Does the choice of stock selection criteria affect the performance of Sharīʿah-compliant equity portfolios?

Abstract

Purpose There are a number of differences in the current Sharīʿah screening guidelines formulated by Sharīʿah scholars associated with world-renowned index providers and financial institutions. The purpose of this study is to highlight the consequences of such differences on the portfolio level outcomes for Sharīʿah-compliant investors. This study also investigates the cost of adopting an alternative stock selection methodology. Design/methodology/approach Seven Sharīʿah-compliant equity portfolios (SCEPs) are created from the active constituents of the S&P 500. Size, sector allocation and financial performance of the resulting seven portfolios are evaluated for the period 1984–2019. Style analysis is performed to attribute the difference in financial performance caused by the choice of selection criteria to different risk factors. The cost of switching the selection criteria is evaluated with turnover analysis and break-even transaction cost. Findings The choice of stock selection criteria has a significant effect on the size, sector bets and financial performance of the portfolios. Those portfolios which are constructed with market capitalization-based screens outperform portfolios constructed with total assets-based screens. The turnover analysis revealed that SCEPs are relatively costly in practice. Originality/value This study investigates the performance of Sharīʿah-compliant portfolios in the context of seven different screening guidelines. The effects of transaction cost and performance attribution to different risk factors represent the key contributions of this study.

Political risk and portfolio performance: implications for Shariah-compliant investors

“…The higher turnover (TO) values in Table 2 indicate that the Shariah-compliant investors have to pay an additional cost as the SCEPs result in higher turnover. These results are consistent with Boudt et al (2019a), and Raza (2021). However, in practice, a SCEP is rebalanced every quarter.…”

“…A SCEP is not allowed to invest in firms whose core operations are noncompliant (Ashraf, 2016; Boudt et al , 2019a; Raza and Ashraf, 2019; Raza et al , 2019). Thus, a SCEP cannot be invested in firms whose core operations are production or distribution of interest ( Riba ); alcohol, tobacco, weapons of mass destruction, media (except news); adult entertainment services; and pork-related products (Arslan-Ayaydin et al , 2018; Raza, 2021). Shariah also strictly prohibits gambling ( Maisir ), excessive risk under uncertainty ( Gharar ) and speculation ( Mujazafah ) (Raza and Ashraf, 2019).…”

Stock Selection and Market Timing Ability to Increase Indonesia's Equity Mutual Fund Performance

“…The stock selection model was developed by Henriksson and Merton (1981), called the model of active portfolio to transfer the stock value into the selected stock with optimized mean-variance of the risk asset portfolio in the right market timing. The choice of stock selection criteria affects the size and portfolio of mutual funds (Raza, 2021). In the IDX market, fund managers increase the mutual fund's performance by optimizing the expected returns more than the market value, represented by the Jakarta Composite Index (Susilo & Najah, 2018), and stock selection can be determined by increasing net active value (Agarwal & Pradhan, 2019).…”

Covid-19 and informational efficiency in Asian emerging markets: a comparative study of conventional and Shariah-compliant stocks

“…Furthermore, the performance and volatility of both CS and SCS is different in period of crisis (Boudt et al , 2019a, 2019b; Raza, 2021). Therefore, we also expect a significant difference in the level of informational efficiency of these stocks in period of crisis caused by Covid-19 pandemic.…”

“…Because firms with compliant core operations may still generate nonpermissible revenues as a minor source of income (Derigs andMarzban, 2009 andRaza, 2021), financial screens are used to filter further. These screens use financial ratios and compare financial IMEFM 16,3 leverage, cash and short-term investments and interest revenues with a maximum allowed threshold level.…”