Is faith‐based investing rewarding? The case for Malaysian Islamic unit trust funds

Abstract

PurposeThe growing demand for alternative investment vehicle which adheres to shari'a principles has prompted other measures to boost the Islamic capital market. Unit trust funds in Malaysia have been growing exponentially and their existence signifies the extent of development in the Malaysian financial market. For foreign and domestic investors who have low risk tolerance and wish to diversify, unit trust funds offer the opportunity to invest. The increasing relevance of unit trust funds as an investment instrument has driven us to analyze the fund's performance. This paper addresses these issues.Design/methodology/approachThe paper examines the comparative performance of Malaysian unit trust funds vis‐à‐vis their non‐Islamic counterparts using a variety of measures, such as Sharpe, Treynor, Jenson and Fama's selectivity, net selectivity and diversification. The paper also examines the persistence of performance using Carhart's four‐factor pricing models. Lastly, the paper employs an analysis of cointegration to examine how the Islamic unit trust funds are related in long term with their non‐Islamic counterparts, as well as their respective market portfolios.FindingsThe paper finds no convincing performance differences between Islamic and non‐Islamic Malaysian unit trust funds. Controlling performance for style differences, the paper finds that non‐Islamic unit trust funds in Malaysia are value‐focused while Islamic unit trust funds are small cap oriented. In addition, similar reward to risk and diversification benefits exist only between Islamic and non‐Islamic Malaysian unit trust funds.Research limitations/implicationsThe Worldscope data are used to construct four‐factor models as opposed to Malaysian‐based data – given that Malaysia is an open economy that attracts global investors. Also, US T‐Bill rate is used rather than Malaysian risk‐free rate because no other securities are as riskless as US Treasury Bills.Practical implicationsThe paper observes a significant long‐term relationship between Islamic unit trust funds portfolio and non‐Islamic unit trust funds portfolio. The implication here suggests that investors in Malaysian unit trust funds will most likely benefit from international diversification of financial risks. They do not, however, stand a good chance to gain from portfolio diversification in the local unit trust funds market.Originality/valueThe study contributes to the existing Islamic investment literature by pursuing an empirical analysis on the performance of both Islamic and non‐Islamic Malaysian unit trust funds by using more recent data and further investigating the long‐run relationship between Islamic and non‐Islamic unit trust funds.