Conventional Portfolio Research Articles

Do green investments improve portfolio diversification? Evidence from mean conditional value-at-risk optimization

This study investigates how green investment assets improve optimal portfolio diversification in terms of tail downside risk. We use the wavelet conditional value-at-risk ratio to explore the benefits of adding green assets to conventional portfolios. We quantify risk based on the contagion between conventional stock market indices and green environmental assets, including a sustainability index, clean energy, and green bonds. Our findings emphasize the high variance between conventional stock pairs, providing evidence of contagion effects before and during the COVID-19 pandemic. We show that including clean energy and green bond indices in conventional portfolios reduces the extreme risk of portfolios. In addition, we find that the diversification benefits of clean energy, green bonds, and safe-haven investments apply especially in the short term during the pandemic. Finally, we show that the considered portfolios could not decrease long-term risk during the COVID-19 crisis because of the systematic risk spread. Our portfolio optimization design supports the superiority of clean energy and green bonds in portfolio diversification over the sustainability index. These insights can be used by portfolio managers to inform diversification in different investment horizons.

Does Islamic investing modify portfolio performance? Time-varying optimization strategies for conventional and Shariah energy-ESG-utilities portfolio

This paper aims to assess the performance of Islamic portfolios vis-à-vis their conventional counterparts across two distinct periods: the pre-COVID-19 era and the COVID-19 era. Departing from prior studies, this study makes a novel contribution by employing an extensive array of 18 portfolio optimization techniques to construct optimal portfolios for conventional stock indices encompassing energy, utilities, and environmental, social, and governance (ESG) dimensions, as well as their Islamic equivalents. Performance comparisons are made utilizing three risk-adjusted performance measures, namely the Sharpe ratio, the Omega ratio, and the Sortino ratio. Our findings reveal that Shariah portfolios outperform conventional portfolios across all performance measures and risk-aversion levels when the most effective optimization methods are employed, both during pre-crisis and crisis periods. Additionally, our analysis highlights certain methods, namely EWMA, GM, DCC, and SHC, which produce portfolios exhibiting superior performance relative to alternative methods, as assessed by risk-adjusted metrics. Furthermore, Islamic portfolios demonstrate higher average returns compared to their conventional counterparts. Notably, incorporating ESG-related stocks into energy and utilities assets significantly enhances average returns, underscoring the potential of ESG investments. Collectively, our findings have noteworthy implications for investors, as they emphasize the role of Islamic stocks as effective diversifiers, yielding favorable resource allocation opportunities during times of crisis as well as stability. However, investors should exercise caution in selecting the optimal portfolio optimization method, as substantial performance disparities exist among different approaches.

PORTFOLIO MANAGEMENT AND SYSTEMIC RISK IN THE AGE OF ARIFICIAL INTELLIGENCE

Artificial intelligence has emerged as a transformative force with profound implications for diverse domains, including finance and portfolio management. This paper delves into the multifaceted impact of AI on portfolio management and the dynamic landscape of systemic risk. The proliferation of AI is fueled by rapid advancements in computational capabilities, the abundance of extensive datasets, and breakthroughs in AI algorithms. It offers unparalleled accuracy, speed, and practical applicability, revolutionizing traditional paradigms. Globalization and AI applications have amplified systemic risks on a global scale, necessitating a reevaluation of risk management strategies. Conventional portfolio theories, like Modern portfolio theory, have historically emphasized the diversification of idiosyncratic risks while downplaying systemic risk. The comprehension and effective mitigation of systemic risks are paramount to preserving financial stability, particularly in the aftermath of systemic crises such as the 2007 2009 financial meltdown. AI's transformative potential extends beyond risk management, reshaping the labor landscape in asset management. Forecasts anticipate substantial job reductions in the field, prompting professionals to embrace adaptability and acquire new skill sets. This paper examines AI's integration into portfolio management, shedding light on the intricate interplay between AI, systemic risk dynamics, and investment practices. In conclusion, the integration of AI into portfolio management heralds an era of unparalleled opportunities and complex challenges. AI's capacity to process vast datasets, enhance pattern recognition, and refine predictive modeling has reinvented investment methodologies. However, this paradigm shift comes with inherent risks, especially pertaining to systemic instability. Identifying, understanding, and mitigating these risks is pivotal for sustaining financial market. Collaborative efforts among industry experts, regulators, and AI developers are instrumental in fostering responsible and sustainable AI integration within financial markets. As AI continues to exert its influence, professionals must remain adaptable and acquire new competencies to navigate the evolving financial landscape effectively. The future of portfolio management lies in harnessing AI's capabilities while safeguarding against potential pitfalls, ultimately steering the financial sector toward greater efficiency and resilience.

Portfolio instability and socially responsible investment: Experiments with financial professionals and students

Efficiency of SRI portfolios is commonly assessed based on an inconclusive risk-return ratio. We propose to approach the efficiency of portfolios with the notion of instability. Unstable portfolios are characterized by higher transaction costs and human resources costs that justify search for more stable portfolios. We examine the instability of SRI portfolios from the perspective of behavioral finance. Based on data from incentivized experiments with 153 financial professionals and 233 students, we compare a baseline treatment to a ranking treatment in which participants received feedback regarding their average investment in SRI assets. We found that SRI portfolios had significantly lower instability: portfolios with a majority of SRI shares exhibited less instability in both treatments compared to conventional portfolios. Moreover, in the ranking treatment subjects invested more in SRI assets than in the baseline. In addition, the experiment revealed the convergence of professionals’ and students’ behavioral patterns.

Bayesian optimization of ESG (Environmental Social Governance) financial investments

Financial experts seek to predict the variability of financial markets to ensure investors’ successful investments. However, there has been a big trend in finance in the last few years, which are the ESG (Economic, Social and Governance) criteria, due to the growing importance of investments being socially responsible, and because of the financial impact companies suffer when not complying with them. Consequently, creating a stock portfolio should consider not only its financial performance but compliance with ESG criteria. Portfolio optimization (PO) techniques previously applied to ESG portfolios, are all closed-form analytical ones. But the real world is rather a black box with unknown analytical expressions. Thus, in this paper we use Bayesian optimization (BO), a sequential state-of-the-art design strategy to optimize black-boxes with unknown analytical and costly-to-compute expressions, to maximize the performance of a stock portfolio under the presence of ESG criteria soft constraints incorporated into the objective function. And we compare it to two other black-box techniques widely applied for the optimization of ‘conventional portfolios’ (non-ESG ones): the metaheuristics Genetic algorithm (GA) and Simulated Annealing (SA). Although BO has many theoretical advantages over GA and SA, it has never been applied to PO. Thus, this paper investigates whether BO can be used in the ESG PO framework as an alternative and compares it with GA and SA. This is the research gap to which this paper responds. To show the empirical performance of BO, we carry out four illustrative experiments and find evidence of BO outperforming the baselines. Thus we add another different optimization approach to the world of ESG investing: a black-box non-heuristic optimization approach through BO. Our study is the first paper that leverages BO and ESG scores into a PO technique. This paper opens the door to many new research lines in (ESG) portfolio optimization.

Political risk and portfolio performance: implications for Shariah-compliant investors

Purpose Political risk is an important determinant of portfolio returns. The basic purpose of this study is to revisit the importance of political risk in a constrained portfolio, namely, a Shariah-compliant equity portfolio (SCEP). Furthermore, the performance of such a constrained portfolio is also compared with a conventional portfolio that invests in all stocks. Design/methodology/approach The portfolios are constructed from stock-level data and invested in 61 international markets. The set of Shariah-compliant stocks is obtained with screening guidelines of Dow Jones Islamic Market indices. The weights of each constituent in both Shariah-compliant and conventional portfolios are driven by its relative exposure to political risk for the period 1996–2018. Findings Results show that, compared to conventional investors, 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 SCEP successfully reduces the downside risk, resulting in improved financial performance stability. Originality/value To the best of the authors’ knowledge, this is the first effort of its nature to highlight the importance of political risk in the context of SCEPs.

Is the Performance of Conventional and Shariah-Compliant Portfolios Two Sides of the Same Coin? Evidence from Bursa Malaysia

This study arises from the rapid global growth of the Shariah-compliant financial services industry and the evident paucity of research on the direct comparison between a conventional portfolio and a Shariah-compliant portfolio. Therefore, this study undertakes to investigate the differences in the performance between a hypothetical conventional portfolio and a hypothetical Shariah-compliant portfolio on Bursa Malaysia over the 1 December 2005-28 February 2018 examination period. The examination period is divided into: (1) the overall period (1 December 2005-28 February 2018); (2) the bullish 1 period (1 December 2005-30 June 2007); (3) the crisis period (1 July 2007-28 February 2009); (4) the bullish 2 period (1 March 2009-30 June 2014); and (5) the consolidation period (1 July 2014-28 February 2018). The risk and return characteristics, the risk-adjusted return measures, the return correlation measure, and the sample paired t-test are the performance evaluations employed in this research. The results revealed that the performance of the conventional and Shariah-compliant portfolios was broadly similar in different economic regimes.

Re-evaluating the hedge and safe-haven properties of Islamic indexes, gold and Bitcoin: evidence from DCC–GARCH and quantile models

PurposeThis paper aims to investigate the hedge, safe-haven and diversifier properties of Islamic indexes, Bitcoin and gold for ten of the most affected countries by the coronavirus, which are the USA, Brazil, the UK, Italy, Spain, Germany, France, Russia, China and Malaysia.Design/methodology/approachThis research uses the Ratner and Chiu (2013) methodology based on the dynamic conditional correlation models to improve Baur and McDermott (2010). The authors adopt a careful investigation of the features of a diversifier, hedge and safe haven using the dynamic conditional correlation–GARCH and quantile regression models.FindingsEmpirical results indicate that Islamic indexes are not considered as hedge assets for the conventional market for all studied countries during the COVID-19 pandemic crisis period. However, gold works as a strong hedge in all countries, except for Brazil and Malaysia. Bitcoin is a strong hedge in the USA and a strong hedge and safe haven in China.Practical implicationsInternational investors in China and the US stock markets should replace Islamic ‎indexes with Bitcoin in their conventional portfolio of securities during the pandemic.Originality/valueTo the best of the authors’ knowledge, this is the first paper that re-evaluates the hedge, safe-haven and diversifier properties of Islamic indexes, Bitcoin and gold for ten of the most affected countries by the coronavirus.

Fama and French (1993) Three-Factor Model: Evidence from Conventional and Shariah-Compliant Portfolios in Bursa Malaysia

The main objective of this research is to test whether the style factors employed by the Fama and French (1993) three-factor model adequately explain the performance of four conventional sub-portfolios sorted by book value-to-market value (BVTMV) and their Shariah-compliant counterparts in Bursa Malaysia over the examination period from 1 December 2005 to 28 February 2018. To ensure the regression results of this research are unbiased estimations, tests for unit root, heteroskedasticity and autocorrelation bias were conducted on the regression variables. The regression test was conducted by regressing the monthly excess returns of the conventional and Shariah sub-portfolios on the monthly returns of the three factors of Fama and French (1993), which are the market risk premium, the small-cap risk premium, and the value risk premium. The results of this research revealed that the Fama and French (1993) three-factor model can significantly explain the performance of the four conventional sub-portfolios sorted by BVTMV and the four Shariah-compliant sub-portfolios sorted by BVTMV in Bursa Malaysia.

Portfolio replication: Islamic vs conventional

PurposeThis conceptual paper aims to explore portfolio replication to resolve post-COVID pandemic private and public debt. This paper stresses the need to be less dependent on a debt-based system and the emergence Islamic equity market.Design/methodology/approachThis study analyses different types of risks involved in Islamic and conventional portfolios by using risk measures such as relative beta and comparatively examining the systematic and downside risk exposure of Islamic and conventional portfolios. Data was collected monthly from 2016 to 2022.FindingsThe findings indicate that the replications of a conventional portfolio into an Islamic portfolio are compatible with the regulatory standard, sharia boundaries and professional practices developed from investment theory. The result shows that Islamic portfolios have lower risk exposure compared with their conventional counterparts in most of the sample years, therefore, become further attractive for debt–equity portfolio swaps and Sharia-compliant investors preferring low-risk preferences. The result confirmed that the Islamic portfolios have a higher return and less risk than conventional portfolios.Research limitations/implicationsThe implications of this research are to provide a road map to the regulators, policymakers, governments and the financial industry on how to rearrange some of the public and private debt. A likely remedy is incorporating Islamic financial instrument principles through the equitisation of public and private debt.Practical implicationsThis research contributes to investors (particularly those who want to avoid riba [usury] based investment) to make more diversified portfolios by considering Islamic portfolios to reduce risk exposure.Originality/valueTo the best of the authors’ knowledge, this is the first paper to create bivariate debt–equity portfolios swaps composed of Islamic and conventional assets.

A Behavior Perspective of Distress Anomaly: Evidence From Overnight Returns

Using measurement of overnight returns, this article documents that trading behaviors due to information shocks and investor sentiments contribute to distress anomaly. We find that stocks with the highest (lowest) overnight returns are accompanied with the greatest (smallest) distress risk premium, and accordingly, a conditional distress probability portfolio composed with double sort of overnight returns and distress probability would yield significant profitability. The regression outcomes demonstrate that probability of default significantly interacts with average overnight returns in explaining the future stock returns. The conventional distress anomaly is subsumed by the conditional distress factor, but not vice versa; and only profits of conventional distress-probability portfolios, not of the conditional portfolios, mainly come from stocks with characteristics that are associated with stock mispricing. The empirical results indicate that investors hold distressed stocks longer than expected because positive information shocks occur with high level of information supply and good information quality.

Portfolio Performance of Islamic Versus Conventional Market Indices and Regime Shift Behavior: Empirical Evidence from Asian Emerging Markets

Purpose: The main objective of this study is to examine the performance analysis of Islamic and conventional portfolio of emerging market of Asia and to investigate whether Islamic indices outperform the conventional indices or not. Moreover, to investigate the regime shift behavior of these markets.
 Design/Methodology/Approach: Emerging markets of Asia like China, India, Indonesia, Malaysia, Pakistan and Thailand are taken. Data is taken for the period January 2010 to December 2019. Data frequency is on monthly closing prices basis for both markets. Risk adjusted measures like Sharpe ratio, Treynor ratio and Jensen alpha are used for performance evaluation. Markov switching model is used to investigate the performance of both indices. Morgan Stanley capital international risk- free rate is used as risk proxy.
 Findings: Sharpe ratio is outperformed in Islamic markets while Treynor ratio is outperformed in conventional markets. Jensen alpha is outperformed in Islamic market so result proved that mostly Islamic markets is outperformed. The Markov switching model divide the MSCI returns into two parts recession and expansion. Results indicated that the presence of regime in both recession and expansion period so investor can diversify the international portfolios. Mix portfolio strategy is indicated that investor behavior is indifferent. There is a change in both regime in recession and expansion period so investor consider the international portfolio diversification with regime shifts.
 Implications/Originality/Value: This study is important for global investor as well as local investor for portfolio diversification. This study is also important for academic scholars, Regulatory authorities and for those who is interested in Islamic funds by their religious views.

The impact of Islamic portfolio on risk and return

The purpose of this study is to investigate the comparative impact of conventional and Islamic bonds over returns. It provides useful insights to investors to diversify investment by lowering the risk to the optimum level. This study examines the impact of the conventional and Islamic portfolios on returns through simple OLS regression, suggesting that Sukuk returns are positive and significant. Simultaneously, conventional bonds show a negative trend, but in the long run, the returns are significant. It indicates that the market is volatile due to macroeconomic factors that can reduce risks through portfolio diversification. Thus, this research suggests that investment can be secured by taking a rational portfolio decision that confirms robustness. Therefore, it is a good opportunity for the investors to get high margins over the investment tenure.

Doing well by doing good with the performance of United Nations Global Compact Climate Change Champions

Are Climate Change Champions favorable to investors? This is the first study of portfolio performance of a fourth generation SRI screening strategy based on United Nations Global Compact firms who are Climate Change Champions. The operational changes made by UNGC firms are real and disproves the notion that UNGC firms are merely green-washing. We find that after firms join UNGC, there is a positive effect on long term portfolio performance. UNGC firms have lower volatility and so less risk than their competitors. We find an apparent mispricing of lower risk in market returns as standard asset pricing models may not be pricing investors’ aversion to climate change risk and preference for firms actively combating climate change. This lends support to Fama and Frenchs’ theory that says that these “tastes” are valid factors to provide a more complete asset pricing model. Our study encourages investment in UNGC-CCC firms as we find there is no underperformance penalty against a conventional portfolio because the lower return reflects lower risk. Thus, our evidence suggests that “doing good for society is also good for business.”

Portfolio optimization of financial commodities with energy futures.

The recent growth in economic and financial markets has brought the focus on energy derivatives as an alternative investment class for investors, financial analysts, and portfolio managers. The financial modeling and risk management of portfolios using the energy derivatives instrument is a requirement and challenge for researchers in the field. The energy and other commodity futures force the expert investors to investigate the broader investment spectrum and consequently diversify their portfolios using the futures instruments. Going beyond the conventional portfolios and developing out-of-the-box strategies that comply with the changing financial and economic advancements are the keys to long-term sustainability in the financial world. This study investigates the impact of diversification with five energy futures from January 2011 to July 2020 on three traditional commodity futures portfolios. The results show that diversification increased the returns while simultaneously reducing the portfolio volatility in all portfolios. The diversified portfolios provided higher returns than the traditional portfolios for the same level of risk. This study also revealed that the results might improve when a short position in the futures contracts is allowed. Moreover, we conclude that adding multiple energy futures in a portfolio provides enhanced diversification results, whereas the WTI crude oil futures fail to diversify any portfolio considered in the study.

Make the Best from Comparing Conventional and Islamic Asset Classes: A Design of an All-Seasons Combined Portfolio

This paper aims to contribute to the existing literature in portfolio management and strategy by investigating the performance, diversification, and hedging benefits arising from integrating Sharia-compliant stocks into a conventional portfolio. Thus, this paper tests the performance of a Combined Portfolio, resulting from the combination of conventional Islamic instruments, covering different macroeconomic scenarios in the last decade (2010–2020). The strategic asset allocation was designed following the Global Macro Anima (GMA) strategy, solving a risk-parity optimisation problem using a specifically developed MATLAB™ algorithm. The findings will contribute to answering the question related to the possibility of including alternative instruments to increase diversification with hedging benefits by building asset allocations that perform well across different macroeconomic scenarios.

Quantitative Sharia-Screening Effect on Portfolio Performance and Volatility: Evidence from Indonesia

The aim of this study is to examine the comparative performance and volatility between Sharia and conventional portfolios listed on the Indonesia Stock Exchange (IDX) and to investigate the effect of quantitative (debt-ratio) screening on the Sharia-and-conventional-portfolios returns specifically applied in the selected public firms with the inter-industrial low-correlations. Applying a non-parametric test, the autoregressive integrated moving average (ARIMA) model, and the regression analysis, the results suggest that there is no difference in performance between Sharia and conventional portfolios; Sharia portfolios show the lower risks than conventional portfolios. Using quantitative Sharia-screening, the debt-to-equity ratio (DER) affects Sharia-portfolio returns, but not conventional-portfolio returns. This study contributes to providing country-specific evidence on applying quantitative Sharia-screening. Taking notice of the existing high-profile debt-ratio and applying the relatively loose standard of quantitative Sharia-screening for the public firms in Indonesia, this suggests that a country-specific quantitative Sharia-screening standard should be supported.

The Classification of Sharia Assets and Performance of Financial Portfolio

The paper investigates the Shariah compliant and conventional portfolios in financial settings of Pakistan during the period 2009-2019 by using Markowitz Minimum-Variance (MMV) framework. Using daily excess returns, we first investigate the impact of Shariah screening criteria on stock returns then we evaluate the overall risk of Shariah compliant and conventional portfolios. The results reveal negative impact of Shariah screening criteria on stock returns’ cross-section. Further, unconstrained portfolio investment strategy outperforms faithbased investing. Finally, the findings of the study suggest that induction guidelines employed in PSX for companies to be listed in Shariah compliant index needs to be reviewed to practically attain the objectives of Islamic moral economy such as avoiding Gharar (uncertainty) and Maysir (speculation). More importantly formulate a criterion that truly reflects Islamic principles of investing. In addition, more could also be done to educate investors about Shariah compliant stocks and enhance the projection of Shariah compliant index. Secondly, our study also indicates that investors that prefer faith based investing should be aware of the costs of faith investment in PSX. Investors can encounter additional costs while investing in Shariah compliant stocks. Moreover, these additional costs are driven high risk and low performance of faith portfolios.

Network-augmented time-varying parametric portfolio selection: Evidence from the Chinese stock market

Recently, the connection between assets in a portfolio has attracted widespread attention. How to improve the performance of a large portfolio selection from the perspective of network is still a challenging but meaningful work. To this end, we propose a novel network-augmented time-varying parametric portfolio selection model labeled as NA-TVPP. First, we construct a financial network using the least absolute shrinkage and selection operator-vector autoregression (LASSO–VAR) approach. Then, we extract two network topological characteristics and incorporate them into the time-varying parametric portfolio selection (TVPP) model to improve its performance. Finally, we apply it to construct a portfolio using the constituent stocks from the Shanghai Stock Exchange (SSE) 50 Index of China from 2010 to 2019. The empirical results illustrate the effectiveness of the NA-TVPP model in two aspects. To be specific, the NA-TVPP model outperforms several conventional portfolio selection models in terms of standard deviation, Sharpe ratio, and efficient frontier. Additionally, the stock network topological characteristics, such as degree centrality (DC) and eigenvector centrality (EC), are significant to portfolio selection through the negative effect on the weights.

Investor behavior and the demand for conventional and socially responsible mutual funds

AbstractThis study analyzes the demand for conventional and socially responsible (SR) mutual funds using cash flow data from a large sample of U.S. equity funds. For both types of funds, previous results have a positive impact on inflows. However, redemptions' behavior differs. Outflows correlate negatively with past results in conventional portfolios, whereas this relationship is positive for SR funds: investors are more likely to redeem shares in the best‐performing funds while holding funds that performed poorly. This behavior is compatible with a disposition effect in SR funds. These results hold even after controlling for other variables driving mutual fund demand. Hence, inflows and outflows of conventional funds were found to be positively related to past idiosyncratic risk, expenses and turnover, but negatively related to size and age. For SR funds, these relationships are stronger for size and idiosyncratic risk, and take the opposite sign for age, expenses and turnover.