Shari-ah convergence and stock portfolio returns: a field study
Authors: Parlak Deniz 
Published: February 2024

Purpose- The aim of this study is to develop a Shari-ah compliance index that measures the degree of convergence to Islamic rules and to examine the relationship between the developed Shari-ah compliance index and the performance of stock portfolios consisted of the shares of the companies in the dataset.
Methodology- Shari-ah compliance criteria was determined after an analysis of the existing literature and the practices of multinational financial institutions. In current practices, Shari-ah compliance is assessed in two stages; in the first stage, companies operating in industries that do not comply with Islamic rules are identified, and in the second stage, Shari-ah compliance is determined with the calculation of certain ratios. In this study, in line with current practices, companies engaged in entertainment, media (except newspapers), conventional finance, gambling, hotel-restaurant-bar management, pork products, cigarettes, weapons and defence, gold and silver trading industries were marked as non-compliant. For the second stage of Shari-ah compliance assessment, there are significant differences in the ratios applied by financial institutions; in the context of this study two ratios measuring indebtedness level (total liabilities/total assets and interest-bearing liabilities/total assets), one ratio measuring liquidity level (the ratio of the sum of cash and financial investments to total assets). and two ratios measuring income compliance level (the ratio of the sum of interest-earning cash and financial investments to total assets and the ratio of financial income to total income) were employed. The variable weights were assessed with IDOCRIW multi-criteria decision-making technique. The dataset consisted of stock exchange listed 1,235 manufacturing, service and technology industry companies located in 10 different Islamic countries (Bahrain, Bangladesh, Jordan, Kuwait, Malaysia, Oman, Pakistan, Qatar, Turkiye, and the United Arab Emirates) that have adopted the international financial reporting standards. The Sharia-ah compliance ratios were calculated for five years between 2017 and 2021 by using financial statement data and food notes obtained from stock exchanges and/or company websites.
Findings- To construct stock portfolios, companies were divided into nine groups according to their degree of compliance for each year for which the Shari-ah compliance index is calculated. The first group included companies with a compliance degree between 90% and 100%, and the last group included companies with a compliance degree between 0% and 50%. 10-year adjusted monthly stock returns of all companies for the 2013-2022 period were obtained from the investing.com website. For each of the five years and for all nine groups, stock portfolio weights were calculated with minimum variance technique developed by Markowitz by using the past five years adjusted stock returns; yearly portfolio returns were computed by applying the calculated stock weights. When five-year portfolio returns are analyzed, the portfolio composed of 0-50% Shari-ah compliant stocks is third in return ranking. Among the remaining eight portfolios four portfolios composed of stocks with Shari-ah compliance degree above 75% take the first four rankings. The return difference is statistically significant at 5% confidence level.
Conclusion- Although the threshold values applied for Shari-ah compliance varies among institutions, the generally accepted level is 70%. The findings of the study show that in Islamic geography, portfolios consisting of stocks of companies that keep the indebtedness, liquidity and non-compliant income levels below the threshold accepted by Sharia rules have higher performance than others. A possible explanation of the findings is the demand of Islam conscious investors.

Keywords: Sharia-ah convergence, multi-criteria decision-making techniques, minimum variance technique, indebtedness, liquidity
JEL Codes: G31, G32, G12