Performance Evaluation Of Islamic Mutual Funds In Malaysia Based On Asset Portfolio

Performance Evaluation Of Islamic Mutual Funds In Malaysia Based On Asset Portfolio Aida Yuzi aidayuzi@tmsk.uitm. edu.my Shamshimah Samsuddin shamshimah@tmsk. uitm.edu.my Syazreen Niza Shair syazreen@tmsk.uitm.edu.my Mohd Hafiz Hazny hafizhazny@gmail. com Abstract The purpose of this study is to evaluate the s performance of Islamic mutual funds in Malaysia according to four types of asset portfolios which are Equity, Debt, Money Market and Asset Allocation. Using Sharpe and Adjusted Sharpe Ratio, Treynor and Jensen Indices as well as Modigliani Measure, the average daily s for each type of asset fund are being compared relatively to two market benchmarks namely Kuala Lumpur Composite Index (KLCI) and Bursa Malaysia EMAS Shariah Index (FBMS). The period of comparison is divided into three; between 2001 to 2006 which is before Global Financial Crisis, during the period of crisis from 2007-2008 and post crisis of 2009 to 2010. Findings show that generally, all types of asset portfolios performed throughout 2001 until 2010. However, during Global Financial Crisis, Money Market Islamic mutual funds show better performance as compared to other types of asset portfolios. In addition, all types of Islamic mutual funds outperform in relative to market benchmarks and the outperformance is continued until 2010. The under performance results were only shown through Debt and Money Market Islamic Mutual funds from 2001 to 2006. The results provide information that would benefit the investors and market players in asset funds selection and weighing their investment during bullish or bearish periods. Keywords: Islamic Mutual Funds; performance evaluation; equity funds, debt funds I. INTRODUCTION The Islamic mutual funds in Malaysia is similar to Conventional mutual funds but it is based on Syariah - compliance which means that the transaction involved in the investment is not against Islamic principles. In the Syariah s context, it promotes the use of profit sharing and partnership schemes and strongly forbids investment involving three elements which are riba (interest), maysir (gambling) and gharar (uncertainty). The Islamic mutual fund was established as an alternative approach for those who are interested to invest and gain from investment based on Syariah compliance. The funds experienced rapid growth for less than a decade among other sectors in the Islamic financial system. As a result, the Islamic equity funds outperformed their benchmark by gaining high s due to technology boom in the late 1990s. Based on [1], 23 % of Islamic funds are domiciled in Malaysia with $4.579 billion in total assets. At the end of the year 2008, [2] reported that for Malaysian Islamic market, the total of Syariah based unit trust funds is 149 or 25.7% of the total of 579 approved funds. The Net Asset Value of Syariah based unit trust funds from 2003 to 2008 grew at a compounded annual growth rate of 26.3% and in the same period, the total industry recorded a growth rate of 11.4%. The number of Islamic unit trusts and mutual funds in Malaysia was 155 as at June 2010 with a total volume of RM22.69 billion [3]. The Islamic mutual funds market is one of the fastest growing sectors within the Islamic financial system. However, most of performance analyses are reporting the overall performance of Islamic mutual funds in Malaysia without focusing on different types of funds portfolio. Thus, this study aims to measure the performance of Islamic mutual funds in Malaysia based on asset portfolios or type of funds, as compared to its two market benchmarks, during period of 2001 until 2010. This is important to capture the effect of bearish and bullish market related to Global Financial Crisis in year 2008. II. LITERATURE REVIEW The Islamic mutual funds market is one of the fastest growing sectors in the Islamic financial system although it is still in its infancy stage of growth and development as compared to the mutual fund industry at large. During the late 1990s, the Islamic equity funds have experienced excellent growth as they benefited from the technology boom and most of them indicating high positive s and performed their benchmarks. Nevertheless, more funds were launched since 2002, with brighter market expectations and more lessons being learned [4]. [4] also pointed out that Islamic mutual funds FRGS, Ministry of Higher Education, Malaysia

was launched after it received wider acceptance by Syariah s scholars in the early 1990s. Besides providing halal investment, the Islamic mutual funds also serve for more liquid investment tools. Some of the countries have their own local market index for conventional and Syariah s. Therefore, investors can compare the performance of funds by comparing them with the local indices as a benchmark. According to [5], Further, the establishment of credible equity benchmarks by Dow Jones Islamic Market Index (DJMI) and FTSE Global Islamic Index Series, followed by the Malaysian Kuala Lumpur Syariah Index, has been a turning point for the industry, giving both Islamic and conventional investors something to compare to. Malaysia is one of the largest hubs for Islamic Funds market with largest funds in Islamic funds market. According to [3], the number of Islamic unit trusts and mutual funds in Malaysia was 155 as at June 2010 with a total volume of RM22.69 billion based on the latest data in the latest Security Comission s Report. At the end of the year 2008, [2] reported that the total of Syariah based unit trust funds is 149 or 25.7% of the total of 579 approved funds. These funds consists of 68 equity funds, 21 balanced funds, 18 sukuk funds while the rest are money market funds, structured products, feeder funds, fixed income funds and mixed asset funds. The Net Asset Value of Syariah based unit trust funds from 2003 to 2008 grew at a compounded annual growth rate of 26.3% and in the same period, the total industry recorded a growth rate of 11.4% [2]. The performance of funds can be measured by their on investment. There are several studies conducted to observe the performance of Islamic Mutual Funds. Treynor Ratio is useful for measuring performance as well as to compare mutual funds within a category. This ratio is a measure of excess per unit of systematic risk. The first models used to evaluate risk-adjusted fund performance were based on the work by Sharpe, Lintner, Treynor and Mossin on the Capital Asset Pricing Model (CAPM) [6]. Based on previous research done by [7], the performance of Islamic equity mutual fund in Malaysia was compared using Sharpe Ratio and Treynor Ratio. Data consists of Net Asset Value (NAV) of nine Malaysian equity mutual funds on weekly basis during period of 2002 to 2006 and the prices on market portfolio or Kuala Lumpur Syariah Index (KLSI). From the finding, only Public Ittikal fund was found to achieve higher average than Kuala Lumpur Syariah Index (KLSI) but the rest have shown a lower. Results from Treynor analysis showed Islamic Equity fund performance was significant and positively related to the performance of the KLCI. [8] measured and compared the performance of Malaysian Islamic Market and Indonesia. Daily data from June 2006 until April 2009 were evaluated using Sharpe ratio, Treynor ratio, Jensen Index, Snail Trail and Market Timing methods. They found that Indonesian s asset allocation Islamic mutual funds seem to be slightly outperformed the same type of Malaysian funds. The same outperformance result also showed Indonesian s debt Islamic mutual funds were performed better compared to the Malaysian counterparts. In the area of Islamic mutual fund, investors can monitor its performance fluctuations by means of Islamic index. [9] investigated the risk behaviour of Islamic and conventional mutual funds in Saudi Arabia using methods such as Sharpe, Treynor, Jensen Alpha and their variants. They reported that Islamic mutual funds underperformed compared to Conventional funds during these periods: full and bullish. However, during bearish and financial crisis period, Islamic mutual funds tend to perform better than their Conventional counterparts. They concluded that Islamic mutual funds offer the opportunity for hedging during financial crisis period due to some prohibitions in Islamic laws that put some limitations on portfolio selection. [10] is commonly used by many researchers to measure a ratio of to volatility. It is useful for comparing risk adjusted between mutual funds. The Sharpe ratio is an appropriate measure of performance for an overall portfolio particularly when it is compared to another portfolio, or another index such as the S&P 500, KLSI, JII, etc. compared to Treynor ratio which is appropriate to be used in measuring the individual assets, Sharpe ratio is more appropriate to be used in evaluating the well diversified portfolios since the later ratio uses total risk as one component of its calculation [8] III. DATA AND METHODOLOGY A. Data The sample data consist of 177 Islamic mutual funds in Malaysia which is categorized according to asset portfolio or types of fund which are equity, debt, money market and asset allocation. Daily average s are extracted from Bloomberg database for period of 10 years from 2001 to 2010. The period cover one market cycle which is pre, during and post Global Financial Crisis in 2008. These periods represent the bearish and bullish market development. The average daily s of each mutual fund is calculated as below:

(1) Where R it is daily on mutual fund, NAV it is the net asset value of mutual fund i at time t and D it is dividend of mutual fund i at time t The average daily s of each islamic mutual fund are compared with two market benchmarks, namely FTSE Bursa Malaysia Kuala Lumpur Composite Index (FBMKLCI) and FTSE Bursa Malaysia EMAS Syariah Index (FBMS). Returns for market index can be calculated by using: (2) Where is on the market during time t, is market index at time t and is market index at time t-1. B. Sharpe Ratio The Sharpe Ratio was introduced by William F. Sharpe [10], which divides the funds excess s (annual total s minus risk free s) by its standard deviation. This traditional Sharpe index measures the excess per unit of total risk. Thus, the higher the index values of the portfolio, the more desirable the portfolio. The equation is given as: (3) Where is the mean s of a portfolio, is the mean s to a risk-free asset, and is the standard deviation of s on the portfolio. The daily rate of Malaysian 3 Months Treasury Bills (MRMGB3) will be used as proxy for risk free rate. By assuming no risk involved, investor can estimate the market to be obtained. Altogether the is free from the risk, which is the default risk, yield curve risk, inflation risk and other risks. C. Adjusted Sharpe Ratio [11] found that the Sharpe ratio produced biased outcome and they had identified the exact unbiased percentage was 0.75 with a sample size of twelve (12) years. Various sample size (n) provides different biasness in the estimation of standard deviation, thus Sharpe ratio had been adjusted by [12] as follows: Where n is the number of observation. (4) D. Treynor Ratio [13] is a risk-adjusted measure of portfolio performance where risk is measured by beta. Beta is the measure of portfolio s risk in relation to the market. Therefore, the higher the index value of the portfolio, the more desirable is the portfolio. The equation is given as: (5) Where is average of the portfolio i, is average risk free rate of and is systematic risk for portfolio which also known as market risk responding to market changes. If the beta shows the higher values it implies that the of portfolio has the high sensitivity to the market s. In contrast, low sensitivity is represented by the lower values of beta. E. Modigliani s Measure This method was first introduced by Modigliani [14] in order to measure the riskadjusted performance. The model is as follows: (6) where σ m is standard deviation of market s. IV. ANALYSIS AND FINDINGS Table I shows the mean of equity, debt, money market and asset allocation mutual funds (MF) compared to market benchmarks (KLCI and FBMS). TABLE I. DESCRIPTIVE STATISTIC OF RETURN Asset Portfolio 2001-2006 2007-2008 2009-2010 Overall Mean Std. dev Mean Std. dev Mean Std. dev Mean Std. dev Equity IMF 0.0027 0.3349 0.0074 0.5029 0.0294 0.3426 0.0188 0.4266 Debt IMF -0.0022 0.1445 0.0151 0.1494 0.0131 0.1358 0.0055 0.1589 Money Market IMF -0.0457 0.1372 0.0257 0.1175 0.0023 0.0359 0.0041 0.1152 Asset Allocation IMF 0.0022 0.2900 0.0028 0.3667 0.0262 0.2276 0.0129 0.2968 Market (KLCI) 0.0133 0.3388-0.0196 0.5335 0.0481 0.2984 0.0137 0.3783 Market (FBMS) 0.0099 0.3525-0.0171 0.5643 0.0460 0.3026 0.0117 0.3949 Notes: IMF is referred to Islamic mutual fund

Mean s for equity and asset allocation IMF are positive while debt and money market IMF show negative s during pre-crisis (2001-2006). However, all types of IMF are still underperform the market s. The second two years (2007-2008) which is during global financial crisis shows the outperformance of all types of IMF as compared to market benchmarks. This period of bearish market indicates that money market IMF denotes the highest s. The outperformance result continues during post-crisis period or bullish Islamic MF outperform with significant margin as compared to other two types of fund. Money market Islamic MF shows the highest outperformance result during that bearish period. Year 2009 to 2010 show the positive performance results of all types of asset portfolios which brings to overall positive results from 2001 to 2010. There is no significance difference in the performance result for both measurements since Adjusted Sharpe ratio already modified the biasness under Sharpe TABLE II. SHARPE and ADJUSTED SHARPE RATIO Performance Asset Portfolio Period of Evaluation Measurement 2001-2006 2007-2008 2009-2010 Overall Sharpe Ratio E-IMF 0.0045 0.0145 0.0853 0.0423 D-IMF -0.0232 0.1000 0.0957 0.0298 MM-IMF -0.3413 0.2177 0.0604 0.0293 AA-IMF 0.0036 0.0073 0.1145 0.0410 Adjusted Sharpe Ratio E-IMF 0.0043 0.0141 0.0852 0.0423 D-IMF -0.0232 0.0996 0.0955 0.0297 MM-IMF -0.3407 0.2173 0.0606 0.0293 AA-IMF 0.0035 0.0073 0.1143 0.0409 Notes: E-IMF is refered to equity Islamic mutual fund, D-IMF is debt Islamic mutual fund, MM-IMF is money market Islamic mutual fund and AA-IMF is asset allocation Islamic mutual fund. market from 2009 to 2010. However, mean for money market IMF significantly reduces by 91% during that period. The results in Table 1 indicates that all types of Islamic MF outperform the market bechmarks during crisis and after crisis ends. Next, we measure the performance of portfolios s by using Sharpe and Adjusted Sharpe ratios. The results are showed in Table II. Table II represents the risk-adjusted s for all types of Islamic mutual funds using two measurements, Sharpe ratio and Adjusted Sharpe ratio. During pre-crisis period, i.e from 2001 to 2006, equity and asset allocation Islamic MF performs better than debt and money market Islamic MF using both performance measures. However, the results are vice versa during the crisis period (2007-2008) where debt and money market ratio. Sharpe and Adjusted Sharpe ratios measure the performance of mean excess of each asset portfolio given its own standard deviation. Thus, it is also important to evaluate the performance of each portfolios with market proxies namely, Kuala Lumpur Composite Index (KLCI) and Bursa Malaysia EMAS Shariah Index (FBMS). The results are presented in Table III. All types of asset portfolios show positive performance during bearish market compare using both market proxies.. Again as result in Table II, money market Islamic MF performs better as compared to other types of Islamic MF during that crisis period. The risk-adjusted performances are slightly better by using FBMS as market benchmark. Prior to that, money market Islamic MF and debt Islamic MF are underperformed. Another bullish period which is after the crisis, no negative performance exhibits, thus, indicating that TABLE III. TREYNOR RATIO and MODIGLIANI S MEASURE Performance Measurement Asset Portfolio Proxy: KLCI Proxy: FBMS 2001-2007- 2009- Overall 2001-2007- 2009- Overall 2006 2008 2010 2006 2008 2010 Treynor Ratio E-IMF 0.0029 0.0122 0.0459 0.0295 0.0029 0.0128 0.0431 0.0300 Modigliani s Measure D-IMF -0.0528 0.4738 0.2845 0.0977-0.0532 0.4839 0.2618 0.0953 MM-IMF -0.4253 1.2422 0.5635 0.0820-0.4578 1.3716 0.3357 0.0849 AA-IMF 0.0024 0.0053 0.0524 0.0259 0.0024 0.0055 0.0491 0.0262 E-IMF 0.0007 0.0246 0.0284 0.0172 0.0005 0.0249 0.0286 0.0178 D-IMF -0.0065 0.0564 0.0284 0.0116-0.0065 0.0589 0.0287 0.0120 MM-IMF -0.0762 0.1197 0.0288 0.0107-0.0802 0.1268 0.0337 0.0109 AA-IMF 0.0008 0.0042 0.0344 0.0157 0.0008 0.0042 0.0349 0.0163

in overall, all funds outperform througout that 10 years period. However, the performance results are higher during both bullish periods with KLCI as market proxy. Table IV illustrates summary of all findings above. All types of asset portfolios for Islamic MF performed better than two markets over V. CONCLUSION This study aims to investigate the performance of different types of Islamic mutual funds by using risk-adjusted perfromance measurements of Sharpe ratio, Adjuested Sharpe ratio, Treynor ratio and Modigliani s measure. Daily average s of each portfolio are calcluated over 10 years TABLE IV. SUMMARY OF PERFORMANCE RESULTS Performance Measurement Mean excess Fund 2001-2006 2007-2008 2009-2010 Overall E-IMF + + + + D-IMF - + + + MM-IMF - + + + AA-IMF + + + + Sharpe Ratio E-IMF + + + + Adjusted Sharpe Ratio D-IMF - + + + MM-IMF - + + + AA-IMF + + + + E-IMF + + + + D-IMF - + + + MM-IMF - + + + AA-IMF + + + + KLCI FBMS KLCI FBMS KLCI FBMS KLCI FBMS Treynor Ratio E-IMF + + + + + + + + Modigliani s Measure D-IMF - - + + + + + + MM-IMF - - + + + + + + AA-IMF + + + + + + + + E-IMF + + + + + + + + D-IMF - - + + + + + + MM-IMF - - + + + + + + AA-IMF + + + + + + + + the period of 2001 to 2010. The mean for all funds were positive during period of crisis and postcrisis and only two types of asset portfolios showed negative s during pre-crisis period. This suggests that Islamic MF were not affected by the Global Financial Crisis, eventhough there were significant loss in market value during that period. The findings also suggest that all types of Islamic asset portolios performed in bearish and bullish market except before the financial crisis. All performance evaluations indicate that money market Islamic MF performs relatively higher than the other types of funds during and after crisis while equity and aset allocation Islamic MF show positive performance throughout the period of study. However, in terms of consistency, equity and asset allocation, Islamic MF give positive s and outperformance in pre, during and post crisis periods. There is also no significant differences in the s performance results using two market portfolios. In general, all Islamic funds regardless the type of asset portfolios would peform over the study period. period which then is sub-divided into three terms, pre-criris (2001-2006), during Global Financial Crisis (2007-2008) and post crisis (2009-2010). Both pre-crisis (2001-2006), during Global Financial Crisis (2007-2008) and post crisis (2009-2010). Both pre-crisis and post-crisis periods also known as bullish market while bearish market condition is during crisis. The main finding reveals that all types of Islamic mutual funds show positive and better performance by using Sharpe and Adjusted Sharpe ratio. Two types of Islamic funds which are equity and asset allocation MF shows positive results regardless the different market conditions. During bearish period, money market Islamic MF performs better compared to the other types of asset portfolio. Relative to two market portfolios, the findings show that all types of Islamic funds outperformed during period of crisis and after. Equity and asset allocation Islamic MF again show consistency by producing positive performance

thoughout the ten year period. Eventhough money market Islamic MF shows negative perfromance in pre-crisis period, the fund shows the highest positive performance during bearish period as compared to KLCI and FBMS. The results imply that all types of Islamic MF were not affected by the market movement especially during Global Financial Crisis in 2007 to 2008. Money market Islamic MF can be regarded as the best portfolio to be invested during bearish market as it is least affected by the crisis. However, in terms of consistency of outperformance, equity and asset allocation Islamic MF are the preferred funds. This evidence provides investors some vital information regarding the types of fund to be invested during various market conditions and also for diversifying purposes. case study, Journal of King Abdulaziz University, Islamic Economics, 2010, 23, 161-198 [10] Sharpe, W. F. Mutual fund performance, The Journal of Business, 1966, 39:1, 119-138 [11] Miller, R. E. and Gehr, A. K. Sample size bias and sharpe's performance measure: a note, Journal of Financial and Quantitative Analysis, 1978, 13, 943-946. [12] Jobson, J.D. and Korkie, B. Performance hypothesis testing with the sharpe and treynor measures, Journal of Finance, 1981, 36, 888-908 [13] Treynor, J. How to rate management of mutual funds, Harvard Business Review, 1965, 8, pp. 63-75. [14] Modigliani, F. "Risk-adjusted Performance," Journal of Portfolio Management, 1997 (Winter): 45 5413 ACKNOWLEDGEMENT We would like to express our appreciation to Ministry of Higher Education, Malaysia and Universiti Shah Alam for awarding the Fundamental Research Grant (600- RMI/ST/FRGS 5/3/Fst (21/2011). REFERENCES [1] Asia Law; Saudi Gazette: Asia vs. the Middle East: The Islamic Investment Race. Retrieved from http://www.asialaw.com/article/1971321/search/results/a sia-vs-the-middle-east-the- Islamic-Investment Race.html?Keywords=New+Exchange&PageMove=6, May 2012. [2] Security Commission. Securities Commission Annual Report 2008. Malaysia, TX:Author [3] Mushtak Parker. Malaysia: Hub for Islamic Fund Firms.Retrieved May 7, 2012 from http://arabnews.com/economy/islamicfinance/article82771. ece, July 2010 [4] Elfakhani, Hassan, M. K., & Sidani, Y. Comparative performance of islamic versus secular mutual funds, 12th Economic Research Forum Conference, University of New Orleans, USA, November 2005. [5] Elfakhani, S., & Hassan, M. K. Performance of islamic mutual funds, The 12th Annual Conference, 19-21 December 2005 at Grand Hyatt Hotel, Cairo, Egypt. Grand Hyatt Hotel, Cairo, Egypt, December 2005. [6] Roger Otten & Dennis Bams. How to measure mutual fund performance economic versus statistical relevance, Accounting & Finance, 2004, 44: 2, pp 203 222, [7] Nik Maheran Nik Muhammad & Masliza Mokhtar (n.d). Islamic equity mutual fund performance in malaysia: risk and analysis, Retrieved from http://nikmaheran.com/v1/attachments/030_islamicequity MutualFundinMalaysia.pdf, May 2012 [8] Miranti Kartika Dewi & Ilham Reza Ferdian. Evaluating performance of islamic mutual funds in Indonesia and Malaysia, Journal of Applied Economics and Business Research, 2012, 2:1, pp. 11-33 [9] Merdad. H, Hassan M.K, and Alhenawi Y. Islamic versus conventional mutual funds performance in saudi arabia: a