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Mixing Equity with Gold: A Case of Islamic Risk Management

IIT Kharagpur, 16 Pages
AUTHOR(S) : Adnan Ahmed Siddiqui and Arun Kumar Misra - Vinod Gupta School of Management, IIT Kharagpur

Case Preview

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?


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

Teaching Note Preview

Mixing Equity with Gold: A Case of Islamic Risk Management


Islamic Banking and Finance (IBF) is an emerging market segment. It is based on Islamic principles dealing with risk-sharing, materiality, non-exploitation of transacting parties, and prohibition of sinful activities as per the Holy Quran. Out of all the prohibited activities, prohibition of charging or paying interest makes conventional financial and banking system useless for an investor keen to adhere to these principles. Interest is at the heart of conventional financial and banking system. However, this avoidance of the system deprives people of basic financial needs. It creates a dilemma whether to compromise the principles to become part of the system or keep suffering the hardships by not being part of it. Moreover, the non-participation in the system impedes achievement of financial inclusion goals, a priority among governments across the world.

To take care of people being in economic backwaters due to avoidance of mainstream financial and banking system, many banks came up with separate IBF divisions to cater to these clients. These new ventures have been highly profitable, particularly during financial crisis. Many governments permitted IBF in their markets which resulted in improved financial inclusion and economic well-being of its people. In fact, IBF segment has emerged as a highly profitable segment. It is also being marketed as an ethical and socially conscious financial product segment.

IBF segment in India is almost non-existent. Although there are some equity-based investment products available, there are no Shariah complaint financing or insurance products. Even with the available investment products it is difficult to develop a sound investment plan due to highly risky nature of equity. Given this context, the case deals with equity risk management using gold and develops a profitable strategy.

Teaching Objectives and Target Audience

This case makes an important contribution to Shariah complaint risk management. It can be used as an brief introduction to IBF. The case is targeted at students of master’s degree in Management and Finance. It can be made part of finance courses such as Financial Markets, Security Analysis and Portfolio Management to introduce students to econometric analysis. The case also demonstrates how to develop an investment strategy under constraints. It highlights major aspects of a quantitative trading strategy. This will inspire students to come up with variants of this strategy or their own strategy. The case will also benefit participants in MDPs and FDPs....................

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Product code: BFS-1-0014, BFS-1-0014A


This case study develops and tests a risk management strategy given intricacies of Islamic investment. The approach uses two sharia-complaint financial instruments, a sharia ETF, and gold ETF. Primarily, the relationship between them is examined. Given the relationship, a strategy is formed using an indicator based on David Varadi Oscillator (DVO). The indicator signals holding the sharia ETF as a long-term instrument. It shifts to holding gold when the sharia ETF is overbought, and gold ETF is oversold. When this specific condition is gone, it again indicates to holding sharia ETF. This strategy provides considerable profit over holding either gold ETF or sharia ETF.

Pedagogical Objectives

This case study helps to understand:

  • Current scenario of Islamic Finance
  • Intricacies of Shariah-complaint investment
  • Formation of an investment strategy based on econometric relationships

Case Positioning and Setting

  • Security Analysis and Portfolio Management
  • Introduction to Islamic Finance
  • Primer on Econometrics, particularly Time Series

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    - Abstract
    - Case Study
    - Teaching Note (**ONLY for Academicians)

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