Comparing Funds
There are many funds such as Islamic funds, mutual funds, and several others. It is important to compare them because they have different returns and different characteristics. There are many funds and information on them is readily available online. When it comes to mutual funds, choosing is a daunting task. To make the selection process easy, use a Compare Funds tool. All you have to do is enter the symbols of the funds you would like to compare and the tool will offer comparisons of each funds performance, Morningstar rating, and more. These tools let you analyze the funds data in two distinct views. Islamic funds outside of predominantly Muslim countries are most commonly expected to underperform. McKenzie (2009) stated that, The estimated growth is partly related to extended estimation coverage. Nevertheless, Islamic financial services market value was only about 150bn in the mid 1990s. Hence, it grew nearly 400 until the end of 2007 with average annual growth rates of about 14. However, with an increase in interest in such funds, the western market for it has grown. This paper in particular shows an analysis of the performance of the United Kingdom Islamic funds. The regression formulation developed by Michael Jensen is used for 32 fund portfolios and the Jensens alpha, and other important parameters are determined. With a null hypothesis of alpha equal to zero, the average alpha shows that in general, the sample collected for the time frame from January 2001 to December 2008 has not beaten the market.
Money market funds are more advantageous over bank deposits. However, money market funds are different and it is important to compare them to get the best funds. Money market funds are managed to provide liquidity, competitive money market returns, and capital security. However, different funds concentrate on different things and you should choose depending on your specific needs and short-term and long-term goals. Bogle (1994) stated that, since there are variations in investment characteristics even among funds with the same investment objective, closer evaluation is required if you prefer to fine-tune the analysis. Funds all over the world are managed according to conservative guidelines, but this does not mean they are risk free. Comparing different funds allows an investor identify the best fund to invest in.
When comparing funds, it is important to consider interest rate risks. Funds hold fixed income securities and as such, they are influenced by changes in interest rates. The value of securities increases whenever interest rates decline and vice versa. As central banks lowered interest rates, money market funds which are more sensitivity to interest rate risk have benefited and when interest rates rise, funds which are less sensitivity to interest rates will benefit. Investors can use WAM or Weighted Average Maturity to measure the interest rate risk of a fund. The longer the WAM or the modified duration, the more the fund will react to changes in interest rates. When comparing funds, it is also important to consider credit risk. Some funds only invest in government securities such as gilts. However, investors who are looking for slightly higher returns usually invest in prime or traditional funds. To evaluate credit risk, investors can look at the credit ratings of the securities held by the fund. Credit risk is sometimes approximated by WAFM or weighted average final maturity of the securities in the fund. A fund with a low WAFM or a higher credit quality is less susceptible to losses due to issuer defaults. However, you will get lower returns with these funds. Liquidity risk is another important consideration, especially during hard economic times. As an example, during the recent financial crisis, many fixed income securities stopped trading. This presented a problem for investors in these securities, including money market funds, as it was not possible to sell the securities to obtain cash. During this time, investors had to resort to natural liquidity, or the maturing of their investments. Even in a market with no trading - which is very rare - when a security matures the fund will automatically receive the initial principal invested. Funds invested in securities that mature will receive these proceeds, and can then pass them along to investors wishing to exit the fund. One way of estimating liquidity the liquidity of a money market fund is looking at the amount of securities maturing overnight and in one week. Holding securities with very short maturities, such as overnight and or one week will provide natural liquidity to the fund irrespective of the market conditions. However, funds which hold a large amount of securities with very short maturities are likely to offer a lower return in a normal interest rate environment. In order to obtain more information about money market funds, investors can look at copies of the funds prospectus, which is a detailed description of how the fund is set up and makes its investments, a simplified version of this prospectus, as well as the funds annual report. Investment managers also publish monthly factsheets which provide a brief overview of the fund and its performance. The simplified prospectus and factsheets often include many of the statistics to measure investment risk which are mentioned above. Additionally, several data providers publish regular information on money market funds, including many of these statistics. Some of these services are freely accessible via the internet, whereas others require a subscription. In all cases, investors can contact the investment manager for more information on how the fund is managed. Before investing, it is important to identify a suitable investment which provides prudent cash management. Money market funds can provide a viable means of obtaining both security and liquidity. However, given the variety of funds available, an investor should carefully assess any fund and consult with financial professionals before investing. You should also compare fixed annuity rates. When comparing these rates, consider the fees charged. Just because a fund advertises a certain interest rate on an annuity does not mean that you will be able to bring in that much money without any exceptions. Many times, a fund will take their fee out of the returns from the annuity investments. This means that you need to make sure that you understand whether the fees will be coming out of this interest rate. You should consider the length of the term. Some annuities will provide you with a particular interest rate for the rest of your life. Other annuities will guarantee you this payment only for a particular period of time, such as 20 years. Make sure that you understand exactly how long they are promising this rate of interest. You also need to ask the fund if this rate of interest is guaranteed by anything. Some states will have guaranty pools that will back these annuities. However, some annuities are not guaranteed, and you are relying solely on the financial strength of the fund.
Background
An important contemporary issue for financial institutions and financial markets are
Islamic financial services which are rapidly growing worldwide. In 2007, Islamic law
(Shariah) compliant assets are estimated to have grown by 37 to 729bn. They are
Expected to reach the 1 trillion mark in 2010. While many assets are based in
Countries like Saudi Arabia, Malaysia or Kuwait, western financial institutions and
Governments have also developed a strong interest in Islamic finance (Cihk and
Hesse 2008 McKenzie 2009). The British government praises the UK as the leading
Centre for Islamic finance outside of the Gulf Cooperative Council GCC and
Malaysia and has defined clear policy objectives for its development (HM Treasury
2008, 5). The UK is the world leader for Islamic finance education. Islamic financial
Services are offered in Britain by nearly two dozen banks including Barclays, HSBC,
Lloyds, and RBS. The market leader, HSBCs Islamic finance division Amanah, has
Realized an annual asset growth of more than 50 in 200708. As Shariah law
Prohibits many high risk activities, Islamic financial services have been much less
Affected by the credit crisis than their conventional counterparts, which adds to their appeal. Western countries like the US, France, Germany or Switzerland are also promoting their Islamic financial services to attract especially petro-dollars (McKenzie 2009). One multibillion dollar industry within Islamic finance is Islamic investment.
Dow Jones, FTSE, MSCI Barra and Standard Poors offer hundreds of Islamic
Equity indices. Similarly, more than seven hundred Islamic mutual funds are currently
Offered, which specialize in a variety of different assets (e.g. equities, Islamic bonds, real estate, commodities). The few previous studies of their financial performance investigate samples of less than sixty funds and also lack nearly any control for investment style. In this study, we utilize the largest existing dataset of Islamic funds (which is unexplored to date) to analyze 265 Islamic equity funds from twenty countries over a twenty year sample period. Specifically, we investigate the following research questions
Does financial performance of Islamic equity mutual funds significantly differ from the respective equity market benchmark(s)
What are the investment styles preferred by Islamic equity mutual funds
Are there any existing differences in Islamic equity funds financial performance and investment style
What are the existing differences in Islamic equity funds financial performance and investment style
Islamic mutual funds
Islamic funds are defined by their compliance with Islamic law, commonly known as Shariah law. Ebrahim (2008) stated that, While Islam promotes improving ones economics condition, it has to be done within a framework of good values and good economicbusiness practices Inter alia, Shariah law prohibits mutual funds from Riba al Nasiah, Maysir, Gharar, and Haram products or services and it requires Haram purifcation. Riba al Nasiah represents the receipt of interest on capital. Hence, Islamic mutual funds cannot invest in conventional bonds, warrants, preferred stock, certificates of deposit and some derivatives. Maysir and Gharar can be translated as gambling and uncertainty, respectively. Their prohibition commonly prevents Islamic funds from leverage, short selling and any derivate product. In addition to Riba al Nasiah, Maysir, and Gharar, products or services that adversely affect dignity or promote the exploitation of one another are Haram (forbidden). Examples are pork, (non-medical) alcohol, gambling, non-Islamic financial services, pornography, tobacco or weapons. Given the sheer size of contemporaneous multinational companies, many of them receive (very) small proportions of their revenue from a prohibited activity. Contemporary Shariah scholars therefore tend to allow investment in stocks with tolerable proportions of revenues from prohibited activities under the condition of Haram purification. Derigs and Marzban (2008) stated that, This condition requires investors to donate the equivalent proportion of their distributions from such companies to charities to purify their earnings from prohibited activities.
Several theoretical implications result from Shariah law and demographics of Islamic funds. First, Islamic mutual fund managers are restricted in their ability to exploit superior information or winning markets (e.g. using leverage). However, the average mutual fund manager has not been found to display superior skills (Bollen and Busse 2001 Kosowski et al. 2006). Hence, the opposite argument might also apply that Shariah law limits the potential damage caused by a manager (Abdullah, Hassan and Mohamad 2007). Second, like socially responsible investment, Shariah compliant investment refuses to purely pursue profits. Some argue that such a distraction by concerns about responsibility would be detrimental for financial performance (e.g. Geczy, Stambaugh and Levin 2005). They are supported by evidence suggesting standard sin stocks (alcohol, gambling, tobacco) excluded by Islamic funds to deliver significantly positive abnormal returns (Hong and Kacperczyk 2009). However, others consider responsible, non-financial investment criteria to represent advanced risk management (e.g. Lee and Faff 2009). Evidence to support this argument comes from the cases of Enron, Tyco and Worldcom. Before their scandals, these companies were excluded from the Dow Jones Islamic Market Index (Ghoul and Karam 2007). The Shariah Supervisory Board of the Dow Jones Islamic Index, for instance, tolerates corporations, whose ratios of total debt, sum of cash and interest bearing security, and accounts receivable are less than a third of the corporations market capitalization (Dow Jones 2009). Other Islamic indices use similar ratios (Derigs and Marzban 2008). Third, the Shariah compliance of products and services is likely financially more beneficial in economies, whose customers and agents experience a higher utility from adherence to Shariah law. Hence, Islamic mutual funds might experience a better financial performance in predominantly Muslim economies than elsewhere. Fourth, Christoffersen and Sarkasian (2009) find financial centers with a high density of financial intermediaries and competitors to have a significantly positive effect on mutual fund managers learning gains and their eventual financial performance. They explain the performance relevance of being located in a financial centre with better information and knowledge spill-over effects. If such learning processes also drive Islamic funds financial performance, we expect funds from nations with the most developed Islamic financial markets to perform better than their peers elsewhere.
Fifth, Islamic mutual funds investment styles are probably more homogeneous than their conventional counterparts styles due to Shariah laws narrow framework of eligible activities. Islamic funds could have somewhat lower betas than conventional, possibly leveraged funds. Islamic funds also likely invest over-proportionally in smaller stocks, as large stocks have a higher risk of receiving intolerable revenues from prohibited activities. Similarly, we expect Islamic funds to be more exposed to growth stocks than value stocks, as the former are considered to have a lower leverage than the latter (Campbell and Vuolteenaho 2004). However, we cannot see any theoretical reason, why Islamic funds should be more exposed to momentum than contrarian investment strategies or vice versa.
Saudi Arabia and the UK countries
Comparison in performance of Islamic Mutual funds
The primary characteristic that distinguishes Islamic fund management from conventional investing is its compliance with Shariah law. Fund managers who are Shariah compliant must adhere to moral economic activity and invest only in companies that have an ethical purpose. In addition, the investors cannot deal with conventional banks that trade in fixed rate interest, or Riba, but instead would depend on Ijara, an Islamic method of financing. Investments must also be screened for companies that trade items restricted in Islamic laws, such as alcohol, tobacco, pork, gambling or pornography. While limiting investment strategy might seem a hindrance, there are advantages to this ethical investing. For instance, Islamic funds were little affected by the scandals afflicting companies such as Enron and WorldCom several years ago, as these companies highly leveraged balance sheets restricted Shariah funds from buying them. In fact, some conventional managers have adopted Shariah law for strategic purposes. Eurekahedge (2010)
The wider acceptance of equity investments by sharia scholars in the early 1990s paved way to the launch of mutual funds that operates in compliance to the ethical guidance of Islamic law. According to the London based institute of Islamic banking and insurance, there are over 250 Islamic institutions in some 75 countries that are managing funds worth over used 200 billion. In the early 1990s many sharia compliant mutual funds started to appear. There are now about 126 funds with approximately 4 billion used in assets under management. Other than being halal investment alternative for Muslim investors, the funds also respond to specific need for more liquid tools. Further, the establishment of equity benchmarks by Dow Jones Islamic Market index and FTSE Global Islamic Index Series has been the turning point for the industry in the UK, giving both Islamic and conventional investors something to compare to.
Within Islamic financial systems such as Saudi Arabian systems, Islamic mutual funds are one of the fastest growing sectors. Yet compared to the UK for example, Islamic mutual funds are still in their infancy stage of growth and development most being around for less than a decade. Islamic funds are pretty diverse for a young industry. While the majority of the funds are equity funds as well as Islamic bond funds are recently launched. Out of 126 available Islamic funds 5 are European funds (4) while 13 are country funds mostly Saudi Arabian (10)
Luther Matatko and corner (1992) provide weak evidence that the performance of U.K Islamic mutual funds outperform two market indexes. Their findings demonstrate that Islamic mutual funds perform better when evaluated against a small company benchmark, than when only the financial times all share indexes is used. Kraender etal (2000) extend this study to consider Islamic mutual funds from a smaller number of countries. They find that Islamic mutual funds perform at least as well as the Morgan Stanley capital international world index.
Very recently, a study by Hoepner, Rammal and Rezec (2009,) analyzed the financial performance and investment style of Islamic equity funds from 20 countries in five regions (Africa, Asia-Pacific, Europe, Gulf Cooperation Council, and North America). The
Study sampled a period of two decades and is based on the performance of 262 equity funds, which makes it, by far, the largest analysis of Islamic funds to date. Specifically for the purpose of investigating and comparing the performance of Islamic funds around the world, the authors extend Carharts famous four factor model (1997, Journal of Finance) and
Developed a three level Cahart model (12 factors). This model simultaneously assesses the financial performance of assets at the national, regional and global level and thereby allows to compare Islamic funds from different nations (e.g. Saudi Arabia and U.K) and different
Regions (e.g. GCC countries, North America) in their ability to deliver abnormal risk adjusted financial returns.
The findings of Hoepner et al s (2009) study reveal that, in the UK markets, Islamic equity funds appear to trail their equity market benchmark returns on average. Furthermore,
European Islamic funds are significantly exposed to a small stock preference. In contrast,
Islamic funds from Saudi Arabia neither underperform their equity market benchmarks nor experience small cap preference. This result has some economic intuition for two reasons First, Saudi Arabia has more Shariah compliant business activities and hence Islamic fund managers have fewer restrictions in terms of companies and industries they can invest in.
Second, larger, more diversified companies have a higher risk of receiving intolerable degrees of revenue from prohibited activities especially in the European countries. This second explanation can fairly be expected to drive Islamic funds preference
For small cap stocks.
Kraeussl and Hayat (2008) estimate Jensen alphas for 59 international Islamic equity funds identified via Bloomberg over the five year period to August 2006. They find their 31 Saudi Arabian funds to significantly underperform the respective equity market benchmark, while 21 globally investing funds had an insignificant performance difference and 7 other funds even significantly outperformed their market benchmark. However, their results have to be interpreted with some care, as they had to replace missing net asset values by the average of the previous and subsequent observation. Contrary to the other studies, Abderezzak (2008) investigates Islamic fundsinvestment styles in addition to their financial performance for a sub-sample of 19
US, European or global funds. But as his data access is limited to two UK investments
Style benchmarks, his results are only fully sensible for his six UK funds. Four of these six funds display the expected small cap style, while the six funds have no clear preference for a value or growth style.
In summary, previous studies provide some indication that a few Islamic mutual funds might trail their conventional benchmarks and display a preference for small cap stocks. However, the financial performance and investment style of hundreds of Islamic mutual funds is unexplored to date.
Aims and objectives of the study
Our main aim of this study is to compare the performance of Islamic funds in the Islamic country (Saudi Arabia) and non-Islamic country (U.K). The study will be guided by specific objectives which will include
To find out whether the financial performance of Islamic equity mutual funds significantly differs from the respective equity market benchmark(s)
To analyze the investment styles preferred by Islamic equity mutual funds
To find out if there are any existing differences in Islamic equity funds financial performance and investment style.
To explain existing differences in Islamic in Islamic equity funds financial performance and investment style.
To examine the challenges faced in disbursing the Islam Mutual Fund.
Research questions.
The research will be guided by the following research questions
Does financial performance of Islamic equity mutual funds significantly differ from the respective equity market benchmark(s)
What are the investment styles preferred by Islamic equity mutual funds
Are there any existing differences in Islamic equity funds financial performance and investment style
What are the existing differences in Islamic equity funds financial performance and investment style
Data and Methodology
Data is the main shortage in analyses of Islamic mutual funds. Previous studies lacked
Time series data on both, hundreds of Islamic mutual funds and international
Investment style benchmarks. We address both shortages. In the first part of this
Section, we analyze the descriptive statistics of our sample of 265 Islamic equity funds
From twenty countries. Since the characteristics of these twenty countries could
Explain differences in Islamic funds financial performance and investment style, we
Analyze our sample countries financial market and Islam related properties in the
Second part. The third part describes our international investment style benchmarks.
Islamic mutual fund data
We will be using Eurekahedge which is a worldwide database of Islamic mutual funds
It currently lists 758 Islamic mutual funds, which more than doubles the funds listed on Falaika, the only other provider of return data on hundreds of Islamic funds. 455 of these funds are equity funds. Of these equity funds, Eurekahedge reports monthly return data for 304. However, in a few dozen cases, Eurekahedge lists several asset classes of the same mutual fund. In these cases, we follow Da et al. (2009) and calculate an equal weighted average of these fund classes simple returns. This leaves us with a survivorship bias adjusted sample of 265 Islamic equity mutual funds, whose monthly return data we convert in US.
Although Islamic mutual funds are spread over all continents except Latin America, our sample will mainly look at Saudi Arabia and the U.K. Based on Eureka hedges simple return data, we construct equal weighted fund of fund portfolios for each nation. Eurekahedges simple return data is supplied net of annual management fees but it unfortunately excludes distributions. This is a considerable problem, as estimating mutual funds financial performance using return data excluding distributions against common market benchmarks, whose return data includes distributions, would lead to significantly downwards biased financial performance estimates.
In summary, while information value is lost due to the fact that Eurekahedges
Return data does not include distributions with regard to the precise size of financial
Performance estimates, no meaningful information value appears lost regarding the
Significance level of financial performance estimates.
Sample country characteristics
Since national differences in Islamic funds financial performance and investment
Style might result from national characteristics, relation to Islam and their financial markets. The population of Saudi Arabia is predominantly Muslim and incorporates Islam in their constitution. Saudi Arabia follows the Hanbali School with its literal interpretations of Quran.
While the second sample country is U.K which is the seventh largest Islamic financial market and the largest in the western world. The UK is a predominantly Christian country and has a developed Islamic financial market with Islamic fund attrition rates over 20 percent suggesting that Islamic investment services might develop smoother in Muslim economies.
Benchmark Data
We construct our benchmark factors with the online research tool of Style Research
Limited, which is based on the Worldscope database and has been used in previous
Research (Bauer, Koedijk and Otten 2005 Renneboog, Ter Horst and Zhang 2008).
To assess Islamic mutual funds exposure to a national, regional and global
Equity market, we employ the price indices of value weighted portfolios of all stocks
In the respective market. We use the common investment style benchmark factors
Suggested by Fama and French (1993) and Carhart (1997).
All portfolios are value weighted and based on one month lagged information. As risk
Free asset returns, we retrieve the one or three month(s) treasury-bill or the inter-bank
Interest rate for each nation. Finally, we compute continuously compounded monthly
Returns of each asset.
Methodology
The total monthly returns for each single fund and fund category will be calculated, as well as the returns of the SP index (as proxy for conventional funds) and the five FTSE Islamic Indices and the Dow Jones Islamic Technology Index (as proxy for Islamic funds benchmark). In addition mean portfolios returns, standard deviations and betas for each portfolio are calculated.
Sharpe(1966) measure, Treynor(1965) measure, Jensen(1968) measure, Fama(1972) measures (covering on overall performance, return premium when fully diversified, reward for the lack of diversification, and return on net selectivity) and the transformed Sharpe measure introduced by jobson and korkie(1981) are used to measure the performance of each portfolio and compare it to its benchmark. A one way ANOVA test is also used to test the hypothesis of means equality and another test for identifying the strength and direction of the difference in means, if any, are conducted. The Sharpe ratio represents the portfolio excess return per unit of total risk, and the higher this ratio is above the benchmark, the better it is. The Treynor ratio an the other hand is equal to the portfolio excess return per unit of systematic risk (beta ), and the higher this ratio above the benchmark, the better it is. Fama intergrates the work of Sharpe, Treynor and Jensen. Fama argues that it is difficult to achieve perfect diversification. Therefore, investors should be rewarded for the lack of diversification. Also additionally net selectivity should be compensated for hence, in a world of imperfect diversification Fama measure is superior over Sharpe, Treynor and Jansen measures. Additional risk and net selectivity should be compensated for. Using security market line (SML) model, Fama measure divides the overall portfolio return into three components return premium when fully diversified, reward for the lack of diversification and return on net selectivity.
Literature Review
Bogle (1994) stated that, I cannot emphasize enough the importance of fairness (and common sense) in assuring that you compare only funds that have similar investment policies and characteristics. Sensible performance comparisons can be made only after establishing that fairness. Even then, as I shall now show, selecting equity funds on the basis of past performance is likely to be a futile effort on your part and virtually certain to be a futile effort for fund investors in the aggregate.
To compare mutual funds, there are several statistics that can be used. The selection of a mutual fund should not be based solely on quantitative factors. Once you have identified some good funds, additional investigation is required to ensure that your final selections meet your criteria and will complement one another in your portfolio. At a minimum, you will need to determine if the funds that pass your screening are indeed what they say they are, as names can be misleading and style drift is all too common. Before you get started, you may want to refer to the section on Mutual Fund Types or to the list of mutual fund types, which includes links to descriptions of the various types of mutual funds. Some statistics are more comprehensive than others, so youll have to try a few and decide which you like best. To compare Mutual Fund Returns, you can use arithmetic mean or geometric mean. To measure mutual fund risk, you can use standard deviation, Beta, R-squared, or Bond Duration. To measure mutual fund performance or risk-of-return, you can use Coefficient of Variation, Sharpe Ratio, or Treynor Ratio. To compare the expense ratio, the Turnover Rate and Manager Tenure, you can use Expense Ratio, Turnover, or Manager Tenure and Succession. You can use these statistics with a mutual fund screener to find mutual funds that are good candidates for inclusion in your portfolio.
Islamic funds are usually based in Islamic countries such as Dubai and Saudi Arabia, but many western organizations are beginning to appreciate them because of their low risk and attractive returns. Mckenzie (2009) stated that, Such services grew by nearly 400 from mid 1990s to the end of 2007. Hoepner et al (2009) stated that, ...the British Government recognizes the lead UK has taken in aspect of Islamic finance outside of the Gulf Cooperative and Malaysia. Today, the UK is a world leader for Islamic finance education and it has set clear policy objectives for the development of Islamic financial services. In the UK, about 24 British banks offer Islamic fund services, including HSBC, Barclays, RBS, and Lloyds. The top bank in the UK in Islamic finance is HSBC. Hoepner et al (2009) stated that, ...its annual asset growth is more than 50 in 200708. Other than the rapid growth rate of the services, the market has not been much affected by the credit crisis as Shariah law prohibits many high risk activities.
According to Brooks (2002), the performance of mutual funds performance was first tested systematically by Jensen back in 1968. Jensen examined whether any of those funds beat the market. Using a sample of annual returns on 115 mutual funds from 1945-1964. Each of those funds from the portfolios was subjected to a separate OLS time series regression of the form
QUOTE
The QUOTE in the formula refer to the returns at a time t. The indices j, f and m corresponds the R to portfolio j, to risk-free proxy (1-year government bond), and to a market portfolio proxy, respectively. The error term is QUOTE and QUOTE , QUOTE are parameters that are to be estimated. In particular, QUOTE is called the Jensens alpha. This parameter defines whether the fund outperforms or underperforms the market index. Brooks (2002) stated that, A positive and significant QUOTE for a given fund would suggest that the fund is able to earn significant abnormal excess returns in excess of the market-required return for a fund of this given riskiness.
Investopedia offers a comprehensible explanation of Jensens alpha. The analyst should not exclusively look at the overall return of a portfolio but also the risk of the portfolio in analyzing the performance of an investment manager. For instance, if there are two mutual funds both having 12 return, a rational investor will opt for the fund that is less risky. Jensens measure denoted by the alpha is one of several ways to help determine if a portfolio is earning the proper return for the level of risk associated with it. A positive alpha means that the portfolio is earning excess returns. Hence the fund manager has beat the market with hisher stock picking skills. Hoepner et al (2009) particular investigated the financial performance of Islamic equity funds. They examined 262 Islamic equity funds from five regions and twenty countries over a sample period of up to two decades. They developed a conditional three level Carhart model Hoepner et al (2009) stated that they did this to simultaneously control for their exposure to different national, regional and global equity market benchmarks, while funds from only three nations do the opposite. They used four main findings.
Shariah law, with its prohibitions, substantially limits the investment possibilities of Islamic mutual funds. This has several implications which are stated by Hoepner et al (2009) observed that, Islamic mutual fund managers are restricted in their ability to exploit superior information or winning markets Shariah law limits the potential damage caused by a manager in a losing market and especially a financial crisis. Second, like socially responsible investment, Shariah compliant investment refuses to purely pursue profits. Third, the Shariah compliance of products and services is likely beneficial in economies, whose customers are highly influenced by Shariah law. Hence, Islamic mutual funds might experience a better financial performance in predominantly Muslim economies than elsewhere. Fourth, Islamic mutual funds investment styles are probably more homogeneous than their conventional counterparts style due to Shariah laws narrow framework of eligible activities.
Based on a standard Carhart model, it is clear that more than half of our equal weighted national Islamic equity fund portfolios to significantly underperform their national equity market benchmarks. At national level, Islamic funds display a tilt towards growth and small cap stocks. However, Islamic mutual funds from the same country tend to invest in a variety of different international regions. Hence, we cannot sufficiently assess their financial performance and investment style without controlling for their exposure to regional and global equity market benchmarks and investment styles. To control for these regional and global factors, a three level Carhart model can be developed.
Islamic fund portfolios from most other nations with often barely developed Islamic financial services significantly underperform their benchmarks. This result can be explained with learning effects resulting from the development of markets, which have also been found for conventional mutual funds (Christoffersen and Sarkissaian 2009). The nations with lesser developed Islamic financial services can further be structured in two groups. While the fund portfolio from only one of the predominantly Muslim countries among these nations significantly trails its benchmarks, Islamic funds from seven western nations underperform on average. This implies that incorporation in an Islamic economy benefits Islamic funds financial performance. As funds from Islamic economies tend to have a home bias, a possible reason for this relevance of home country religion might be that a stocks Shariah compliance is likely financially more beneficial in an Islamic economy than elsewhere. The home bias of funds from Islamic economies with often comparatively small corporations can also explain why these funds exhibit a small cap preference at regional and global level in contrast to the remaining funds. Their small cap investment style at national level might result from larger corporations being usually more diversified, which increases the risk that they operate in sectors forbidden by Shariah law.
The internet is the best place to get information on different funds. Venditto (1996) observed that, Americans need more financial information than ever before, and the number of personal finance solutions available on America Online and the Internet are meeting that demand. To perform any sort of comparison on funds, you will need to gather data. Facts on fund asset size, age, manager tenure, and cost are readily available through prospectuses and major financial publications. While information on portfolio characteristics and portfolio statistics is more difficult to obtain, several statistical services provide it.
Money market funds are more advantageous over bank deposits. However, money market funds are different and it is important to compare them to get the best funds. Money market funds are managed to provide liquidity, competitive money market returns, and capital security. However, different funds concentrate on different things and you should choose depending on your specific needs and short-term and long-term goals. Bogle (1994) stated that, since there are variations in investment characteristics even among funds with the same investment objective, closer evaluation is required if you prefer to fine-tune the analysis. Funds all over the world are managed according to conservative guidelines, but this does not mean they are risk free. Comparing different funds allows an investor identify the best fund to invest in.
When comparing funds, it is important to consider interest rate risks. Funds hold fixed income securities and as such, they are influenced by changes in interest rates. The value of securities increases whenever interest rates decline and vice versa. As central banks lowered interest rates, money market funds which are more sensitivity to interest rate risk have benefited and when interest rates rise, funds which are less sensitivity to interest rates will benefit. Investors can use WAM or Weighted Average Maturity to measure the interest rate risk of a fund. The longer the WAM or the modified duration, the more the fund will react to changes in interest rates. When comparing funds, it is also important to consider credit risk. Some funds only invest in government securities such as gilts. However, investors who are looking for slightly higher returns usually invest in prime or traditional funds. To evaluate credit risk, investors can look at the credit ratings of the securities held by the fund. Credit risk is sometimes approximated by WAFM or weighted average final maturity of the securities in the fund. A fund with a low WAFM or a higher credit quality is less susceptible to losses due to issuer defaults. However, you will get lower returns with these funds. Liquidity risk is another important consideration, especially during hard economic times. As an example, during the recent financial crisis, many fixed income securities stopped trading. This presented a problem for investors in these securities, including money market funds, as it was not possible to sell the securities to obtain cash. During this time, investors had to resort to natural liquidity, or the maturing of their investments. Even in a market with no trading - which is very rare - when a security matures the fund will automatically receive the initial principal invested. Funds invested in securities that mature will receive these proceeds, and can then pass them along to investors wishing to exit the fund. One way of estimating liquidity the liquidity of a money market fund is looking at the amount of securities maturing overnight and in one week. Holding securities with very short maturities, such as overnight and or one week will provide natural liquidity to the fund irrespective of the market conditions. However, funds which hold a large amount of securities with very short maturities are likely to offer a lower return in a normal interest rate environment. In order to obtain more information about money market funds, investors can look at copies of the funds prospectus, which is a detailed description of how the fund is set up and makes its investments, a simplified version of this prospectus, as well as the funds annual report. Investment managers also publish monthly factsheets which provide a brief overview of the fund and its performance. The simplified prospectus and factsheets often include many of the statistics to measure investment risk which are mentioned above. Additionally, several data providers publish regular information on money market funds, including many of these statistics. Some of these services are freely accessible via the internet, whereas others require a subscription. In all cases, investors can contact the investment manager for more information on how the fund is managed. Before investing, it is important to identify a suitable investment which provides prudent cash management. Money market funds can provide a viable means of obtaining both security and liquidity. However, given the variety of funds available, an investor should carefully assess any fund and consult with financial professionals before investing. You should also compare fixed annuity rates. When comparing these rates, consider the fees charged. Just because a fund advertises a certain interest rate on an annuity does not mean that you will be able to bring in that much money without any exceptions. Many times, a fund will take their fee out of the returns from the annuity investments. This means that you need to make sure that you understand whether the fees will be coming out of this interest rate. You should consider the length of the term. Some annuities will provide you with a particular interest rate for the rest of your life. Other annuities will guarantee you this payment only for a particular period of time, such as 20 years. Make sure that you understand exactly how long they are promising this rate of interest. You also need to ask the fund if this rate of interest is guaranteed by anything. Some states will have guaranty pools that will back these annuities. However, some annuities are not guaranteed, and you are relying solely on the financial strength of the fund.
Background
An important contemporary issue for financial institutions and financial markets are
Islamic financial services which are rapidly growing worldwide. In 2007, Islamic law
(Shariah) compliant assets are estimated to have grown by 37 to 729bn. They are
Expected to reach the 1 trillion mark in 2010. While many assets are based in
Countries like Saudi Arabia, Malaysia or Kuwait, western financial institutions and
Governments have also developed a strong interest in Islamic finance (Cihk and
Hesse 2008 McKenzie 2009). The British government praises the UK as the leading
Centre for Islamic finance outside of the Gulf Cooperative Council GCC and
Malaysia and has defined clear policy objectives for its development (HM Treasury
2008, 5). The UK is the world leader for Islamic finance education. Islamic financial
Services are offered in Britain by nearly two dozen banks including Barclays, HSBC,
Lloyds, and RBS. The market leader, HSBCs Islamic finance division Amanah, has
Realized an annual asset growth of more than 50 in 200708. As Shariah law
Prohibits many high risk activities, Islamic financial services have been much less
Affected by the credit crisis than their conventional counterparts, which adds to their appeal. Western countries like the US, France, Germany or Switzerland are also promoting their Islamic financial services to attract especially petro-dollars (McKenzie 2009). One multibillion dollar industry within Islamic finance is Islamic investment.
Dow Jones, FTSE, MSCI Barra and Standard Poors offer hundreds of Islamic
Equity indices. Similarly, more than seven hundred Islamic mutual funds are currently
Offered, which specialize in a variety of different assets (e.g. equities, Islamic bonds, real estate, commodities). The few previous studies of their financial performance investigate samples of less than sixty funds and also lack nearly any control for investment style. In this study, we utilize the largest existing dataset of Islamic funds (which is unexplored to date) to analyze 265 Islamic equity funds from twenty countries over a twenty year sample period. Specifically, we investigate the following research questions
Does financial performance of Islamic equity mutual funds significantly differ from the respective equity market benchmark(s)
What are the investment styles preferred by Islamic equity mutual funds
Are there any existing differences in Islamic equity funds financial performance and investment style
What are the existing differences in Islamic equity funds financial performance and investment style
Islamic mutual funds
Islamic funds are defined by their compliance with Islamic law, commonly known as Shariah law. Ebrahim (2008) stated that, While Islam promotes improving ones economics condition, it has to be done within a framework of good values and good economicbusiness practices Inter alia, Shariah law prohibits mutual funds from Riba al Nasiah, Maysir, Gharar, and Haram products or services and it requires Haram purifcation. Riba al Nasiah represents the receipt of interest on capital. Hence, Islamic mutual funds cannot invest in conventional bonds, warrants, preferred stock, certificates of deposit and some derivatives. Maysir and Gharar can be translated as gambling and uncertainty, respectively. Their prohibition commonly prevents Islamic funds from leverage, short selling and any derivate product. In addition to Riba al Nasiah, Maysir, and Gharar, products or services that adversely affect dignity or promote the exploitation of one another are Haram (forbidden). Examples are pork, (non-medical) alcohol, gambling, non-Islamic financial services, pornography, tobacco or weapons. Given the sheer size of contemporaneous multinational companies, many of them receive (very) small proportions of their revenue from a prohibited activity. Contemporary Shariah scholars therefore tend to allow investment in stocks with tolerable proportions of revenues from prohibited activities under the condition of Haram purification. Derigs and Marzban (2008) stated that, This condition requires investors to donate the equivalent proportion of their distributions from such companies to charities to purify their earnings from prohibited activities.
Several theoretical implications result from Shariah law and demographics of Islamic funds. First, Islamic mutual fund managers are restricted in their ability to exploit superior information or winning markets (e.g. using leverage). However, the average mutual fund manager has not been found to display superior skills (Bollen and Busse 2001 Kosowski et al. 2006). Hence, the opposite argument might also apply that Shariah law limits the potential damage caused by a manager (Abdullah, Hassan and Mohamad 2007). Second, like socially responsible investment, Shariah compliant investment refuses to purely pursue profits. Some argue that such a distraction by concerns about responsibility would be detrimental for financial performance (e.g. Geczy, Stambaugh and Levin 2005). They are supported by evidence suggesting standard sin stocks (alcohol, gambling, tobacco) excluded by Islamic funds to deliver significantly positive abnormal returns (Hong and Kacperczyk 2009). However, others consider responsible, non-financial investment criteria to represent advanced risk management (e.g. Lee and Faff 2009). Evidence to support this argument comes from the cases of Enron, Tyco and Worldcom. Before their scandals, these companies were excluded from the Dow Jones Islamic Market Index (Ghoul and Karam 2007). The Shariah Supervisory Board of the Dow Jones Islamic Index, for instance, tolerates corporations, whose ratios of total debt, sum of cash and interest bearing security, and accounts receivable are less than a third of the corporations market capitalization (Dow Jones 2009). Other Islamic indices use similar ratios (Derigs and Marzban 2008). Third, the Shariah compliance of products and services is likely financially more beneficial in economies, whose customers and agents experience a higher utility from adherence to Shariah law. Hence, Islamic mutual funds might experience a better financial performance in predominantly Muslim economies than elsewhere. Fourth, Christoffersen and Sarkasian (2009) find financial centers with a high density of financial intermediaries and competitors to have a significantly positive effect on mutual fund managers learning gains and their eventual financial performance. They explain the performance relevance of being located in a financial centre with better information and knowledge spill-over effects. If such learning processes also drive Islamic funds financial performance, we expect funds from nations with the most developed Islamic financial markets to perform better than their peers elsewhere.
Fifth, Islamic mutual funds investment styles are probably more homogeneous than their conventional counterparts styles due to Shariah laws narrow framework of eligible activities. Islamic funds could have somewhat lower betas than conventional, possibly leveraged funds. Islamic funds also likely invest over-proportionally in smaller stocks, as large stocks have a higher risk of receiving intolerable revenues from prohibited activities. Similarly, we expect Islamic funds to be more exposed to growth stocks than value stocks, as the former are considered to have a lower leverage than the latter (Campbell and Vuolteenaho 2004). However, we cannot see any theoretical reason, why Islamic funds should be more exposed to momentum than contrarian investment strategies or vice versa.
Saudi Arabia and the UK countries
Comparison in performance of Islamic Mutual funds
The primary characteristic that distinguishes Islamic fund management from conventional investing is its compliance with Shariah law. Fund managers who are Shariah compliant must adhere to moral economic activity and invest only in companies that have an ethical purpose. In addition, the investors cannot deal with conventional banks that trade in fixed rate interest, or Riba, but instead would depend on Ijara, an Islamic method of financing. Investments must also be screened for companies that trade items restricted in Islamic laws, such as alcohol, tobacco, pork, gambling or pornography. While limiting investment strategy might seem a hindrance, there are advantages to this ethical investing. For instance, Islamic funds were little affected by the scandals afflicting companies such as Enron and WorldCom several years ago, as these companies highly leveraged balance sheets restricted Shariah funds from buying them. In fact, some conventional managers have adopted Shariah law for strategic purposes. Eurekahedge (2010)
The wider acceptance of equity investments by sharia scholars in the early 1990s paved way to the launch of mutual funds that operates in compliance to the ethical guidance of Islamic law. According to the London based institute of Islamic banking and insurance, there are over 250 Islamic institutions in some 75 countries that are managing funds worth over used 200 billion. In the early 1990s many sharia compliant mutual funds started to appear. There are now about 126 funds with approximately 4 billion used in assets under management. Other than being halal investment alternative for Muslim investors, the funds also respond to specific need for more liquid tools. Further, the establishment of equity benchmarks by Dow Jones Islamic Market index and FTSE Global Islamic Index Series has been the turning point for the industry in the UK, giving both Islamic and conventional investors something to compare to.
Within Islamic financial systems such as Saudi Arabian systems, Islamic mutual funds are one of the fastest growing sectors. Yet compared to the UK for example, Islamic mutual funds are still in their infancy stage of growth and development most being around for less than a decade. Islamic funds are pretty diverse for a young industry. While the majority of the funds are equity funds as well as Islamic bond funds are recently launched. Out of 126 available Islamic funds 5 are European funds (4) while 13 are country funds mostly Saudi Arabian (10)
Luther Matatko and corner (1992) provide weak evidence that the performance of U.K Islamic mutual funds outperform two market indexes. Their findings demonstrate that Islamic mutual funds perform better when evaluated against a small company benchmark, than when only the financial times all share indexes is used. Kraender etal (2000) extend this study to consider Islamic mutual funds from a smaller number of countries. They find that Islamic mutual funds perform at least as well as the Morgan Stanley capital international world index.
Very recently, a study by Hoepner, Rammal and Rezec (2009,) analyzed the financial performance and investment style of Islamic equity funds from 20 countries in five regions (Africa, Asia-Pacific, Europe, Gulf Cooperation Council, and North America). The
Study sampled a period of two decades and is based on the performance of 262 equity funds, which makes it, by far, the largest analysis of Islamic funds to date. Specifically for the purpose of investigating and comparing the performance of Islamic funds around the world, the authors extend Carharts famous four factor model (1997, Journal of Finance) and
Developed a three level Cahart model (12 factors). This model simultaneously assesses the financial performance of assets at the national, regional and global level and thereby allows to compare Islamic funds from different nations (e.g. Saudi Arabia and U.K) and different
Regions (e.g. GCC countries, North America) in their ability to deliver abnormal risk adjusted financial returns.
The findings of Hoepner et al s (2009) study reveal that, in the UK markets, Islamic equity funds appear to trail their equity market benchmark returns on average. Furthermore,
European Islamic funds are significantly exposed to a small stock preference. In contrast,
Islamic funds from Saudi Arabia neither underperform their equity market benchmarks nor experience small cap preference. This result has some economic intuition for two reasons First, Saudi Arabia has more Shariah compliant business activities and hence Islamic fund managers have fewer restrictions in terms of companies and industries they can invest in.
Second, larger, more diversified companies have a higher risk of receiving intolerable degrees of revenue from prohibited activities especially in the European countries. This second explanation can fairly be expected to drive Islamic funds preference
For small cap stocks.
Kraeussl and Hayat (2008) estimate Jensen alphas for 59 international Islamic equity funds identified via Bloomberg over the five year period to August 2006. They find their 31 Saudi Arabian funds to significantly underperform the respective equity market benchmark, while 21 globally investing funds had an insignificant performance difference and 7 other funds even significantly outperformed their market benchmark. However, their results have to be interpreted with some care, as they had to replace missing net asset values by the average of the previous and subsequent observation. Contrary to the other studies, Abderezzak (2008) investigates Islamic fundsinvestment styles in addition to their financial performance for a sub-sample of 19
US, European or global funds. But as his data access is limited to two UK investments
Style benchmarks, his results are only fully sensible for his six UK funds. Four of these six funds display the expected small cap style, while the six funds have no clear preference for a value or growth style.
In summary, previous studies provide some indication that a few Islamic mutual funds might trail their conventional benchmarks and display a preference for small cap stocks. However, the financial performance and investment style of hundreds of Islamic mutual funds is unexplored to date.
Aims and objectives of the study
Our main aim of this study is to compare the performance of Islamic funds in the Islamic country (Saudi Arabia) and non-Islamic country (U.K). The study will be guided by specific objectives which will include
To find out whether the financial performance of Islamic equity mutual funds significantly differs from the respective equity market benchmark(s)
To analyze the investment styles preferred by Islamic equity mutual funds
To find out if there are any existing differences in Islamic equity funds financial performance and investment style.
To explain existing differences in Islamic in Islamic equity funds financial performance and investment style.
To examine the challenges faced in disbursing the Islam Mutual Fund.
Research questions.
The research will be guided by the following research questions
Does financial performance of Islamic equity mutual funds significantly differ from the respective equity market benchmark(s)
What are the investment styles preferred by Islamic equity mutual funds
Are there any existing differences in Islamic equity funds financial performance and investment style
What are the existing differences in Islamic equity funds financial performance and investment style
Data and Methodology
Data is the main shortage in analyses of Islamic mutual funds. Previous studies lacked
Time series data on both, hundreds of Islamic mutual funds and international
Investment style benchmarks. We address both shortages. In the first part of this
Section, we analyze the descriptive statistics of our sample of 265 Islamic equity funds
From twenty countries. Since the characteristics of these twenty countries could
Explain differences in Islamic funds financial performance and investment style, we
Analyze our sample countries financial market and Islam related properties in the
Second part. The third part describes our international investment style benchmarks.
Islamic mutual fund data
We will be using Eurekahedge which is a worldwide database of Islamic mutual funds
It currently lists 758 Islamic mutual funds, which more than doubles the funds listed on Falaika, the only other provider of return data on hundreds of Islamic funds. 455 of these funds are equity funds. Of these equity funds, Eurekahedge reports monthly return data for 304. However, in a few dozen cases, Eurekahedge lists several asset classes of the same mutual fund. In these cases, we follow Da et al. (2009) and calculate an equal weighted average of these fund classes simple returns. This leaves us with a survivorship bias adjusted sample of 265 Islamic equity mutual funds, whose monthly return data we convert in US.
Although Islamic mutual funds are spread over all continents except Latin America, our sample will mainly look at Saudi Arabia and the U.K. Based on Eureka hedges simple return data, we construct equal weighted fund of fund portfolios for each nation. Eurekahedges simple return data is supplied net of annual management fees but it unfortunately excludes distributions. This is a considerable problem, as estimating mutual funds financial performance using return data excluding distributions against common market benchmarks, whose return data includes distributions, would lead to significantly downwards biased financial performance estimates.
In summary, while information value is lost due to the fact that Eurekahedges
Return data does not include distributions with regard to the precise size of financial
Performance estimates, no meaningful information value appears lost regarding the
Significance level of financial performance estimates.
Sample country characteristics
Since national differences in Islamic funds financial performance and investment
Style might result from national characteristics, relation to Islam and their financial markets. The population of Saudi Arabia is predominantly Muslim and incorporates Islam in their constitution. Saudi Arabia follows the Hanbali School with its literal interpretations of Quran.
While the second sample country is U.K which is the seventh largest Islamic financial market and the largest in the western world. The UK is a predominantly Christian country and has a developed Islamic financial market with Islamic fund attrition rates over 20 percent suggesting that Islamic investment services might develop smoother in Muslim economies.
Benchmark Data
We construct our benchmark factors with the online research tool of Style Research
Limited, which is based on the Worldscope database and has been used in previous
Research (Bauer, Koedijk and Otten 2005 Renneboog, Ter Horst and Zhang 2008).
To assess Islamic mutual funds exposure to a national, regional and global
Equity market, we employ the price indices of value weighted portfolios of all stocks
In the respective market. We use the common investment style benchmark factors
Suggested by Fama and French (1993) and Carhart (1997).
All portfolios are value weighted and based on one month lagged information. As risk
Free asset returns, we retrieve the one or three month(s) treasury-bill or the inter-bank
Interest rate for each nation. Finally, we compute continuously compounded monthly
Returns of each asset.
Methodology
The total monthly returns for each single fund and fund category will be calculated, as well as the returns of the SP index (as proxy for conventional funds) and the five FTSE Islamic Indices and the Dow Jones Islamic Technology Index (as proxy for Islamic funds benchmark). In addition mean portfolios returns, standard deviations and betas for each portfolio are calculated.
Sharpe(1966) measure, Treynor(1965) measure, Jensen(1968) measure, Fama(1972) measures (covering on overall performance, return premium when fully diversified, reward for the lack of diversification, and return on net selectivity) and the transformed Sharpe measure introduced by jobson and korkie(1981) are used to measure the performance of each portfolio and compare it to its benchmark. A one way ANOVA test is also used to test the hypothesis of means equality and another test for identifying the strength and direction of the difference in means, if any, are conducted. The Sharpe ratio represents the portfolio excess return per unit of total risk, and the higher this ratio is above the benchmark, the better it is. The Treynor ratio an the other hand is equal to the portfolio excess return per unit of systematic risk (beta ), and the higher this ratio above the benchmark, the better it is. Fama intergrates the work of Sharpe, Treynor and Jensen. Fama argues that it is difficult to achieve perfect diversification. Therefore, investors should be rewarded for the lack of diversification. Also additionally net selectivity should be compensated for hence, in a world of imperfect diversification Fama measure is superior over Sharpe, Treynor and Jansen measures. Additional risk and net selectivity should be compensated for. Using security market line (SML) model, Fama measure divides the overall portfolio return into three components return premium when fully diversified, reward for the lack of diversification and return on net selectivity.
Literature Review
Bogle (1994) stated that, I cannot emphasize enough the importance of fairness (and common sense) in assuring that you compare only funds that have similar investment policies and characteristics. Sensible performance comparisons can be made only after establishing that fairness. Even then, as I shall now show, selecting equity funds on the basis of past performance is likely to be a futile effort on your part and virtually certain to be a futile effort for fund investors in the aggregate.
To compare mutual funds, there are several statistics that can be used. The selection of a mutual fund should not be based solely on quantitative factors. Once you have identified some good funds, additional investigation is required to ensure that your final selections meet your criteria and will complement one another in your portfolio. At a minimum, you will need to determine if the funds that pass your screening are indeed what they say they are, as names can be misleading and style drift is all too common. Before you get started, you may want to refer to the section on Mutual Fund Types or to the list of mutual fund types, which includes links to descriptions of the various types of mutual funds. Some statistics are more comprehensive than others, so youll have to try a few and decide which you like best. To compare Mutual Fund Returns, you can use arithmetic mean or geometric mean. To measure mutual fund risk, you can use standard deviation, Beta, R-squared, or Bond Duration. To measure mutual fund performance or risk-of-return, you can use Coefficient of Variation, Sharpe Ratio, or Treynor Ratio. To compare the expense ratio, the Turnover Rate and Manager Tenure, you can use Expense Ratio, Turnover, or Manager Tenure and Succession. You can use these statistics with a mutual fund screener to find mutual funds that are good candidates for inclusion in your portfolio.
Islamic funds are usually based in Islamic countries such as Dubai and Saudi Arabia, but many western organizations are beginning to appreciate them because of their low risk and attractive returns. Mckenzie (2009) stated that, Such services grew by nearly 400 from mid 1990s to the end of 2007. Hoepner et al (2009) stated that, ...the British Government recognizes the lead UK has taken in aspect of Islamic finance outside of the Gulf Cooperative and Malaysia. Today, the UK is a world leader for Islamic finance education and it has set clear policy objectives for the development of Islamic financial services. In the UK, about 24 British banks offer Islamic fund services, including HSBC, Barclays, RBS, and Lloyds. The top bank in the UK in Islamic finance is HSBC. Hoepner et al (2009) stated that, ...its annual asset growth is more than 50 in 200708. Other than the rapid growth rate of the services, the market has not been much affected by the credit crisis as Shariah law prohibits many high risk activities.
According to Brooks (2002), the performance of mutual funds performance was first tested systematically by Jensen back in 1968. Jensen examined whether any of those funds beat the market. Using a sample of annual returns on 115 mutual funds from 1945-1964. Each of those funds from the portfolios was subjected to a separate OLS time series regression of the form
QUOTE
The QUOTE in the formula refer to the returns at a time t. The indices j, f and m corresponds the R to portfolio j, to risk-free proxy (1-year government bond), and to a market portfolio proxy, respectively. The error term is QUOTE and QUOTE , QUOTE are parameters that are to be estimated. In particular, QUOTE is called the Jensens alpha. This parameter defines whether the fund outperforms or underperforms the market index. Brooks (2002) stated that, A positive and significant QUOTE for a given fund would suggest that the fund is able to earn significant abnormal excess returns in excess of the market-required return for a fund of this given riskiness.
Investopedia offers a comprehensible explanation of Jensens alpha. The analyst should not exclusively look at the overall return of a portfolio but also the risk of the portfolio in analyzing the performance of an investment manager. For instance, if there are two mutual funds both having 12 return, a rational investor will opt for the fund that is less risky. Jensens measure denoted by the alpha is one of several ways to help determine if a portfolio is earning the proper return for the level of risk associated with it. A positive alpha means that the portfolio is earning excess returns. Hence the fund manager has beat the market with hisher stock picking skills. Hoepner et al (2009) particular investigated the financial performance of Islamic equity funds. They examined 262 Islamic equity funds from five regions and twenty countries over a sample period of up to two decades. They developed a conditional three level Carhart model Hoepner et al (2009) stated that they did this to simultaneously control for their exposure to different national, regional and global equity market benchmarks, while funds from only three nations do the opposite. They used four main findings.
Shariah law, with its prohibitions, substantially limits the investment possibilities of Islamic mutual funds. This has several implications which are stated by Hoepner et al (2009) observed that, Islamic mutual fund managers are restricted in their ability to exploit superior information or winning markets Shariah law limits the potential damage caused by a manager in a losing market and especially a financial crisis. Second, like socially responsible investment, Shariah compliant investment refuses to purely pursue profits. Third, the Shariah compliance of products and services is likely beneficial in economies, whose customers are highly influenced by Shariah law. Hence, Islamic mutual funds might experience a better financial performance in predominantly Muslim economies than elsewhere. Fourth, Islamic mutual funds investment styles are probably more homogeneous than their conventional counterparts style due to Shariah laws narrow framework of eligible activities.
Based on a standard Carhart model, it is clear that more than half of our equal weighted national Islamic equity fund portfolios to significantly underperform their national equity market benchmarks. At national level, Islamic funds display a tilt towards growth and small cap stocks. However, Islamic mutual funds from the same country tend to invest in a variety of different international regions. Hence, we cannot sufficiently assess their financial performance and investment style without controlling for their exposure to regional and global equity market benchmarks and investment styles. To control for these regional and global factors, a three level Carhart model can be developed.
Islamic fund portfolios from most other nations with often barely developed Islamic financial services significantly underperform their benchmarks. This result can be explained with learning effects resulting from the development of markets, which have also been found for conventional mutual funds (Christoffersen and Sarkissaian 2009). The nations with lesser developed Islamic financial services can further be structured in two groups. While the fund portfolio from only one of the predominantly Muslim countries among these nations significantly trails its benchmarks, Islamic funds from seven western nations underperform on average. This implies that incorporation in an Islamic economy benefits Islamic funds financial performance. As funds from Islamic economies tend to have a home bias, a possible reason for this relevance of home country religion might be that a stocks Shariah compliance is likely financially more beneficial in an Islamic economy than elsewhere. The home bias of funds from Islamic economies with often comparatively small corporations can also explain why these funds exhibit a small cap preference at regional and global level in contrast to the remaining funds. Their small cap investment style at national level might result from larger corporations being usually more diversified, which increases the risk that they operate in sectors forbidden by Shariah law.
The internet is the best place to get information on different funds. Venditto (1996) observed that, Americans need more financial information than ever before, and the number of personal finance solutions available on America Online and the Internet are meeting that demand. To perform any sort of comparison on funds, you will need to gather data. Facts on fund asset size, age, manager tenure, and cost are readily available through prospectuses and major financial publications. While information on portfolio characteristics and portfolio statistics is more difficult to obtain, several statistical services provide it.
