

Dharani et al. (2011) examined the performance of Islamic and conventional indices in India and discovered no significant difference among average daily returns of the average daily returns of the Nifty Index and the Nifty Shari’ah index. On the contrary, Mansor et al. (2011) showed that the Kuala Lumpur Shari’ah Index (KLSI) slightly underperformed the Kuala Lumpur Composite Index (KLCI). The risk adjusted returns as well as the beta for the conventional Index were marginally higher in comparison to the KLSI. Sadeghi (2008), examined the influence of the introduction of the Bursa Malaysia Islamic Index on the liquidity and the performance on Islamic stocks in Malysia. He used the approach of event studies and showed that the introduction of the Index had a highly positive influence on the Shari’ah confirm stocks performance. He concluded, that many investors, which are interested in Islamic investment, are highly interested in investing in indices to benefit from comparatively cheap advantages of diversification. The Wilshire 5000 index compared with the Dow Jones Islamic Market index (DJIM) was examined by Hakim et al. (2002). The DJIM index does not include any assets that are not compatible with the Islamic law. Their finding was, that the risk per unit of return of the Wilshire 5000 was significantly higher than the DJIM. They also found that the linkage/correlation between the tow indices is not significant over time. On the other hand, Hassan et al. (2011) applied traditional riskareturn measures like the Sharpe, Treynor and Jenson ratios to examine the conventional and Islamic indices and were not able to find any significant difference in the return performance. Additionally, Bauer et al. (2005), also did not find evidence of the performance in risk adjusted returns between conventional assets and ethical investments in Australia. Furthermore, Hussein (2004) analysed the performance of the FTSE Islamic index and the FTSE AllaWorld index in tow subsamples. He divided the sample in a bullamarket sample and a bearamarket sample in the period of 1996a2000 and 2000a2003. He was able to show that the Islamic index had a similar mean return as the conventional index on the overall period. However, he also states, that if the tow subaperiods are concerned, the Islamic index outperformed in the bull market but underperformed in the bear market. On the other hand, a contrary study by Hoepner et al. (2011), who examined Islamic funds in comparison to international equity market benchmarks, shows that funds from six Islamic countries (GCC and Malaysia) outperformed the international stock markets benchmarks. Other studies, which compare Islamic return performances with conventional return performances during a financial crisis, are also contradictory. For example, Albaity et al. (2012) find no difference, however, Aka (2009) shows that the MSCI World Islamic index outperformed the conventional equivalent significantly by over 15%. Aka (2009) argues that Sharia compliant investments are less volatile are therefore able to outperform the conventional stock market during a crisis. This finding is confirmed by Merdad et al. (2010), who also show that the Islamic funds underperform conventional funds during “normal” and bull market periods, however outperform them in crisis and bear market periods. Another recent study by Hooi et al. (2012) shows that the FTSE Shari’ah index has a higher standard deviation than the conventional equivalent during all periods, crisis and nonacrisis. On the other hand, AlaRifai (2012) shows that the Islamic complaint indices on the Dow Jones outperform the convectional during the last crisis. He argues, that it is not allowed to include high leveraged firms and the Islamic index puts more weight on industries like healthcare, technology and commodity firms rather than on the companies form the financial industry or media/entertainment, which are more effected by the crisis.

Another important research topic than the performance is the customer demand for Shari’ah compliant investment, especially in Muslim countries. Hassan (2007) studied customers’ awareness concerning Islamic banking in Pakistan. His study analysed numerous essential dimensions including knowledge, socioareligious context, Shari’ah compliances and willingness to deal with Islamic banks. Moreover, quality and attractiveness of offerings were examined as well. He showed a positive awareness of all variables, which has been investigated, indicating overall high satisfaction towards products and services of Islamic banks in comparison to conventional banks.

In conclusion, the current existing results regarding the performance are very contradictory. It seems that it is very difficult to make a general conclusion on the performance of Islamic indices, since very similar studies on different indices come to completely different results. Hence, it is not really possible to make an overall conclusion on the performance of Islamic indices in comparison to conventional indices. Accordingly, in section 3 this essay tries to contribute to the discussion by analysing the most recent data.

Data Analyses

This section examines the data and empirical approaches applied to compare the performance of conventional and Islamic indices. The common investment theory describes the goal of a riskaaverse investor to maximize its utility gained from an investment after adjusting for risks. Widely applied measures to adjust for investment risk are Treynor Index (TI) (Treynor, 1965) beta, alpha and Sharpe ratio (SR) (Sharpe, 1966).

In this essay, 2 US indices, a conventional and an Islamic, are investigated. The data is obtained form DataStream, with monthly closing prices of the Dow Jones Islamic US Index (DJI), Dow Jones Industrial index (DJ). The period is from April 2003 to April 2015. This set is further divided into four samples: the overall period, before (2003a2006), during (2007a2008) and after (2009a2015) the global financial crisis. The MSCI All World Index has been chosen as a market benchmark for both indices and used as a proxy for the market return. This method is in accordance to Hassan and Girard (2011) and Hussein (2004) using MSCI All World (MSCIW) indices for their research concerning Islamic index performance. Additionally, the threeamonth US Treasuryabill rate is used as a proxy for the risk free rate. The logarithmic returns are estimated as shown in equation 1.

Abbildung in dieser Leseprobe nicht enthalten.

The Capital Asset Pricing Model (CAPM) regression model is applied with the help of the Microsoft Excel1 to find the beta of the conventional and Islamic index with the market (MSCIW) index as a benchmark.

The SR measures the performance of the indices by dividing the amount of excess return by total risk (standard deviation).

Equation 2

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The TI measures the indices performances in relation to its beta. This performance measure differs from SR because it applies the systematic risk (beta) instead of standard deviation.

Equation 3

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The higher the two measures, the better the performance of the index.

The beta and alpha are obtained by running a simple linear regression with Microsoft Excel. Beta measures the systematic risk of the index. Hence, a higher beta should result in higher returns. The intercept of the regression (alpha) is the performance measure. It estimates if the index performed significantly better/worse than its benchmark. Furthermore, a correlation analysis of the individual indices with the market is conducted to indicate, which index offers a better diversification opportunity.

Table 1 Correlation with the Market

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As we can see form table 1, the correlations for the two indices with the overall market are relatively high and the diversification benefit is only marginal. However, the conventional index shows a lower correlation in all samples, which indicates a lower overall coamovement with the market in comparison with the Islamic index.

The descriptive statistics2 lead to several conclusions. The standard deviation of the Islamic index is higher in all periods, expect after the crisis. This indicates that the index is more risky. As the skewness is concerned, we can see that it is negative for both indices over all periods, which implies the data is negatively skewed and not symmetric, hence not normal distributed. The skewness takes its largest negative value during the crisis for the Islamic index. Kurtosis is around zero in the periods before and during the crisis, however turns highly positive after the crisis, which indicates that the distribution of the returns after the crisis has thicker tails than the normal distribution.

Table 2 Sharpe Ratio

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Table 3 Treynor Index

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During the overall period, before and during the crisis excess returns for both indices are negative and only marginal positive after the crisis. As the SR is concerned, the Islamic index is less negative and more positive after the crisis than the conventional. These findings are consistent to Mansor and Bhatti (2011). However, if the TI is taken into account, the conventional index outperformed the Islamic in the overall, before and during the crisis sample. This can be explained by the lower betas for these periods shown in table 4.


1 For detailed outputs for the regression see Appendix.

2 For descriptive tables see Appendix


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University of St Andrews – School of Management
Alternative Investments Islamic Finance


  • Arthur Ritter (Author)



Title: Islamic Investments. An Overview and Comparison of Islamic Indices