The Effect of Market Regimes on the Performance of Market Capitalization-Weighted and Smart Beta Shariah-Compliant Equity Portfolios

26 Pages Posted: 11 Mar 2019

See all articles by Muhammad Wajid Raza

Muhammad Wajid Raza

Shadeed Benazir Bhutto University, Dir, Pakistan

Barbara L’Huillier

Prince Mohammad Bin Fahd University

Dawood Ashraf

Islamic Development Bank - Islamic Research and Training Institute

Date Written: February 20, 2019

Abstract

Shariah-compliant investment guidelines, while explicit on screening criteria for stock selection, are silent on the weighting methods to be used in the construction of Shariah-compliant equity portfolios. The market capitalization-weighted strategy and smart beta strategies (fundamental value-weighted, equal-weighted, and low-risk weighted strategies) exhibit different risk and return characteristics. This paper investigates whether the choice of weighting strategy affects the performance of Shariah-compliant equity portfolios under different market conditions. The sample consists of active constituent data from S&P 500 for the period 1986-2016. By utilizing the Markov-regime switching model, it is possible to categorize market returns into two regimes — high regimes for bullish market conditions and low regimes for bearish market conditions. The empirical results indicate a significant difference between the performances of Shariah-compliant equity portfolios in high and low regimes following different weighting strategies. The evidence suggests that market capitalization and fundamental value-weighted strategies perform better during market rallies. On the other hand, a low-risk strategy can be used as a hedge during periods of maximum drawdown and is associated with relatively lower value-at-risk and expected shortfalls as compared to alternative strategies.

Keywords: Islamic Equity Investments; Smart Beta Strategies; Market Regimes

JEL Classification: G00; G11; D53

Suggested Citation

Raza, Muhammad Wajid and L’Huillier, Barbara and Ashraf, Dawood, The Effect of Market Regimes on the Performance of Market Capitalization-Weighted and Smart Beta Shariah-Compliant Equity Portfolios (February 20, 2019). Available at SSRN: https://ssrn.com/abstract=3338365 or http://dx.doi.org/10.2139/ssrn.3338365

Muhammad Wajid Raza

Shadeed Benazir Bhutto University, Dir, Pakistan ( email )

http://www.sbbu.edu.pk/
http://www.sbbu.edu.pk/
Sheringal, Khyber Pakhtunkhwa 18000
Pakistan

Barbara L’Huillier

Prince Mohammad Bin Fahd University ( email )

P.O. Box 1664
Al Khobar, 31952
Saudi Arabia

Dawood Ashraf (Contact Author)

Islamic Development Bank - Islamic Research and Training Institute ( email )

P.O. Box. 9201
Jeddah, 21413
Saudi Arabia

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