The Impact of Asset-based versus Market Capitalization-based Shari'ah Screening on US and Japanese Equities: An Empirical Analysis

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 to generate 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 be considered eligible for an Islamic investor to invest in. Generally, different Shari'ah mandates 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 use of 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'ah mandates result in discrepancies in asset universe size, constituents, asset allocation and most 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 and disadvantages 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.