How Costly is Investors’ Compliance With Sharia?

Abstract

The rapid proliferation of Islamic oriented investments has placed an added urgency to better understand their risk profile. With respect to Islamic stock market indexes, this concern is more pertinent to the extent that indexes could be subject to manipulation, and because they are often used as a benchmark for Islamic mutual funds. Using the Capital Asset Pricing Model as our basis, we place the most popular Islamic index under analytical scrutiny, and ask (1) how has the Sharia selection restriction affected its performance? (2) what is the competitive risk-return tradeoff of a Sharia compliant index and (3) to what extent is a Sharia compliant index correlated with the broad stock market. Our results reveal that the most popular index is market competitive but has underperformed in relation to another morally restricted but non-Islamic index. We conclude that investors in the Muslim index are not suffering a discernible cost for complying to the Sharia restriction. Our results add a much needed guidance to Islamic investments in general and help assuage concerns that Islamic indexes have not received a minimum degree of investigation.