Essays on Islamic equity investment : a thesis presented in partial fulfilment of the requirements for the degree of Doctor of Philosophy in Finance at Massey University, Auckland, New Zealand

Abstract

This thesis presents three self-contained studies on Islamic equity investment. Each of these studies contribute to advance understanding of the mechanics of investing in the rapidly growing Islamic equity market.

The first study inspects the systematic risk exposure of a sample of equities domiciled in the United States that have transitioned to ethically screened, Shari’ah compliant, Islamic equities. The conjecture is that the anterior and posterior risk exposures will not be analogous. Our results indicate that Shari’ah compliance initially creates a shock in systematic risk, but transitional behaviors subsequently diverge. Particular screening ratios also behave similarly. In effect, the capital market reinforces the risk position and increases systematic risk. However, this is essentially a transition effect. Over the entire period, we find a downward trend in systematic risk. Shari’ah compliance makes the adopted equities less risky over the long-term with improved market information. Our findings hold even after controlling the screening ratios and conducting a number of robustness checks.

The second study examines pair-wise, net, and total return and volatility spillovers across Islamic equity markets from widely dispersed locations. Using the generalized VAR-based spillovers index, we find increasing interactions in return and volatility spillovers while the extent of spillovers has been asymmetric across the countries. Interestingly, we find the presence of persistent clustering of spillovers. These clustered countries lead Islamic equity return and volatility spillovers in their respective regions. We do not find any supremacy of the cash and oil-rich GCC countries outside their region. Our results also highlight that in the crisis period, aggregate spillovers across the Islamic equity markets intensify. Additionally, we employ cross-section analyses to uncover the underlying macroeconomic variables influencing the magnitude of such spillovers. We find a convincing indication of geographic proximity along with economic linkages that explain the directions of return and volatility spillovers.

The third study explores the investment style of actively managed Islamic equity funds domiciled in both Islamic and non-Islamic countries. We find that Islamic funds initially overwhelmingly skewed to value stocks in Islamic countries and growth stocks in non-Islamic countries. However, there is an increasing shift from these styles to a deep blend orientation. Similarly, we report a trend from initial mid-cap stocks to large-cap stocks in Islamic countries. In contrast, there is a consistent extreme large-cap tilt in non-Islamic countries. We conjecture such deportment as an extrapolative consideration. After inspecting the apparent shift in style over the years, we reveal strong evidence of style shift, with a higher rate in Islamic countries. Collectively, the propensity is larger in asset types than in asset sizes. Islamic funds are more likely to alter their portfolio exposure in the sight of negative performance. More mature funds in Islamic countries are more likely to shift often. Funds from non-Islamic countries are less likely to shift when the market is relatively volatile.