A mutual fund is a pool of money, collected from investors, and is invested according to certain investment objectives. Karachi stock market has shown tremendous growth in terms of volume since 1991. The volume of shares traded in KSE has increased from 2 million shares in 1991 to more than 100 million shares in 2010. This growth in the capital market attracted both local and foreign investors. Risk averse attitude in majority of the local investors who are reluctant to manage their own portfolio of securities has given boost to mutual fund industry in Pakistan.
Investors opt for mutual funds owing to experienced and professional fund management, diversified portfolio, economies of scale and risk diversification, liquidity, convenient processing, affordability (small investors can also invest), transparency and stringent regulatory requirements.
On the other hand, several challenges are being faced by Mutual Funds in Pakistan. These include lack of diversified product range, difficulty in understanding of investors' need, public awareness at mass level, in-stability of stock market, dearth of liquid debt instruments, ensuring consistent performance, providing competitive returns, mitigating the risk involved, inadequate intellectual capital, comforting and convincing with bad past investment, low saving and investment oriented society, information disclosure and transparency and right timing to launch funds.
A strong desire for Islamic mutual funds has also been witnessed in the private sector. Investment in Islamic funds also provides attractive and risk adjusted returns through investing in Sharia'h compliant income instruments.
Structure of the Mutual fund
Mutual Funds are operated by Asset Management Companies (AMC) which exists in the form of a corporation, owned by its shareholders. The AMC launches new funds through the establishment of a Trust Deed, entered between the Asset Management Company and the Trustee, which in most cases is the Central Depository Company of Pakistan Limited, with due approval from the SECP under the Non-Banking Finance Companies (Establishment and Regulation) Rules, 2003 (the "Rules"). The CDC performs the functions of the custodian and trustee, whereas, the AMC can act as the registrar or can appoint an external registrar. Banking/ financial companies may be authorized to act as distributors/ sales agents. The Board of Directors must also approve and appoint a legal advisor and auditor for legal and compliance affairs (MUFAP, n.d.).
Figure 1: General process of investing in mutual funds
Types of Mutual Funds
With respect to choice of redemption, there are two categories of mutual funds: Closed end and open end funds.
Open-end Funds: These funds are in an ongoing process of issuing and redeeming units on demand. The units do not trade in a market. The number of units outstanding varies each time the net asset valuation calculation is carried out, which is daily for most open-ended funds.
Closed-end Funds: Closed-end funds issue a specific number of units. Their capitalization is fixed. The units are not redeemable, but are readily transferable and traded on either a stock exchange or the over-the-counter market. The price of a closed-end fund share fluctuates based on investor supply and demand. Closed-end funds are not required to redeem units.
With respect to investment objectives, there are several types of funds available including money market fund, index funds, balanced funds, income fund, sector funds, stock funds, pension funds, cash funds, sovereign funds etc. Almost all these types of funds are also available in the Islamic funds category.
Advantages of Investing in Mutual Funds
The volume of shares traded in KSE has increased from 2 million shares in 1991 to more than 100 million shares in 2010; Karachi stock market has shown tremendous growth in terms of volume since 1991. This growth in the capital market attracted both local and foreign investors.
The capital market not only opened several avenues of investment, but also gave direction to investors towards other financial markets as well. The investment in the financial markets is very risky. The investors opt to invest in mutual funds due to this risk aversive attitude as they are reluctant to manage their own portfolio of securities.
The flotation of large number of TFCs is a clear manifestation of the corporate sector's preference of mobilizing funds through debt instruments rather than borrowing from financial institutions. Following are some major reasons to invest in mutual funds: (MUFAP, n.d.)
v Diversity
Diversification of portfolio minimizes the unsystematic risk which basically arises due to concentration of investment in particular industry or asset class.
v Affordability
Diversified portfolio shares the fruit of investing in high price asset class which is otherwise not possible to afford separately with relatively smaller amount of money. Specially, it gives the opportunity to small investors to include high priced assets in their portfolio.
v Professional Management
All investors do not necessarily possess the same expertise and skills to manage their own portfolio. It needs time and special technical skills to analyze thousands of securities available in the financial market and to assess their returns on a regular basis.
v Liquidity
The units or shares of mutual funds can be traded in secondary market. Therefore, the investment in mutual funds is more liquid.
v Flexibility
Mutual fund provides an opportunity to switch investment from one asset class to another with respect to risk taking appetite.
Mutual Funds in Pakistan
Establishment of Mutual funds industry in Pakistan dates back to 1962 when the first open end equity fund was launched by the National Investment Trust. Then in 1966, the Government of Pakistan established Investment Corporation of Pakistan which launched several closed end funds. Subsequently in 1990's, significant increase in the number of mutual funds was seen in the private sector. The history of Islamic mutual funds in Pakistan is brief, but the progress so far achieved is outstanding, when compared to the progress achieved in other countries.
The enviable growth of the Islamic financial system can be attributed to the proactive approach of the regulators and a lot of effort being done by the market players. Achieving one after another milestone would not have been possible without the dedicated due diligence by the fraternity of Sharia'h scholars.
As of June 30, 2009, the total number of funds in mutual funds industry recorded was 101 from which 81 were open-ended and 20 were closed end. Furthermore, there were 29 AMC/IAs operating in this industry with total asset size of PKR 227 billion (Securities and Exchange Commission of Pakistan, 2009)
Factors of Growth in Islamic Mutual Funds
Islamic Sharia'h Boards are demonstrating greater understanding.
The Islamic Mutual funds are generating better returns with sound investment policies and reluctance in investments into highly leveraged companies.
The conventional banking industry is emulating the Islamic investment instruments and appointing Sharia'h Board Advisors for Sharia'h compliance.
Conventional banks are also offering Islamic finance products and this trend is also continuing in mutual funds industry whereby several AMCs have launched Islamic funds side by side.
Regulatory Framework for Mutual Funds in Pakistan
There are three regulatory documents governing mutual funds in Pakistan,
Investment Companies and Investment Advisors' Rules, 1971. (Govern closed-end mutual funds).
Asset Management Companies Rules, 1995. (Govern open-ended mutual funds).
NBFC Rules 2003 (For Establishments and Regulations).
Industry Analysis
Between 2002 and 2008, mutual funds in Pakistan have shown rapid growth in terms of net assets. This rapid growth was achieved mainly due to liberalization of mutual fund sector, heavy earnings in the corporate sector amidst economic boom in the period, availability of liquid funds in the economy, macroeconomic stability and arrival of foreign investment in buoyant stock market.
More inclusion of the private sector in mutual fund industry has brought competition, efficiency and improved fund management expertise. After the stock market fiasco in 2008, the trend in mutual fund industry has declined in 2009. The net assets of the mutual fund industry in Pakistan has been recorded Rs. 227 billion in 2009. The main determinants of this deteriorating trend are economic and political instability in the country, lack of economic direction, huge non-performing loans in the financial sector and heavy losses in the corporate sector. The uncertainty in the value of local currency has deterred both the foreign and local investors.
Figure 2 Asset Under Management of the mutual funds industry (in billions PKR)
Source: Mutual Funds Association of Pakistan, www.mufap.com.pk
In addition, the local mutual funds industry appreciated by 6.4% in Jul-10 to close at Rs 212 Billion. On a MoM basis, the positive number in growth was witnessed after three months, when the industry showed an appreciation rather than a declining trend since April 2010. Comparing the industry size to December 2009 level of Rs. 225 Billion, the industry still lags behind by 5.7%. Since the announcement of the Capital Gain Tax (CGT) implementation on equities, investors have been shifting their funds more towards the income and money market funds categories.
In Pakistan, Islamic mutual funds can be invested in 100 Sharia'h compliant companies listed on KSE. The listing is updated semiannually in June and in December. The KSE and Al-Meezan Investment Management Limited launched the first islamic index of Pakistan known as KMI-30 in September 2008 which comprises companies selected on the basis of Shariah screening rules. In addition to the Sharia'h screening criteria, the inclusion of scrips in KMI-30 is based on two criteria; free float methodology and impact cost. The scrips with high free float and impact costs are taken in, provided they are Sharia'h compliant as well.
Figure 3: Performance of Mutual funds in 2010
(Source: FMR, Invest Cap Research)
Performance of Income Funds
During 2010, Income fund performance can be presumed from following graph which depicts that funds peaked in Feb 2010 and were lowest in June 2010.
Figure 4: Income Funds Performance during FMCY10
(Source: FMR, Invest Cap Research)
The main reason for the category to earn a better return during the month was that, some TFCs and Sukuks had been upgraded from the non-performing assets to the rated instruments.
Figure 5: The top-10 income funds with annualized returns earned during July 2010
(Source: FMR, Invest Cap Research)
Equity Funds Performance
In July 2010, the KSE100 index appreciated by 8.4% but the equity funds category grew however by only 4.7%.
Figure 6: Equity Funds Performance during July 2010
(Source: FMR, Invest Cap Research)
Figure 7: The top-10 equity funds with annualized returns earned during July 2010.
(Source: FMR, Invest Cap Research)
Islamic mutual funds
Interest in Islamic mutual funds has developed principally due to a fatwa on investment banking issued by the Islamic Jurisprudence; Karachi stock market has shown tremendous growth in terms of volume since 1991 (MUFAP, n.d.).
Islamic Income Funds
The objective of this fund is to seek protection of capital and earn a reasonable rate of return in a Sharia'h compliant manner. The objective is achieved by investing in Islamic income investments having good worth and liquidity. The fund encompasses investment of various investment horizons, with a significant amount invested in short-term investments for the purpose of maintaining liquidity.
Asset class where Islamic income funds cannot invest
Asset class where Islamic income funds can invest
Conventional Bonds / Term Finance Certificates
Sukuks
Treasury Bills (T-Bills)
Islamic banking placement
Pakistan Investment Bonds (PIB)
Musharaka Certificate
Badla
Commodity Murabaha
Continuous Funding Schemes (CFS)
Currency Trade
Federal Investment Bonds (FIB)
COII
Islamic Equity Funds
Islamic Equity fund invests in both growth and value stocks listed in Pakistan. The Fund seeks to achieve long-term capital appreciation primarily from growth stocks. In Pakistan, mutual funds work under the Sharia'h principal of Wakala bil Istithmar (Investment agency). Under this principal the obligor (AMC) is an investment agent and all the losses unless due to fraud or negligence are borne by investors and the rate of return are variable.
Islamic equity funds prohibits the investment in companies whose income is made from Gambling, Alcoholic beverages, Financial lending for interest, either with or without risk, derivatives, selling short or any other method in conflict with Islamic Law. Also, the lending and borrowing at interest (leverage) is impermissible. The principal of Sharia'h does not allow 'interest' to be considered as a part of the cost of a product or service, it does not add to the end value and plays no part in the commercial system
BACKGROUND OF THE STUDY
The investment in mutual funds has increased dramatically as there has been great awareness of the benefits of diversified portfolio under professional management with safeguard of trustee supervision and regulatory framework as whole.
In Pakistan, Industry has witnessed great support of investors that shows confidence on Mutual funds. Investors have option to select fund of their choice and can choose between Conventional and Islamic mutual fund. The net assets of the mutual fund industry in Pakistan has been recorded Rs. 227 billion in 2009 and still the number is growing.
Keeping in view the investment volume and impact it has on economy, triggers the need to study mutual funds. Various studies have been conducted eliciting the performance of mutual funds but very few studies have been conducted to elaborate Islamic mutual funds' performance. In this study, performance of Islamic and conventional mutual funds is analyzed and compared on the basis of profitability and volatility that will help general public and stake holders of mutual fund to understand the phenomena of said funds.
PROBLEM STATEMENT
Given the fact that there exist numerous structural and regulatory differences between Islamic and conventional mutual funds, there is a need to examine whether these differences reflect also in profitability and price volatility between Islamic and conventional mutual funds operating in Pakistan
RESEARCH OBJECTIVES
To explore regulatory and structural differences between Conventional and Islamic mutual funds operating in Pakistan.
To examine and compare the profitability and volatility of both types of funds.
To investigate and analyze the impact of structural and regulatory differences on profitability and volatility.
IMPORTANCE OF STUDY
The importance of study can be acknowledged from the growth of Mutual funds industry in Pakistan during the last five years. KSE - 100 Index crossed over 15,000 points in 2008 and Islamic finance industry is growing at a rate in excess of 15%. A country with 97% Muslim population and prevalence of pan Islamism sentiments, the future for Islamic mutual funds industry bode well. Conventional mutual funds are also thriving after two severe collapses in equity market in 2005 and 2008 respectively. This study greatly contributes in understanding the differences between Islamic and conventional mutual funds and to analyze the variables that cause both funds to perform differently.
SCOPE OF THE STUDY
This study is confined to Income and Equity funds only and other categories of funds are not taken into consideration.
RESEARCH METHODOLOGY
This study is exploratory and quantitative in nature with strong emphasis on analysis. Performance of Islamic and conventional funds with respect to structural and regulatory differences is compared through 5 year data on equity and income funds for both Islamic and conventional funds. Performance is measured through Net Asset Value (NAV). Volatility is measured through standard deviation in particular and several ratios are calculated for extensive analysis.
LIMITS OF THE STUDY
Study is limited to Pakistan only. There are very few differences between conventional and Islamic mutual funds keeping in view the limited investment avenues as both types of funds invest almost in same instruments. Hence, the profitability of both funds could probably resemble to each other despite the structural and regulatory differences.
CHAPTER 2
LITERATURE REVIEW
Interest in Islamic mutual funds has developed principally due to a fatwa on investment banking issued by the Islamic Jurisprudence Academy in Saudi Arabia. The verdict ruled that, within certain parameters, equity investment was acceptable under Sharia'h.
Shaikh (2010) explained certain criteria for Investee Company for Islamic mutual funds which are as follows:
Nature of Business
The business of the company where investment is made should be Halal. Like investment in the shares of conventional banks, insurance companies, leasing companies, companies dealing in alcohol and tobacco etc. are not allowed.
Minimum Market Price per share
Market price of the share must be greater than the net liquid assets per share. It means that the excess liquid funds of the company should be invested in its operations i.e. to buy the assets for which the company acquired funds from the general public.
The formula to calculate for evaluating a company based on this criterion is as follows:
The Net Liquid Assets / Share = (Total. Assets - Fixed. Assets - Inventory - Current Liabilities - Long Term Liabilities) / No. of shares outstanding
Minimum Illiquid Assets
Illiquid Assets are tangible assets which are not liquid that include Fixed assets. Examples include plant, machinery, inventory, building, furniture, fixtures etc. It implies that the company should invest the funds it generates from the public to invest in the tangible assets.
The formula to calculate for evaluating a company based on this criterion is as follows:
The Illiquid Assets = Total Assets - Liquid Assets (Cash, Cash equivalents, Accounts Receivables, Advances).
Cap on Sharia'h Non-Compliant Income
Non-Compliant Income includes interest; income from gambling, conventional interest based derivatives, structured products, income from nightclubs, casinos, tobacco, alcohol, drugs and dividend income from above mentioned businesses etc should be less than 5% of total gross revenue.
Requirement for Non-Sharia'h Compliant Investment
Non-Sharia'h Compliant Investments include investments in money market funds, money market instruments, bonds, PIBs, FIBs, CoIs, CoDs, TFCs, DSCs, conventional speculative derivatives and structured products etc. These should be less than 33% of total assets.
Cap on Interest Bearing Debts
Interest Bearing Debt includes Bonds, TFCs, Conventional Bank Loans, Finance Lease, and preference shares etc. In Pakistan, the consensus of Sharia'h Advisors is that over all, interest bearing debt of company should be less than 40% of total assets. Previously, it was 45% of total assets and tightened on the presumption that the companies, increasingly, have better and accessible Sharia'h compliant alternatives now than before.
Explaining the difference between an Islamic and conventional mutual fund, El-Gamal (2000) conducted a study stated that an Islamic mutual fund is similar to a "conventional" mutual fund in many ways; however, unlike its "conventional" counterpart, an Islamic mutual fund must conform to the Sharia'h (Islamic law) investment precepts. The Sharia'h encourages the use of profit sharing and partnership schemes, and forbids riba (interest), maysir (gambling and pure games of chance), and gharar (selling something that is not owned or that cannot be described in accurate detail; i.e., in terms of type, size, and amount). When selecting investments for their portfolio (asset allocation), conventional mutual funds can freely choose between interest based investments and non-interest based investments, and can invest across the broad spectrum of all available industries.
An Islamic mutual fund, however, must set up screens in order to select those companies that meet its qualitative and quantitative criteria set by Sharia'h guidelines. Qualitative screens are used to filter out companies based on the nature of their business (e.g., firms producing or selling alcohol, and biotechnology firms using aborted embryos and human cloning), or securities that contain one of the Sharia'h prohibited elements (e.g., involving riba, maysir or gharar) as explained earlier; or companies that conduct unethical business practices as per Sharia'h (Ahmed, 2001).
Thus, excluded from Islamic-approved securities are fixed income instruments such as corporate bonds, treasury bonds and bills, certificates of deposit (CDs), preferred stocks, warrants, and some derivatives (e.g., options). Moreover, Islamic mutual funds cannot trade on margin; in other words, they cannot use interest-paying debt to finance their investments. It is also not permissible to engage in sale and repurchase agreements (El-Gamal, 2000)
In addition, he further articulates that, unlike conventional mutual fund managers, Islamic fund managers are not allowed to speculate. An Islamic economic unit is expected to assume risk after making a proper assessment of the risk with the help of information. Only in the absence of information or under conditions of uncertainty is speculation akin to a game of chance and is reprehensible.
ISLAMIC MUTUAL FUNDS PERFORMED BETTER THAN CONVENTIONAL MUTUAL FUNDS:
With respect to the performance, Hamilton, Jo and Statman (1993) compared the performance of 32 American Islamic funds to that of 170 conventional funds over a ten year period. They found that the average return for the Islamic funds is found to be higher than the average returns of the conventional, suggesting that investors do not lose by investing in similar Islamic funds (Shaikh, 2010).
Elfakhani and Hassan (2005) state that, comparing the profitability of Islamic and conventional Mutual Funds, the research conducted by Reyes and Grieb in 1998, found that average return for the Islamic mutual fund is far superior to that of conventional one hence confirming the results of Hamilton and Statman.
Ferdian and Dewi (n.d.) articulate the results of the research pursued on performance of both Malaysian Islamic and conventional mutual funds. This study found that during the period of January 2nd, 1997 to February 26th, 1999, Islamic mutual funds performed better as compared to the conventional mutual funds. Besides that, his study uncovered that Malaysian Islamic mutual funds outperformed all of their benchmarks, namely KLCI, RHB Islamic Index and KLSE Composite Index.
Ferdian and Dewi (n.d.) claims that, in the period of January 2002 to December 2003, Indonesian equity Islamic mutual funds outperformed the market (JII). This finding was supported by the result of performance measurement which calculated by using Sharpe, Treynor, and Jensen indices. All of the three indices show positive value, which means that all equity Islamic mutual funds performed better than their benchmark.
In another study of Ferdian and Dewi (n.d) conducted study on comparative analysis of Islamic and Conventional Mutual funds, they found that during 2001 to 2002, the performance of equity Islamic mutual funds were higher than equity conventional mutual funds.
The findings of Hoepner et al. (2009) study reveals that, in western markets, Islamic equity funds appear to trail their equity market benchmark returns on average. Furthermore, Western Islamic funds are significantly exposed to a small stock preference. In contrast, Islamic funds from countries with a significant Muslim population neither underperform their equity market benchmarks nor experience a small cap preference.
The study also found some evidence about the pattern of investment in assets with a low debt to equity ratio. This may help explain the strong performance of the Islamic financial sector during economic downturns. As Islamic funds tend to avoid investing in high risk assets (due to uncertainty or gharar) they tend to be less affected during economic crises than investments in high risk/high return assets. This evidence is not only important for Islamic fund managers but also points conventional fund managers to the opportunities to hedge their portfolios against crises by investing in Islamic funds.
The author finds the evidence supporting the view that Islamic investors from predominantly Muslim countries (i.e. GCC countries and Malaysia) do not sacrifice financial returns by investing actively in line with their religious principles. Furthermore they find some evidence that Islamic investors in some countries (e.g. Bahrain, Saudi Arabia) experience a superior protection against overall equity market losses.
A useful review of the literature in the article by Chang and Witte (2005) articulating that Camejo in year 2002 and Harrington in 1992 suggested that socially responsible investing may produce higher risk-adjusted portfolio returns relative to using all available stocks in the equity universe.
Islamic investment products are commonly perceived to underperform conventional asset classes due to restrictions on investment avenues and the overall conservatism of portfolios. But the MSCI World Islamic Index has managed to outperform the conventional MSCI World Index over the last 13 quarters due to its focus on low-debt companies and non-financial stocks (Pasha & Nair, 2010).
Studying the performance of close ended funds in Pakistan in the year 2006, Sipra evaluated the performance of close-ended mutual funds in Pakistan based on the data for the period 1995 to 2004 and reported that according to Jensen and Treynor measures, almost half of the funds outperformed the market portfolio over the last five years (Afza & Rauf, 2009).
CONVENTIONAL MUTUAL FUNDS OUTPERFORMED ISLAMIC MUTUAL FUNDS
Hong and Kacperczyk (2009), conducted study on performance analysis of Islamic and conventional mutual funds They concluded that stocks (alcohol, gambling, tobacco) excluded by Islamic funds to deliver significantly, deliver positive abnormal returns.
Hussein (2004) states that, opponents of Islamic investors highlight the adverse costs and affects that ethical screening may involve. They argue that the potential hidden costs associated with implementing ethical screens adversely affect investment performance and therefore should not be ignored. They perceived that cost associated with screening of Islamic investments reduces the net return yielded.
EFFECTS OF REGULATORY AND STRUCTURAL DIFFERENCES ON THE FUND'S PERFORMANCE
Hussein (2004) states that, opponents of Islamic investing highlight the adverse costs and affects that ethical screening may involve. They argue that the potential hidden costs associated with implementing ethical screens adversely affect investment performance and therefore should not be ignored.
Unscreened benchmarks may outperform ethical investment since using ethical investing criteria may cause additional screening and monitoring costs, availability of a smaller investment universe and restricted potential for diversification.
He further describes the comparison of the returns of DSI to two broad-based benchmark portfolios: S&P 500 and Chicago Centre for Research in Security Prices (CRSP) Value Weighted Market indices. His results showed that additional screening and monitoring costs associated with implementing social-responsibility screens does not necessarily result in higher volatility and reduced returns. The restricted investment may involve higher risk but, it should not yield significantly worse returns since investors do not invest in clearly unprofitable stock.
Ahmed (2009) quoted in his study "Islamic Mutual fund structures" that some scholars allow partially "contaminated" earning income to be cleansed or purified. For instance, contemporary scholars allow investment in stocks of companies with tolerable (i.e., kept at a minimum proportion) amount of interest income or with tolerable revenues from unacceptable business activities if all "impure" earnings is "cleansed" by giving it away to charity. If, for example, the company has 3 percent interest-related income, then 3 percent of every dividend payment must be given away to "purify" the fund earnings.
Cleansing capital gains, however, remains debatable as some scholars argue this is not necessary since the change in the stock price does not really reflect interest. While others suggest that it is safer and more equitable to purify earnings made from selling shares as well. This purification process is done either by the fund manager before any distribution of income, or by reporting the necessary financial ratios for investors to purify earnings on their own (Elfakhani & Hassan, 2005).
On the issue of corporate governance, a study conducted by Cheema and Shah in 2006 about Pakistani fund industry using the annual data for 1994-2004 period concluded that the sufficient protection of minority investors can only be possible if institutional investors in general and mutual funds in particular play a significant role in corporate governance. This study is of particular importance relating to our research as we will be analyzing the structural and regulatory differences between conventional and Islamic mutual funds' performance.
Regarding differences in performance with respect to type of funds, Afza and Rauf (2009) further inform that Glenn (2004) argued that since open-ended funds face the possibility of redemptions, it has to keep more of its assets in the form of cash. Therefore, an open-ended fund will have relatively less money invested than a close-ended fund, which may result in lower returns for the open ended mutual funds.
Regarding determinants of high performance, Afza and Rauf (2009) inform in their article that, Ramasamy (2003) surveyed the relative importance of various factors in the selection of Islamic mutual funds by financial advisors in Malaysia and concluded that consistent past performance, size of the fund and cost of transaction were the three important factors influencing the fund performance.
Next, we move on to mention some controversies in Islamic Mutual fund industry. Several studies have been conducted showing that performance of Islamic and conventional mutual funds is the same. Studies which measure the performance of Islamic mutual funds are still scarce as compared to studies on the conventional counterparts.
The study by Panwar and Madhumathi (n.d.) took a sample of socially responsible equity mutual funds against randomly selected conventional funds of similar net assets to investigate differences in characteristics of assets held, degree of portfolio diversification and variable effects of diversification on investment performance. The study found that socially responsible funds do not differ significantly from conventional funds in terms of any of these attributes. Moreover, the effect of diversification on investment performance is not different between the two groups.
Shah and Hijazi (2005) states that in a research conducted by Bauer, Koedijk, and Otten in 2002 using an international database containing Sharia'h based mutual funds, remarked that the existing empirical evidence on US data suggests that Islamic mutual funds lead to similar or slightly less performance relative to comparable conventional portfolios.
Study of the UK Islamic fund performance by Gregory, Matatko and Luther (1997) adopts a matched-pair approach and employs a size-adjusted measure of performance. Their study concluded that there is no significant difference between the returns earned by the Islamic and Conventional fund and that both groups under-perform the FTSA benchmark index.
Elfakhani and Hassan (2005) notify that, Hamilton (1993) used the CAPM framework to examine the performance of 32 socially responsible mutual funds for the 10-year period commencing January 1981. He observed only two significant alphas out of the 32 (one positive and one negative) and came to the conclusion that the market did not price socially responsible mutual funds fairly and did not earn statistically significant excess return and the performance of such mutual funds were not statistically different from the performance of conventional mutual funds.
They further apprise that, in the study of Mallin, Saadouni and Briston (1995), yielded the result that the returns earned by 29 UK Sharia'h based funds and 29 UK conventional funds, matched on the basis of age and size, between 1986- 1993 using the Jensen, Sharpe and Treynor performance measures. A small majority of funds from both groups under-perform the market as measured by the FTSA index. In addition, Sharia'h based funds tend to outperform relative to their matched conventional pairsl; although this effect is weak.
Authors further apprise that, Statman in year of 2000 analyzed the Islamic mutual funds` performance with conventional fund's performance and found that there was no major statistical difference in risk-adjusted returns of both the Islamic and conventional funds.
Hayat (2006) discussed that, the analyses done by Abdullah, Mohammed and Hassan in 2002 on 67 Malaysian unit trust funds, including 14 Islamic and 53 Conventional Funds using multiple performance measures (Sharp Ratio, the Modigliani Measure and the Information Ratio) argued that, both Islamic and conventional funds slightly underperformed against the benchmarked index KLCI (Kuala Lumpur Composite Index). Results also showed that returns of both funds were quite the same.
When Abdullah et al. put risk into account, Islamic Equity fund (IEF) performed well in bear markets and conventional funds performed well in bull markets. This result shows that investors have the option to switch between these funds depending on the market conditions.
Hayat (2006) on his study about the empirical assessment of Islamic Equity Fund Returns, came to know that there was no significant difference between the total returns of conventional and Islamic benchmarks. He also found that the Islamic Equity Funds had empirically outperformed their Islamic as well as conventional benchmarks during 2002.
Statman and Glushkov (2008) form similar hypotheses like that of Hamilton and others` in the year 1993. The authors investigate both the effect of social responsibility factors, such as community and employee relations, on returns and the effect of shunning stocks of companies associated with tobacco, alcohol, gambling, fire-arms, military and nuclear operations. The authors find that investors inclined towards socially responsible companies gives investors a return advantage relative to conventional investors. Moreover, they find that shunning the above mentioned companies' leads to a return disadvantage for socially responsible investors. The authors conclude that that the return advantage and the return disadvantage mostly offset each other. According to the authors investors should adopt the best-in-class approach in the construction of their portfolios. This method leads to tilts toward companies with high scores on social responsibility, but refrains from shunning any company.
Bauer et al. (2004) focused on performance and investment style using an international database containing 103 Islamic mutual funds - 32 from the UK, 16 from Germany and 55 from the US. Using a Carhart multifactor model to compare Shariah and conventional funds, they found no evidence of significant differences in risk- adjusted performance.
They further indicated that, Kreander et al.(2005) matched 30 ethical funds based on fund size, age, country and investment universe, and used the risk adjusted Sharpe, Treynor, and Jensen measures as well as a size adjusted two-index approach. The empirical findings show similar results to the previous research. The findings suggest that there is not a significant difference between ethical and conventional funds with the applied performance measures.
