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A second look at the performance of Shariah compliant share indices

Comparisons are very sensitive to which years of the global financial crisis are included. Logically, conventional investors should perform better than Shariah compliant ones.

Summary

Posted 25 August 2018

One of the benefits of the internet is the scope for people to interact. In the days of printed newspapers, readers were limited to writing letters to the editor.

Now, most internet publishing enables readers to comment immediately. My website articles enable reader comments using the Disqus facility. When I publicise my writings using Twitter, Facebook and LinkedIn, that enables further comments.

A response via LinkedIn to my June 2018 column in Islamic Finance News about the relative performance of conventional and Shariah compliant share indices (which is linked below) led me to return to the subject in my August 2018 column. You can read my August article below.

The detailed numbers reviewed below do not change my fundamental point.

A conventional equity investor should perform better than a Shariah compliant investor, simply because the the conventional investor can pick from the entire universe of shares, while the Shariah compliant investor cannot.

Do Shariah compliant share indices really perform worse?

In my 6 June 2018 column “Does having principles make you poorer or richer?” I looked at the performance of the FTSE All-World Index and the FTSE Shariah All-World Index from 2008 to 2017 inclusive. For convenience, the figures are reproduced below.

Index % increase (decrease)

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

FTSE Shariah All-World

-38.0

36.2

13.1

-6.0

13.4

20.4

3.9

-4.2

8.5

24.1

FTSE All-World

-41.8

36.2

13.2

-7.3

17.1

23.3

4.8

-1.7

8.6

24.6

Shariah out-performance

3.8

0

-0.1

1.3

-3.7

-2.9

-0.9

-2.5

-0.1

-0.5

A reader disagreed with me, saying that with a longer time-scale, Shariah compliant shares outperformed conventional shares. He cited the MSCI indices which state that from 31 May 2002 to 29 June 2018, the MSCI World Islamic Index returned an annualised 7.59% whereas the MSCI World Index returned only 7.56%. Readers can decide if the 0.03% p.a. difference is significant.

I want to look at the year by year results. The MSCI data-sheet does not give these from 2002, but has the following annual figures. (The Shariah advantage is my subtraction.)

Year

MSCI World Islamic Index % increase (decrease)

MSCI World Index % increase (decrease)

Shariah advantage

2004

13.02

15.25

-2.23

2005

10.39

10.02

0.37

2006

19.54

20.65

-1.11

2007

17.67

9.57

8.10

2008

-34.71

-40.33

5.62

2009

30.81

30.79

0.02

2010

13.79

12.34

1.45

2011

-3.12

-5.02

1.90

2012

11.40

16.54

-5.14

2013

23.16

27.37

-4.21

2014

3.77

5.50

-1.73

2015

-4.11

-0.32

-3.79

2016

8.33

8.15

0.18

2017

20.15

23.07

-2.92

FTSE and MSCI of course use slightly different methodologies. Hence it is no surprise that they report slightly different, but generally consistent numbers. For example, the conventional FTSE index for 2017 shows +24.6% while the conventional MSCI for 2017 shows +23.07%.

What is more important is the consistency of the two sets of indices. The Shariah compliant index generally under-performs its conventional analogue before the global financial crisis years of 2007 and 2008, outperforms during the global financial crisis (due to the absence of banks and insurance companies as I mentioned in my previous column), and then under-performs again afterwards.

Like me, you may want to compute the average annual results. If so, remember that you cannot take the arithmetical average of the annual results. If your investment returns +50% in year 1 and -50% in year two, your average annual return is not 0%. Your $100 initial capital has grown to $150, and then shrunk to $75, making your average annual return -13.4% since $100*(1-0.134)2=$75.

Similarly, if ri is the return in year i, whether positive or negative, and there are n years, your average rate of return is found by multiplying (1+r1)*(1+r2)*…(1+rn) and then computing the nth root, and then subtracting 1.

Doing that to the above figures gives the following average annual returns

% average annual returns

FTSE

MSCI

Conventional

5.29

7.90

Shariah

5.09

8.00

Shariah out-performance

-0.20

+0.10

The difference between the two groups of indices arises from the MSCI figures including both years of the global financial crisis, 2007 and 2008, (which boosts the relative performance of the Shariah compliant index) while the FTSE figures only include 2008.

More importantly, nothing about the numbers affects my fundamental point. We should expect the conventional investor to do better, since he can select from the entire universe of investments, some of which are prohibited to the Shariah compliant investor.

 

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