Evaluating the Shariah-Compliance of Equity Portfolios: The Weighting Method Matters

Abstract

The choice of weighting method in constructing equity portfolio affects not only the financial performance, but also its Shariah-compliance. We show how the implicit bets in market capitalization weights, fundamental value weights, equal weights and low risk weights can affect the individual's perception of Shariah compliance of the financial portfolio. For the universe of Shariah-compliant S&P 500 stocks over the period 1986-2014, we find that the risk-adjusted performance is improved when using the alternative weighting methods compared with the traditional use of market capitalization weighting. The choice of weighting method thus matters for the Shariah-compliant equity investor, both in terms of compliance with the primary objectives of Shariah investing and in terms of the secondary objective of optimizing the financial performance of the portfolio.

Keywords: Shariah equity portfolio, Market capitalization, Fundamental weighting, Equal weighting, Low risk weighting

JEL Classification: G11