Political Risk and Portfolio Performance: Implications for Shariah-Compliant Investors

Abstract

Political risk is an important determinant of portfolio returns. In this study, we revisit the importance of political risk in the context of a constrained portfolio, namely a Shariah-compliant equity portfolio, invested in 61 international markets. The weights of each constituent are driven by its relative exposure to political risk for the period 1996–2018.Results show that, in comparison with conventional investors, the Shariah-compliant investors gain substantial benefits when the allocation decision is based on political risk. A Shariah-compliant portfolio outperforms its conventional counterpart by 7.98% annually when tilted toward politically stable countries. The economic benefits further increase to 804 basis points when the portfolio allocates more funds to politically unstable countries. The tilted Shariah-compliant equity portfolio successfully reduces the downside risk, and hence results in improved stability in financial performance.