Did Islamic equity funds outperform?

decade long performance

AS the Covid-19 virus reached pandemic proportions, national borders closures and country lockdowns led to diminished consumer demand and a collapse of industrial production and service industries. The crisis led to financial distress among small and medium enterprises (SMEs) and sparked massive layoffs. In matter of weeks, unemployment rose to double digits.

Large companies were not immune to the pandemic either (no pun intended). While Boeing and major US airlines pleaded for more than US$100bil in federal funding to stay afloat, several well-known companies including Hertz, Thai Airways, and JCPenney filed for bankruptcy.

As the Covid-19 pandemic ground international trade almost to a halt and wreaked havoc on national economies, stock markets plummeted.

The S&P500 started dropping on February 19 and lost almost a third of its value in a month. Only after the Fed committed to lend trillions of dollars and US Congress allocated more than US$2 trillion in federal emergency assistance to American companies and financial institutions did the American stock market reverse the free fall and partially recover.

Almost simultaneously, dominos started falling in Asian markets. Along with the collapse in the US stock market, the Japanese Nikkei Index and Singapore’s Straits Times Index lost roughly 30% of their values, while Hong Kong’s Hang Seng Index dropped by almost 20%.

As the global economy reached the brink of total collapse, Morningstar Research reported that in March 2020 investors withdrew US$326bil from mutual funds across the world.

Islamic equity funds

In the midst of the unprecedented mayhem, an often-overlooked area of niche investing stands out – Islamic equity funds.

Islamic equity funds avoid non–halal activities such as conventional finance, alcohol, gambling, pork related products, and adult entertainment, as well as tobacco, weapons, arms, and defence manufacturing. Additionally, the screening criteria requires investing in companies with low debt ratio, low cash and interest-bearing items, low accounts receivable and cash, as well as low revenue from non-halal activities.

Originally targeted to Islamic investors, these funds appeal to non-religious investors as well. Notably, shunning sectors associated with weapons production would appeal to the broader investors’ base, especially with the general trend towards environmental, social, and governance (ESG) investing. Furthermore, their conservative nature may be attractive to long-term investors as well.

Covid-19 crisis

During the Covid-19-induced market panic through March, the MSCI World Index lost over 30%, while the MSCI World Islamic Index lost 20%, thus resulting in a relative outperformance of 10%. As the Islamic index fared better than the rest of the market during the crisis, one might argue that Islamic equity funds offered some protection from downside risk to investors.

Remarkably, while the pandemic triggered massive declines of assets under management (AUM) across the world, in-flow into Islamic funds in certain countries picked up. According to the Fitch ratings agency, Islamic funds in Saudi Arabia experienced an increase in AUM by 3%, thus surpassing Malaysia as the largest market for Islamic funds in the world.

Nevertheless, it is still too early for a victory lap since the Covid-19 crisis has been around for a relatively short time and thus corresponding outperformance of Islamic finance index provides relatively few data points to support meaningful conclusions.

Global financial crisis

Even though some analysts were quick to attribute the outperformance during Covid-19 to luck, we find a consistent pattern during another major market downturn – the Global Financial Crisis (GFC) from 2008 to 2009.

While outperformance of Islamic indices during the Covid-19 crisis could have been due to short-term fluctuations, longer data surrounding the GFC provides the ground for more robust experimentation to examine the relative performances of the Islamic versus conventional global indices.

In the six months around the failure of Lehman Brothers, the MSCI World Index lost 42.6%, while the MSCI World Islamic index lost only 12.4%, resulting in an outperformance of over 30%.

Another prominent measure of performance over a decade–long horizon around the GFC – from the Dow Jones Global index’s inception in October 2006 through December 2016 – indicates that a US$100 investment in the Dow Jones Global index would yield US$123.96 while an equivalent investment in the Dow Jones Global Islamic index would yield US$144.99, roughly a 20% improvement.

Part of the difference in the performance in the period surrounding the GFC stems from Islamic funds’ avoidance of conventional financial institutions and the embrace of Islamic financial institutions, making them inherently more defensive and better able to withstand adverse economic conditions.

Notoriously, Bear Stearns, Lehman Brothers, Merrill Lynch, and other behemoths of financial world either filed for bankruptcy or were acquired to escape insolvency.

Their shareholders lost hundreds of billions of dollars. None of these conventional financial institutions were syariah-compliant and thus were not included in Islamic funds.

An IMF study by Jemma Dridi and Maher Hasan suggests that Islamic banks outperformed conventional banks during GFC due to smaller investment portfolios, lower leverage, and avoidance of financing or investing in the innovative (and risky) instruments that wrecked conventional banks.

Surprisingly, Islamic AUM was only US$15bil in 2008. While it grew almost five-fold to US$70.8bil in 2017 according to the Malaysia International Islamic Financial Center, projections are even more optimistic going forward – to approximately US$216bil by 2024.


Islamic equity funds can provide some protection from downside risk as evidenced by their outperformance in two high-profile crises. This is partially due to a limited exposure to highly volatile stocks such as conventional financial institutions. These return characteristics should appeal not only to Islamic investors, but to the broader public as well.

Moreover, Moody’s 2020 Investors Service’s report predicted expansion of Islamic assets by 3% to 4% per annum in the short to medium term. The report states that the demand for Islamic asset management is rising due to “large Muslim populations, supportive legislation and growing investor demand for syariah-compliant products.”

We expect this wake-up call to further boost the development of the Islamic asset management industry and thus expand the existing investable universe.

Ben Charoenwong is an assistant professor of finance at the National University of Singapore and head of research at Chicago Global, a quantitative global investment fund. Emir Hrnjic is an adjunct assistant professor of finance at the National University of Singapore and a co-founder of Block’N’White Consulting. The views expressed here are the writers’ own.

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