Does Syariah-Compliant Investing Limit Returns?

New Straits Times:THERE is a general misconception that syariah-compliant funds do not perform as well as their conventional counterparts, because they are prevented from investing in certain sectors like conventional banking and entertainment.

In my view, this mistaken belief is largely due to the lack of exposure and information on the benefits and results that come with investing in accordance to syariah principles.

Sufficient Diversification

The returns shown by syariah-compliant funds, whether they invest in equity or fixed income (sukuk), compared to their conventional counterparts is not dissimilar because syariah-compliant fund portfolios are as diversified as their conventional counterparts.

In 1970, Lawrence Fisher and James H. Lorie found that the majority (95 per cent) of diversification benefits accrue when a portfolio holds 32 stocks. In 1987, Meir Statman showed a minimum of 30 to 40 stocks are needed to form a well-diversified portfolio of randomly chosen stocks.

Therefore, the investor needs to find out if there are enough stocks out there that are syariah-compliant so that a fund manager can construct a well-diversified syariah-compliant portfolio of about 30 to 50 fundamentally good companies. About 85 per cent of the securities listed on Bursa Malaysia are syariah-compliant.

There are currently 269 stocks in the FTSE Bursa Malaysia EMAS Syariah Index (1). The index comprises constituents of the FTSE Bursa Malaysia EMAS Index that are syariah-compliant according to the Securities Commission's SAC screening methodology and FTSE's screens of free float, liquidity and investability. This is a wide and deep enough investment universe from which to build a diversified portfolio of 30 to 50 companies.

To give investors an idea of the calibre of companies in Malaysia that are syariah-compliant, the table above lists 50 top companies in the Syariah Index.

This is a fairly impressive range of syariah-compliant stocks from which to build a diversified portfolio.

In addition, if the fund's mandate allows investment in syariah- compliant stocks across a region like the CIMB Islamic Asia Pacific Equity Fund, the investment universe grows exponentially. To give investors an idea of the number of regional stocks available to select from, there are 1,004 stocks included in the Dow Jones Asia Pacific Islamic Index (2).

Comparison of Index Performance

Let's now compare the 10 year performance (as at end-February 2008) of one of the widest Islamic indices available, the Dow Jones Islamic Market Index, to its conventional counterpart, the Dow Jones World Stock Index.