Does Islamic Equity Investment Offer Hedging Benefits

Transcription

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 Introduction Shari'ah compliant equities Investment in public listed companies are allowed subject to the condition that the companies business, operations and management complies with the principles of Islamic jurisprudence Shari'ah very small universe for investment due to the nature of existing capital markets Sources of Shari ah guidelines for screening 1. Qur an, Hadith and Ijma : No direct reference 2. Qeyas: Absence of harmony

3 Why so many Shari ah screening standards Exceptions are allowed by Shari'ah scholars subject to: Main business of the corporation is permissible Halal (95 percent rule) Financial leverage + Investment in Interest-based instrument (1/3 rd rule) Investment in real assets (2/3 rd rule) Cleansing of income Screening process: Two levels 1. Qualitative screening (Business 95 percent rule) 2. Quantitative screening (Financial 1/3 rd rule) Basis of quantitative screening 1. Book-value of assets Business is an ongoing concern and investment is longterm Remember day trading is speculation 2. Market-value of equity markets not only dictates the price of the assets but also price the future potential of the company and thus is better reflective of the value of a company

4 Performance Evaluation Recent evidence 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.

5 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

6 Research Approach Shari ah compliant indices Business screening Financial screening Construction of indices Benefits No survivorship bias Same asset universe Same methodology

7 Data sources 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

8 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

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

10 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

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

12 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

13 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

14 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

15 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

16 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