Asian and African Area Studies, 11 (2): 151-165, 2012

Frontier of Islamic Economics and Finance: New Challenges

The Impact of Asset-based versus Market Capitalization-based Shari’ah
Screening on US and Japanese Equities: An Empirical Analysis
Shehab Marzban * and Mehmet Asutay **Abstract
This paper focuses on Shari’ah-compliant investments, which are managed in a
Shari’ah-compliant manner that goes beyond defining a set of rules or guidelines togenerate a static list of automatically screened equities. Shari’ah screening is about
identifying a set of investments that adhere to Shari’ah principles and would thus beconsidered eligible for an Islamic investor to invest in. Generally, different Shari’ahmandates can be found across the industry that may result in different asset universe
sizes and constituents. The main distinction between the different rulebooks is the useof either total assets or market capitalization as the base to value a company and to use
as denominator for the different financial ratios. By using the top 200 large cap companies in the United States as well as Japan, this paper reveals that different Shari’ahmandates result in discrepancies in asset universe size, constituents, asset allocation andmost important, return and risk. Therefore such an analysis of the Shari’ah mandates
is crucial before launching a new Islamic fund to ensure that the advantages anddisadvantages of the different mandates are recognized and taken into consideration.
This analysis also revealed that different mandates might be advantageous in different
regions and time spans.

Introduction
Islamic finance has evolved in recent years into a term characterized by growth, opportunity andlarge discrepancy in terms of definition. Islam and finance are terms that might on first sightnot make much sense if combined together. Islam, which is a life style for its followers, is not
only about defining faith, having ethical responsibilities and following specific religious rituals(called ibadat); it goes beyond that through defining mutual interactions and transactions (calledmuamalat) including financial transactions. Thus, Islamic finance is about conducting financialtransactions that adhere to Islamic principles or are considered Shari’ah-compliant.

* Visiting Research Fellow, School of Government and International Affairs, Durham University** Reader in Middle Eastern and Islamic Political Economy & Finance, Durham Centre for Islamic Economics andFinance, School of Government and International Affairs, Durham University
Accepted January 13, 2012151

Asian and African Area Studies, 11 (2)One such type of financial activities is equity investments that by their nature are classed as
Shari’ah-compliant assets due to their profit-loss (musharakah) characteristics.
Since Shari’ah can be characterized by being highly diversified, in this paper the main
distinguishing Shari’ah requirements for identifying compliant investments are reviewed anddiscussed in depth. This paper also aims to provide a critical approach to Shari’ah screening bysuggesting other issues to be considered as part of moral screening.
It should be noted that Islamic finance is also about generating returns, and so the different
Shari’ah requirements are analyzed with respect to risk and return and compared to each other toexplore whether adhering to religious principles will impact investment returns and undertaken
risks or not. This analysis was empirically conducted from January to December 2010, using the
top 200 large cap companies in the United States as well as Japan to explore the effect of using
different Shari’ah methodologies on different asset universes.

1. Principles of Islamic Finance
Islamic finance is an alternative financing method, which offers various instruments to conduct
the financing of economic activities from basic instruments to rather sophisticated methods.
Regardless of the nature of the instruments used, Islamic financial instruments are all subject tocertain principles, which constitute the contents of the Shari’ah screening. The main principle often
referred to, and through which Islamic finance is known is the prohibition of interest or riba. The
other principles, which shape the nature of Islamic finance contracts, hence, are [Asutay 2010]:(i)

Prohibition of interest or riba, as an explicit Qur’anic injunction with the objective ofproviding not only a stable economy and financial environment but also a socially efficienteconomic environment;(ii)

As a consequence of the prohibition of interest, fixed return is also prohibited as provided
by interest [Ayub 2007];(iii)

Islamic finance aims at creating productive economic activity through asset-based
financing rather than a debt-based system, as the asset-backed principle requires that all
financial activities must be linked to tangible assets [Iqbal and Mirakhor 2006];(iv)

In Islamic finance, as a principle money does not have any inherent value in itself; andtherefore money cannot be created through the credit system [Chapra 1985];(v)

Due to prohibiting interest, Islamic finance changes the nature of the relationship between
capital and work by instituting the profit and loss sharing (PLS) principle as a framework152

MARZBAN and ASUTAY：The Impact of Asset-based versus Market Capitalization-based Shari’ah Screening on US and Japanese Equities

within which economic and business activity takes place [Ayub 2007]; This aims at
establishing justice between work effort and return, and between work effort and capital.
As a consequence, risk sharing becomes another important feature of Islamic finance[Siddiqi 1985];(vi)

Profit-and-loss sharing as well as the risk-sharing principle result in participatory natureeconomic and business activity through participatory financing. Through profit-and-loss
sharing, the providers of capital and labour merge to establish partnerships through theirindividual contributions in different ways within various Islamic finance instruments.

(vii)

Productive economic and business activity together with the prohibition of interest,
defines another principle of Islamic finance and also another rule for Shari’ah screening:
uncertainty (gharar), speculation and gambling is also prohibited with the objective ofdeveloping a stable financial system which continues to link finance with the real economy
through asset-based productive economic activity [Iqbal and Mirakhor 2006].

(viii)

Business activity is also limited, as certain sectors are not considered as ‘halal’ or
lawful, which includes any business activity causing harm to individuals, society andthe environment, such as environmentally harmful business activity, the arms industry,
pornography, pork production and related sectors etc.

It should be noted that despite all these principles, through present legal (fiqhi) scholarship
new and more sophisticated financial instruments are developed within the understandingof acceptable levels of uncertainty in responding to the current needs of the industry. Suchcompromises have also been observed in shifting from asset-based financing to debt-based
financing and from profit-and-loss sharing paradigms such as musharakah and mudarabah tomark-up based debt oriented instruments such as murabahah.
These financial rules in Islam are articulated in the Qur’anic verse that“trade is allowed,
riba (interest) is prohibited.” Accordingly, profit constitutes the essential return for businessactivity, and it is around this point that Islamic financial instruments are shaped [Asutay 2010].
Asutay [2010] summarises the comparison between interest and profit to develop a better
understanding of the differences between the two, as depicted in Table 1.
In summarizing all these, as Figure 1 depicts, Islamic finance is the outcome of religious
ethics in banking due to the fact that, Islamic banking and finance solutions are engineered with
the Shari’ah filter process which is informed through Shari’ah sources producing Islamic financecontracts or fiqh al-muamalat contracts within and according to the principles identified (lower
153

Asian and African Area Studies, 11 (2)Table 1. Comparing Interest and Profit
InterestProfitReturn on a capital
The interest is guaranteed
Fixed return
Return on deposit

Return on a project
The risk of loss is involved
Variable return
Return on joint ventures and participated and financed projects

Source: Prepared by the Authors.

Fig. 1. Shari’ah Screening Process
Source: [Khan 2007]section of Figure 1).
Thus this study aims to apply Shari’ah screening to US and Japanese equities whereby
the impact of asset-based versus market capitalization-based Shari’ah screening is establishedempirically through asset management.

2. Shari’ah-compliant Asset Management
Investing according to the Shari’ah is not a straightforward exercise since it is highly complex
and needs to be handled with great precaution to ensure that the Shari’ah requirements are154

MARZBAN and ASUTAY：The Impact of Asset-based versus Market Capitalization-based Shari’ah Screening on US and Japanese Equities

met as intended by the Shari’ah governing body (the Shari’ah board). Due to the complexityof modern capital markets, the existence of complex investment instruments and themultidisciplinary and global involvement of companies, Shari’ah scholars are required to use
deductive and analytical logic as well as religious interpretation (Ijtihad) to extract from theverbal and historical Shari’ah sources a set of rules or guidelines to be employed to determine
which investments can be undertaken from a compliance perspective.
The responsibility of ensuring that conducted investments such as Shari’ah-compliant funds
are managed in a Shari’ah-compliant manner goes beyond defining a set of rules or guidelines
to generate a static list of automatically screened equities.

Shari’ah-compliance is actually

about providing fund managers with credible Shari’ah advisory, data and screening services,purification, and on-going compliance monitoring capabilities.
To ensure that the entire fund management process is run according to Shari’ah principles,
conventional portfolio management processes need to be extended by multiple Shari’ah-specificrequirements to ensure that funds are managed in accordance with the Shari’ah. In the planningphase a Shari’ah governing body has to be selected to define the set of rules / guidelines, in theform a set of rules or guidelines called a Shari’ah mandate to be followed, to determine whichinvestments are to be considered eligible.

Once the Shari’ah governing body is appointed,

mostly in the form of a Shari’ah board or advisory provider, a data and screening provider has
to be selected to screen assets to determine which investments adhere to the guidelines defined
and would represent a permissible investment universe. Across the industry most funds would
either outsource the Shari’ah governance and screening to an index provider or hire an internal
Shari’ah board and separate screening provider.
Other Shari’ah-specific considerations include the quantification of purification, which isthe process of purifying or cleansing any non-compliant elements from conducted investments,
report generation to capture Shari’ah monitoring requirements reflecting compliance changes
over time, as well as portfolio purification calculations.
2.1 Shari’ah Screening / Guidelines
Shari’ah screening is about identifying a set of investments that adhere to Shari’ah principles andwould thus be considered eligible for an Islamic investor to invest in.
Such screening is first to be applied on an asset class level and afterwards on a security
level. On an asset class level interest-based or speculative instruments are not compliant with
the Shari’ah. Therefore the Shari’ah forbids investment in conventional interest-bearing bonds,
derivative and speculative instruments and activities such as futures, forwards, options, short155

Asian and African Area Studies, 11 (2)selling transactions as well as preferred shares that provide a fixed or guaranteed dividend
payment. Once these asset classes are screened out, the remaining instruments (mainly equities)
are analyzed in depth through applying first a set of sector-specific guidelines / ratios to identify
the level of income from non-compliant activities and secondly a set of financial ratios measuring
the involvement in interest-based investment and borrowing transactions.
The sector-based screening process would investigate whether companies are involved in
Shari’ah non-compliant activities—such as the sale of pork or alcohol—and financial activities.
This enables the exclusion of businesses whose primary activity does not comply with the
Shari’ah, such as conventional banks, bars and casinos. Financial screens, on the other hand,measure businesses’ involvement in Shari’ah non-compliant activities, such as interest earningsand debt financing.
Generally, different Shari’ah mandates can be found across the industry, which may resultin different asset universe sizes and constituents. The main distinction between the different
rulebooks is the use of either total assets or market capitalization as the base to value a company
and to use as the denominator for the different financial ratios.
Formally, financial screens are in the form of ratios that are compared to a maximum
allowable threshold level. Those ratios focus on different aspects of an investment like liquidity,
interest, debt and non-permissible income. Each Shari’ah board uses a bundle of ratios forscreening the potential investments and an investment is compliant if and only if it passes all
screens included in the bundle.
The following are two typical Shari’ah mandates / bundles used across the industry. The
distinguishing factor between them is the divisor.
Other versions of the above-stated rulebooks can be found across the industry such as ones
using a combined cash and receivables ratio or including non-operating interest as part of non-Table 2. Rulebooks
Asset-based Rulebook

Market Cap-based Rulebook

Non-permissible Income / Total Income<5%Interest-bearing Cash and Investments /Assets <33%
Receivables / Assets <33%
Interest-bearing Debt / Assets <33%

Non-permissible Income / Total Income <5%Interest-bearing Cash and Investments / 12 month average
market capitalization <33%
Receivables / 12 month average market capitalization <33%
Interest-bearing Debt / 12 month average market
capitalization <33%

Source: Prepared by the Authors.
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MARZBAN and ASUTAY：The Impact of Asset-based versus Market Capitalization-based Shari’ah Screening on US and Japanese Equities

permissible income.1）
Derigs and Marzban [2008] were the first to survey all the Shari’ah mandates in depth
and to investigate the impact of using different Shari’ah mandates on asset universe size andconstituents using the main Shari’ah mandates (S&P, Dow Jones, MSCI, FTSE and HSBC)
used across the industry. Afterwards, Derigs and Marzban [2009] investigated the impact ofthe different Shari’ah mandates on portfolio performance using a Mean-Variance Optimization
model. The results revealed that market capitalization-based Shari’ah mandates such as Dow
Jones and S&P outperform asset-based rulebooks such as the ones used by MSCI, FTSE
and HSBC. Marzban and Asutay [2009] analyzed the impact of Shari’ah mandates on theperformance of GCC stocks and proved that asset-based rulebooks outperform their market
cap-based counterparts due to the relatively high book value of industrial and petrochemicalcompanies compared to their market capitalization in the GCC. Marzban and Donia [2010]
applied a market-cap weighted asset allocation model for US companies and the results revealed
that market cap-based rulebooks result in much higher returns compared to asset-based
rulebooks in the US.

3. Empirical Analysis of the Shari’ah Mandates
Since scholars differ in opinion on using either total assets or market capitalization as the divisor,
it is important to analyze the impact of using the two rulebook variants on the asset universe size
and the expected performance, as well as the anticipated risk level.
Within this research, this analysis is conducted on two different asset universes. The first
asset universe contains the top 200 large cap companies in the United States, whereas the second
universe contains the top 200 large cap companies in Japan.
3.1 US Large-Cap Universe
Through considering the 200 large-cap companies in the US it can be noted that the number ofcompliant companies using an asset-based or market-cap based rulebook is almost identical,
with about 45% of the asset universe being Shari’ah-compliant. Notable from Table 3 is thatthe market cap-based mandate results in a larger exposure to the technology sector but zero
exposure to the utilities sector. This phenomenon has been discussed by Marzban [2009] where
he proved that the technology and health sector is more appropriately screened using market
cap-based mandates whereas it is preferable to screen utility and industrial companies using total

1）A detailed survey of Shari’ah screens can be found in [Derigs and Marzban 2008].

157

Asian and African Area Studies, 11 (2)Table 3. US Compliant Asset Universe
Sector

Total

AssetsMarket Cap

Basic Materials
Cyclical Consumer Goods / Services
EnergyFinancials
Healthcare
Industrials
Non-Cyclical Consumer Goods / Services
Technology
Telecommunications Services
Utilities

11
30
20
35
22
28
17
25
3
9

10
10
16
0
17
12
7
12
2
5

8
12
13
0
21
9
9
21
1
0

Grand Total

200

91

94

Source: Prepared by the Authors.
Table 4. US Compliance Discrepancies
Total Assets
FAIL
Market Cap

PASSGrand Total

FAIL

43%

10%

53%

PASS

11.50%

35.50%

47%

Grand Total

54.50%

45.50%

100%

Source: Prepared by the Authors.

assets.
Critical from a Shari’ah perspective are the results in Table 4, which indicate that even if
the previous results showed that the asset universe size using different screening methodologies
is almost identical, the constituents of the universe differ widely. In the case of the US Largecap companies analyzed, a 21.5% discrepancy exists between the two Shari’ah mandates, whichmeans that about one out of five companies would be compliant using one mandate and noncompliant using the other.
So, if a fund manager is keen to invest in specific sectors such as the technology sector thiswould mean that he or she is better off using a market-cap based Shari’ah mandate.
Finally, the compliant universes are analyzed from a return and risk perspective. Portfolios
are constructed from the respective asset universe by weighting the investments by their relative
market capitalization on the 1st of January 2010.
The constructed portfolios are evaluated by their Year-To-Date (YTD) weighted portfolio
return and weighted Beta as can be seen in Table 5. As can be noted the conventional portfolios
158

MARZBAN and ASUTAY：The Impact of Asset-based versus Market Capitalization-based Shari’ah Screening on US and Japanese Equities

without Shari’ah restrictions achieved the highest YTD performance which came with the highest
risk almost identical to market risk.
The superiority of the conventional portfolios’ performance when compared to the Shari’ahbased portfolios is mainly attributable to the recovering financial sector, which is not part of the
Shari’ah-compliant asset universe.
It is interesting that the asset-based universe dominates the market cap-based universe
both in terms of return and risk. This behavior is attributable to the utility and basic materials
companies that are compliant using the asset-based rulebook and are non-compliant using
market-capitalization.

These companies actually achieved high return levels and therefore

superior performance.
It is worth mentioning here that in a previous research conducted by Marzban and Donia[2010] on the same asset universe but for the entire year of 2008, the opposite results have beenachieved (see Table 6).
In this previous research the market cap-based mandate outperforms the asset-based
mandates by 8%. This can be explained by the fact that this analysis was based on a pre-crisis
status where market capitalizations were relatively high compared to 2010 numbers. Theseequities have still not totally recovered from the crisis and are thus still non-compliant using
market cap-based mandates.
3.2 Japanese Large-Cap Universe
Conducting the same analysis on the large-cap companies in Japan, it can be noted that theasset-based Shari’ah mandate has a much larger asset universe (capturing an additional 17% of
the total asset universe) compared to the market cap-based universe. This difference is mainly
attributable to the cyclical consumer goods and industrial companies which have a significant
larger asset value compared to market capitalization.
In Table 8, the discrepancy between the two methodologies is much higher for the Japanese
universe (29%) than the US universe (21.50%). So from an asset universe size the results would
prioritize an asset-based Shari’ah mandate in Japan which is also a different result from the one
Table 5. US Return / Risk Analysis
Universe

YTD

Beta

Conventional
Asset-based
Market Cap-based

9.08%
7.81%
6.48%

0.99470.81600.8588Source: Prepared by the Authors.
159

Asian and African Area Studies, 11 (2)Table 6. US Weights and Performance of Market Cap versus Total Assets Mandates
Divisors

Market Capitalization

Sectors
Basic Materials
Consumer Goods
Consumer Services
Financials
Health Care
Industrials
Oil & Gas
Technology
Telecommunications
Utilities
Total Return Jan 08 to Jan 09

Total Assets

WeightWeighted Return

WeightWeighted Return

4.23%
14.01%
7.53%
0.61%
20.37%
4.66%
17.63%
30.96%

4.28%
2.95%
2.68%
0.17%
4.15%
1.80%
3.28%
19.65%

4.75%
15.08%
7.03%
0.34%
17.51%
7.80%
23.50%
14.75%
6.01%
3.22%

4.86%
3.05%
3.04%
0.07%
3.05%
3.45%
4.72%
8.39%
0.15%
0.28%

38.95%

100.00%100.00%

Number of Compliant Equities

89

31.07%
94

Source: Prepared by the Authors.

Table 7. Japan Compliant Asset Universe
Sector

Total

AssetsMarket Cap

Basic Materials
Cyclical Consumer Goods / Services
EnergyFinancials
Healthcare
Industrials
Non-Cyclical Consumer Goods / Services
Technology
Telecommunications Services
Utilities

16
39
3
28
13
54
12
19
4
12

9
19
0
1
11
26
6
12
3
1

6
6
0
0
11
14
6
10
1
0

Grand Total

200

88

54

Source: Prepared by the Authors.

concluded based on the US universe.
Finally, even from a risk and return perspective the Japanese universe results in different
conclusions from the US universe. Even though the market cap-based mandate results in a muchsmaller universe, the quality of the stocks is superior to the ones determined using the asset-based
rulebook, resulting in achieving almost five times the return at a lower risk compared to themarket. The main reason that the market cap-based mandate outperformed the total asset-based
one is that a large number of weakly performing companies (such as Sharp or Toshiba) are non160

MARZBAN and ASUTAY：The Impact of Asset-based versus Market Capitalization-based Shari’ah Screening on US and Japanese Equities

Table 8. Japan Compliance Discrepancies
Total Assets
Market Cap

FAIL
PASS
Grand Total

FAIL

PASS

50%
6%
112

23%
21%
88

Grand Total
146
54
200

Source: Prepared by the Authors.
Table 9. Japan Return / Risk Analysis
Universe

YTD

Beta

Conventional
Asset-based
Market Cap-based

2.47%
0.23%
1.06%

0.98030.97050.8790Source: Prepared by the Authors.

Table 10. Ijmaa Strategy versus Individual Mandates
Universe

YTD

Beta

7.81%
6.48%
8.03%

0.81600.85880.8012

0.23%
1.06%
0.25%

0.97050.87900.8611US Universe
Asset-based
Market Cap-based
Ijmaa
Japan Universe
Asset-based
Market Cap-based
Ijmaa

Source: Prepared by the Authors.

compliant under the market cap-based mandate.
3.3 Harmonizing the Mandates—Ijmaa Strategy
Based on an a strategy developed by Marzban [2009], a consensus or Ijmaa universe is to be usedas the Shari’ah-compliant universe which is determined through selecting only the companies
which are compliant across all the Shari’ah mandates considered.
This approach of course would result in a smaller asset universe but based on the results inTable 10, for the US universe the Ijmaa strategy achieves superior return and risk figures whencompared to each Shari’ah mandate individually and for the Japan universe the Ijmaa strategy
achieves the lowest risk but from a performance perspective is outperformed by the market capbased mandate.
161

Asian and African Area Studies, 11 (2)4. Critical Perspectives on the Shari’ah Screening Process
The analysis in this paper has so far utilized the conventional Shari’ah screening adopted in theIslamic finance industry. This is, however, based on the idea of ‘form’ or the Shari’ah compliancy
in terms of legal requirements.

In other words, in Shari’ah screening the above mentioned

principles as Islamic rules are considered, which has been the common practice.

However,considering that Islamic finance is also the articulation of Islamic ethics and morals in banking as
it is located within Islamic moral economy [Asutay 2007a, 2007b], it is essential to endogenise
the aspirations of Islamic moral economy in the Shari’ah screening process so that the observedsocial failure of Islamic banking can be overcome [Asutay 2007b, 2008].
In understanding the moral aspects of Shari’ah screening as identified by the ethical normsof Islamic moral economy, alongside the above mentioned principles, further principles of Islamic
finance have to be identified, as follows [Khan 2007]:(i)

Community banking aiming at serving communities not markets;(ii)

Responsible finance, as it builds systematic checks on financial providers; and restrainsconsumer indebtedness; ethical investment, and CSR initiatives;(iii)

An alternative paradigm that offers stability by linking financial services to the productive,
real economy while providing a moral compass for capitalism; and(iv)

Fulfils aspirations in the sense that it widens the ownership base of society, and offers‘success with authenticity.’

These additional principles help to endogenise ethics into the Shari’ah screening process,thus ensuring the ethical outcomes expected by Islamic moral economy. In other words, theoperations, activities, returns, and revenues of Islamic banking and finance institutions as wellas corporations should be screened with such a comprehensive process in order to yield a moral
outcome.

This will also respond to the shortcomings in ‘Shari’ah compliancy’ by ensuring‘Shari’ah based’ results by implying that in addition to ‘form’ the ‘substance’ is also served. For
example, ‘form’ oriented Shari’ah screening does not consider CSR initiatives and environmental
issues in evaluating the performance of banks, financial institutions and corporations. However,the framework of the comprehensive Shari’ah screening process suggested in this section aims
to make sure that a Shari’ah screening consequentialist approach should be adopted throughwhich the social and environmental consequences of the financing activities of Islamic banks and162

MARZBAN and ASUTAY：The Impact of Asset-based versus Market Capitalization-based Shari’ah Screening on US and Japanese Equities

financial institutions should also be taken into account. These comprehensive Shari’ah screening
rules as an extension of the Shari’ah screening rules identified in Figure 1 are depicted in Figure 2:
As can be seen in Figure 2, in the comprehensive screening process, the Shari’ah filtering
process includes a ‘moral screening process’ as well, which can be seen in the top right-handbox (dashed line box). This Shari’ah screening process is expected to deliver solutions, which
also serves the moral objectives as stated above, as a consequence, which are identified in thebottom right-hand box (dashed line box). Thus, through endogenising morals into the Shari’ahscreening process, it is possible to achieve Shari’ah based results which maximise the social
outcome whereby not only the ‘form’ but also the ‘substance’ of Islamic finance is ensured.
An example of the distinction between the processes identified in Figure 1 (Shari’ahcompliancy or form oriented screening) and Figure 2 (Shari’ah based or substance oriented
screening) can be illustrated by the case of Zamzam Towers, which is a large block of up-market,
luxurious apartments overlooking the Kabah in Makkah offered through a time-sharing concept.
The construction of the tower was possible through Islamic finance.

Fig. 2. Comprehensive Shari’ah Screening Process
Source: Asutay [2011] is an extended version of Khan [2007].
163

Because the Shari’ahAsian and African Area Studies, 11 (2)screening they employed was based on a ‘form’ oriented understanding as explained in Figure 1,
the Shari’ah scholars who approved the project did not find any problem in approving it, while
it clearly undermines the spirituality of Islam’s most holy place, undermines equal opportunities
in worshipping, damages the historicity of the place, and harms the environment. However, if
it had been judged according to the moral screening process based on ‘substance’ in addition to‘form’; Zamzam Towers would not have been found acceptable as an Islamic finance project.
Thus, the consequentialist approach produces a moral outcome in the screening process, which iswhat Islamic finance aims to achieve in an aspirational sense, as Islamic finance is the outcome ofreligious ethics in banking and finance.
In summary, there is a need for a paradigm shift in Islamic finance not only in terms of the
Shari’ah screening of investments and the credit policies of Islamic banking and finance, but also
in the Shari’ah screening of these institutions by rating agencies. The comprehensive screening
process proposed in this study should be considered as part of the mentioned paradigm shift
towards comprehensive ‘Shari’ah based finance’ as opposed to narrow and form based ‘Shari’ahcompliant financing.’

Conclusion
The analysis in this study reveals that different Shari’ah mandates result in discrepancies in asset
universe size, constituents, asset allocation and most importantly return and risk. Therefore
an analysis of the Shari’ah mandates is crucial before launching a new Islamic fund to ensurethat the advantages and disadvantages of the different mandates are recognized and taken into
consideration.
The analysis also revealed that different mandates might be advantageous in different
regions and time spans. For instance the ‘asset-based mandate’ resulted in a much larger asset
universe in Japan while ‘market capitalization’ resulted in a larger universe in the US. Basedon previous research, pre-crisis market capitalization resulted in better portfolio performance,
whereas during circumstances when the markets had not yet recovered from the crisis, assetbased mandates were superior.
Finally, better results and harmonization might be achievable through using the Ijmaa
strategy [Derigs and Marzban 2009] that resulted in promising results in terms of risk and/or
return for both the US and Japan markets.
Lastly, this paper suggests that the Shari’ah screening process, not only at the institutional
level but also in its overall evaluation, should follow a comprehensive screening process by164

MARZBAN and ASUTAY：The Impact of Asset-based versus Market Capitalization-based Shari’ah Screening on US and Japanese Equities

endogenising ethical and social factors whereby the aspirations of Islamic moral economy can befulfilled and the narrow ‘form’ oriented screening process can be substantiated by a ‘substance’
oriented process.

The outcome of the evaluation of the Shari’ah assets of Islamic financeinstitutions will then be different. Such a paradigm shift would be a really positive step in theright direction for the development of the industry.
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