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Islamic Indexes. Khaled Hussein Islamic Development Bank, Islamic Research and Training Institute, P.O. Box 9201, Jeddah 21432, Saudi Arabia Email: [email protected] I. Introduction. Over the past decade, the world of finance paid more attention to the area of "ethical" investment.

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Islamic indexes
Islamic Indexes

Khaled Hussein

Islamic Development Bank,

Islamic Research and Training Institute,

P.O. Box 9201,

Jeddah 21432, Saudi Arabia

Email: [email protected]


I introduction
I. Introduction

  • Over the past decade, the world of finance paid more attention to the area of "ethical" investment.

  • For example, the size of ethical funds jumped from $1.18 to 2.2 trillion in the US between 1997 and 2000.



  • 1987 there was a Call from eminent scholars was not involved in any stock market investments due to Islamic prohibition of certain business activities

  • Equity funds at NCB, Al-Baraka Group

  • In the 1990s, a major breakthrough took place in religious rulings related to equity investment, and since then Islamic equity funds have started to operate.



  • By March 2002, the number of Islamic funds rose to 105 with total assets of US$3.3 billion, down from US$5 billion in 2000

  • The International Investor in collaboration with FTSE Group launched the first Islamic equity index series, FTSE Global Islamic Index Series (GIIS) at the end of 1998.

  • In February 1999 the first Dow Jones Islamic market index (DJIMI) was launched

  • The KLSE Syariah Index, in 1999


Equity index
Equity index total assets of US$3.3 billion, down from US$5 billion in 2000

  • A statistical indicator that provide a representation of the value of the equities which constitute it.


Aims of constructing equity indexes
Aims of constructing equity indexes total assets of US$3.3 billion, down from US$5 billion in 2000

  • to provide information about various types of investments.

  • to encourage companies to disseminate information that will assist investors in making decisions.

  • to provide criterion to compare performance of a portfolio relative to the corresponding index


Index construction
Index construction total assets of US$3.3 billion, down from US$5 billion in 2000

  • Market capitalization weighting

    A stock's weight is based on the outstanding number of shares and the price per share (S&P 500)


  • Price weighting (DJIA) total assets of US$3.3 billion, down from US$5 billion in 2000

    A stock's weight is determined by its price only

    The concern with such an index is that a stock with small market capitalization but a high price can have large impact on the overall index return

  • Equal weighting

    Each stock has the same weight in the index


Stocks screening
Stocks Screening total assets of US$3.3 billion, down from US$5 billion in 2000

  • The screening is divided into two parts:

  • First: an Islamic investor should not buy shares of companies whose primary or basic business is unlawful.

  • Alcohol, tobacco, pork products, conventional financial services, weapons, and entertainment (such as hotels, casinos, cinema, pornography, and music)



  • Second: Components of the company revenues in business activities that are beneficial to the society

  • Leverage:

  • Shariah Board of DJIM index allow for acquisition of shares in companies with debt less than one-third of market capitalization.

  • The FTSE Global Islamic index uses debt/assets


  • Cash plus interest-bearing securities: in business activities that are beneficial to the society

  • To ascertain the level of non-operating interest income where a negligible amount of such income does not prohibit the acquisition of shares

  • Non-operating interest income/revenue (sales) should not exceed 5% …….

  • DJIM: (cash + interest-bearing securities)/market cap. Is less than 33%

  • FTSE does not have either an interest income or cash screen


  • Liquidity screen: in business activities that are beneficial to the society

  • If the Accounts receivable/total assets exceeds 50%, this means the majority of the company's dealings are in money and not in goods and services.

  • DJIM apply this criterion up to 45%


How to measure index performance
How to measure Index performance in business activities that are beneficial to the society

  • A single model based on the classical CAPM developed by Sharpe (1964) and Lintner (1965):

    (Rit– Rft) = α + β (Rmt– Rft) + ε

    Rit is the return on index i in month t,

    Rft is the risk-free rate,

    Rmt is the return on the benchmark portfolio in month t,

    ε is an error term,

    β is the index's systematic risk, i.e., its sensitivity to the return of the benchmark.

    α is called Jensen's alpha,


  • As an extension of the CAPM model, in business activities that are beneficial to the society

    Fama and French (1992, 1993) developed a multi-factor model,

    suggesting that stock returns in excess of the risk-free rate are explained by the sensitivity of their return with respect to three factors:


  • Fama and French (1993) argue that in business activities that are beneficial to the society

    size,

    earnings/price,

    leverage,

    and book to market equity

    have explanatory power in explaining average returns if each variable is used alone.

  • In combination, size and book to market equity seem to absorb the apparent role of leverage and earnings/price in average returns.


( in business activities that are beneficial to the society Rit– Rft) = α + β (Rmt– Rft) +β1iSMBt + β2i

HMLt + ε

SMB The difference between the return on a portfolio of small capitalisation stocks and the return on a portfolio of a large capitalisation stocks;

HML The difference between the return on a portfolio of high book-to-market stocks and the return on a portfolio of low book-to-market stocks.


Hypothesis
Hypothesis in business activities that are beneficial to the society

Due to increased monitoring costs, availability of a smaller investment universe,

and restricted potential for diversification,

it has been argued that unscreened benchmarks should outperform Islamic (ethical) investment.


Data in business activities that are beneficial to the society

  • The data set of this study contains the monthly prices of DJIMI,

    its 13 sub-indices (based on size and industry), and their DJ counterparts.

    Data were obtained from the Dow Jones company database for the time period December 1995 and July 2003.


  • we use the monthly data for the World Index All International, established by Morgan Stanley database, as an appropriate proxy for the world portfolio.

  • Furthermore, we use the one-month treasury bill return as a proxy for risk-free rate.


Jakarta conference
Jakarta Conference International, established by Morgan Stanley database, as an appropriate proxy for the world portfolio.

  • DJIMI: January 1996 to December 2004

  • FTSE Islamic index: December 1993 to December 2004


Summing up
Summing Up International, established by Morgan Stanley database, as an appropriate proxy for the world portfolio.

The papers leave us with a paradox: The positive abnormal returns of Islamic indices in the bull market period, then negative abnormal performance in the subsequent period (bear period).


Are the abnormal negative returns of Islamic indices attributed to market inefficiency, where these indices experience huge gains in the bull market and then underperform their index counterparts in the downturn period?

What is the exact role of leverage ratio in determining firm performance under different market conditions?

And do the prevailing interest rates in the market matter? More investigation is needed to cover these issues, among others, to be able to provide additional evidence regarding some of the patterns of Islamic indices’ behavior, and before the results of this paper can be interpreted conclusively.


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