Impact of ethical screening on risk and returns. The case of constructed Moroccan Islamic stock indices
| Date | 11 July 2016 |
| Pages | 268-291 |
| Published date | 11 July 2016 |
| DOI | https://doi.org/10.1108/JFRC-01-2016-0002 |
| Author | Issam Bousalam,Moustapha Hamzaoui |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
Impact of ethical screening on
risk and returns
The case of constructed Moroccan Islamic
stock indices
Issam Bousalam and Moustapha Hamzaoui
Department of Economics, Abdelmalek Essaadi University,
Tangier, Morocco
Abstract
Purpose – This paper aims to expand the literature on performance and volatility of Islamic funds and
indices in comparison to their conventional unscreened counterparts, by studying the Moroccan case
considering the recent introduction of Islamic nance in the country toward the end of 2015.
Design/methodology/approach – As there are still no Shariah-compliant indices in Morocco, the
authors rst applied four Shariah screening methodologies of some of the world leading equity index
providers (i.e. Dow Jones, FTSE, S&P and MSCI) to screen the public listed companies in Casablanca
Stock Exchange for Shariah compliance. Next, the authors constructed four Islamic oat-weighted
indexes for which they modeled the dynamic volatility using an extension of the AutoRegressive
Conditional Heteroskedasticity models, namely, EGARCH(1,1).
Findings – The ndings show that the screening process resulted in a well-diversied universe of
Shariah-compliant stocks (25.6 per cent) to invest in. Furthermore, it is found that constructed Islamic
indices outperformed the broad-based Moroccan All Shares Index (MASI) during the considered period
of analysis (January 2013 to December 2014), and their long-run volatility is higher. This indicates that
investors in Shariah-compliant stocks do not sacrice nancial performance for their risky investment.
The estimates of the model show that volatility for the MASI is more persistent and takes longer time
to die, and the leverage effect is positive for all indices, meaning that volatility of indexes’ returns is
inuenced more by good news than bad news, a result that is in contrast to other studies for developed
countries.
Practical implications – On the arrival of the new banking law that introduced Islamic nance for
the rst time in Morocco, the authors suppose that these results could be very helpful for the Moroccan
nancial authorities in consideration with the construction of Islamic equity indices for Muslim
investors seeking to invest ethically in accordance to their religious convictions but also for index funds
managers and other equity market players.
Originality/value – The present study is the rst of its kind in Morocco to construct Islamic indices
using Shariah screening methodologies for which the volatility is modeled using an EGARCH(1,1)
dynamic volatility model.
Keywords Morocco, EGARCH volatility model, Islamic index, Shariah screening
Paper type Research paper
1. Introduction
Shaken by the Arab spring of 2011 and the global nancial crisis of 2008, Morocco as one
of the most promising emerging countries in the world has recently aligned its economic
development strategy with the inclusion of Islamic nance to strength its economy and
diversify its funding sources.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm
JFRC
24,3
268
Received 6 January 2016
Revised 15 February 2016
Accepted 6 March 2016
Journalof Financial Regulation
andCompliance
Vol.24 No. 3, 2016
pp.268-291
©Emerald Group Publishing Limited
1358-1988
DOI 10.1108/JFRC-01-2016-0002
After the approval of an earlier Islamic nance bill by the Moroccan parliament in
November 2014, the Moroccan Ministry of Finance and Economy adopted in July 2015 a
circular outlining the banking licensing process including for Shariah-compliant units
(TAN, 2015). The new banking law allows the establishment of Shariah (Islamic
law)-compliant banks and enables foreign lenders to set up Islamic units in Morocco as
well.
The success of this new nancial industry in Morocco is perceived to be mainly
attributed to the Muslim-majority community representing more than 95 per cent of the
Moroccan population. In fact, the Islamic Finance Advisory and Assurance Services
conducted a study in Morocco in June 2012 and revealed that 94 per cent of those polled
were in favor of the practice of Islamic nance in the country. The introduction of
Islamic nance will surely bolster domestic savings, draw foreign and domestic
alternative investors into the country’s nancial sector and boost the commercial capital
of Casablanca Finance City as a regional nancial hub. More importantly, it would grant
a higher level of accessibility and attraction for investors from the Arab states of the
Gulf region, allowing the country to position itself as an Islamic nancial hub for the
Arab states and French-speaking portion of Africa as well.
To meet the needs of the wealthy investors desiring to fructify their capital and
diversify their portfolios by holding halal[1] assets, nancial operators should urgently
establish Shariah-compliant equity funds to invest in and develop a set of indices that
list Shariah-compliant companies, and serve as benchmarks for Shariah-compliant
portfolios managers. Unfortunately, Moroccan stock market players did not yet create
such indices by which international Muslim investors could be tempted and could track
the evolution of equity markets in a style that is consistent with their underlying ethical
principles.
As for Shariah-compliant investment, the economic literature argued that, mostly,
screened investments funds such as the Islamic mutual funds bring lower expected
returns than unscreened investments (Langbein and Posner, 1980;Rudd, 1981;Temper,
1991;Johnson and Neave, 1996) and the low diversication of screened investments
results in a higher portfolio risk. Furthermore, screened investments are also perceived
to incur high monitoring and administration costs. As consequence, a persistent
challenge for Morocco goes with enabling domestic and foreign investors to pursue
equity investment in conformity to their religious beliefs without sacricing nancial
performance.
In this paper, we aim to verify whether the Shariah screening process of companies
listed in Casablanca Stock Exchange (CSE) results in a riskier universe of stocks to
invest in and whether Shariah-compliant stocks underperform (outperform eventually)
their conventional counterpart. For this, we rst apply four Shariah screening
methodologies set by some of the world leading equity index providers (i.e. Dow Jones
Islamic Market World Index; S&P Global BMI Shariah Index; MSCI ACWI Islamic;
FTSE Shariah All-World Index) to the 74 companies listed in CSE to lter out the
Shariah-compliant stocks. Next, we construct four oat-weighted Islamic indices for
which we compare returns against the broad-based Moroccan All Shares Index
(MASI)[2]. Finally, we model the dynamic volatility of all indices including the MASI
using an extension of the AutoRegressive Conditional Heteroskedasticity models,
namely, EGARCH(1,1) model.
269
Impact of
ethical
screening
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