Mixing Equity with Gold: A Case of Islamic Risk Management
Azhar has started an investment advisory firm. He holds an MBA in Finance from a reputed management institute. Most of the clients of his firm are his friends and relatives, mostly belonging to middle income group. However, the new venture is struggling to grow due to lack of High Net-worth Investor (HNI). His younger brother, Irfan, studies Mass Communications at a top-notch institute and has good network with people from diverse background. One night while dining with his family, Azhar shares his concern regarding the lack of HNI clients.
Azhar: I am having trouble with my firm.
Father: Have patience! Beginning is always difficult.
Mother: Son, have patience and carry on. You will succeed.
Irfan: Brother, one of my friend’s father is a big businessman. May be you can approach him.
Azhar: Thanks. That would be great. (In a delighted tone)
Irfan: I have few concerns though. He is religious and avoids any interest income.
Azhar: Hmm. May be I can pitch him some Shariah-complaint investment strategy. Let’s meet him and see how things unfold!
Azhar knows a thing or two about Islamic Banking and Finance (IBF). But to handle this new sort of client, he begins studying literature on IBF.
Islamic Banking and Finance
IBF has emerged as an alternative to the conventional finance and banking with tremendous business opportunity. El Hawary et al., (2004) describes IBF as a system that adheres to the principles of risk-sharing, materiality (directly connected to a real underlying economic transaction), non-exploitation of transacting parties, and prohibition of sinful activities as per the Holy Quran (e.g. alcohol, narcotics, tobacco, pork-related products, gambling, etc.). The economic activities that follow the Islamic principles are called Sharia/Shariah-compliant economic activities...........
Potential of IBF
IBF has experienced enormous growth over the past decade. As per IMF (2015), “Islamic finance assets grew at double-digit rates during the past decade, from about US$200 billion in 2003 to an estimated US$1.8 trillion at the end of 2013”. Islamic banks’ assets grew by 111% whereas conventional banks assets only grew by 6% (Khan, 2010). Islamic banks are more capitalized, more liquid and more profitable than American and European banks (Bitar and Taramasco, 2017)............
Unlocking the Potential
Given the business potential, the National Stock Exchange of India (NSE) launched two indices, NIFTY50 Shariah, and NIFTY500 with NIFTY 50 and 500 as parent indices respectively, on February 19th 2008, to offer Shariah-compliant investment solutions to the investors. It again launched NIFTY Shariah 25 index on May 12th 2014, that includes 25 largest and most liquid stocks. Taqwaa Advisory and Shariah Investment Solutions (TASIS) is the screening partner of NSE for Shariah Indices. The Sharia compliance criteria on which stocks are included in the NIFTY50 Shariah Index is divided into business and financial screening.......
The Dilemma of Equity Risk Management
“We are all faced with a series of great opportunities brilliantly disguised as impossible situations.”
– Charles R. Swindoll
Azhar concludes that there is dire need of Sharia-complaint investment alternatives. He proposes investing in Sharia ETF as equity markets provide good long-term returns. Nevertheless, equity markets are prone to large drawdowns. Conventional methods of risk mitigation are non-Sharia-complaint...........
Assignment Questions
I. What are the concerned principles of IBF? Why IBF does sustain its performance unlike mainstream financial system?
II. What are the Shariah complaint investment products available in India?
III. What is equity risk and how it is managed?
IV. Why conventional methods of equity risk management cannot be used in IBF? What are the alternatives?
V. Why does gold act as a haven? How is holding gold ETF better than physical gold?
VI.....................
Tables
Table I: Summary Statistics
Table II: Correlation Matrix of Gold and Sharia ETF Prices
Table III: Augmented Dickey-Fuller Unit Root Tests. LogGold and LogSharia are Log Prices of Gold and Sharia ETFs
Table IV: VAR Lag Order Selection Criteria
Table V: LM tests
Table VI: Granger Causality Tests
Table VII: Johansen Cointegration Tests
Table VIII: Performance Summary of the Strategies
Table IX: Year-wise Return of the Strategies
Table X: T-test of the Strategy and Sharia ETF Returns
Table XI: F Test of Strategy and Sharia ETF Returns
Table XII: Performance Summary of the Strategy with Transaction Costs
Table XIII: Performance Summary of the Strategy with Nifty 100 with Gold or Midcap 100 with Gold ETFs