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Borsa Istanbul Review 19-3 (2019) 207e218
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Full Length Article

Doing well while doing good: The case of Islamic and sustainability equity
investing
Wajahat Azmi a,*, Adam Ng a,b, Ginanjar Dewandaru a, Ruslan Nagayev c
a
International Centre for Education in Islamic Finance (INCEIF), Kuala Lumpur, Malaysia
b
Oxford Centre for Islamic Studies and Global Economic Governance Programme, University of Oxford, UK
c
Istanbul Sabahattin Zaim University, Turkey
Received 15 August 2018; revised 23 January 2019; accepted 1 February 2019
Available online 7 February 2019

Abstract

The objective of this paper is to investigate the notion of “doing well while doing good” through examining the performance of Islamic,
sustainability, and Islamic sustainability equity indices and comparing against the global equity market benchmark. Specifically, we address
three key issues that are of concern to most investors: (i) how different are the global portfolio's efficient frontiers that comprise the four types of
equities?; (ii) what are the driving factors behind these index performance differences?; and (iii) do the performance and volatilities of these four
indices vary across time-periods and regimes? Overall, our findings reveal that investors do not have to pay a price for investing in Islamic or
sustainable equity indices. In fact, combining Islamic and sustainability investing strategies are more rewarding, particularly during the eco-
nomic boom, bullish equity markets and subprime crisis periods. Policy implications are provided.
_
Copyright © 2019, Borsa Istanbul Anonim Şirketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-
ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Keywords: Islamic equity; Sustainability investing; Wavelet analysis; Efficient frontier; Bayesian model averaging; Markov switching

1. Introduction also progressed on a double-digit growth trajectory, with an

Sustainable, responsible and impact investing (SRI) (also
known as sustainable investing/socially responsible investing
and ethical investing) has witnessed significant growth and
acceptance in the global financial industry, particularly in the
last decade.1 It has been hailed as one of the significant de-
velopments in the financial industry (Bauer, Koedijk, & Otten,
2005). Global SRI assets rose 61 percent, from $13.3 trillion at
the outset of 2012 to $21.4 trillion in 2014. As a result, the
assets employing sustainable investing strategies have risen
from 21.5 percent to 30.2 percent of professionally managed
assets (GSIA, 2015). At the same time, Islamic finance has
* Corresponding author.
E-mail address: wajahat_azmi@yahoo.com (W. Azmi).
_
Peer review under responsibility of Borsa Istanbul Anonim Şirketi.
1
The terms socially responsible investment, sustainable investment, and
ethical investment are used interchangeably in the paper.
increase from $200 billion in 2003 to $1.8 trillion by the end
of 2013 (Kammer et al., 2015). However, the growth has
slowed to a single digit in last few years (Dar 2017). Within
the Islamic asset allocation universe, equity funds represent
one-third of Islamic funds worldwide. Islamic equity indexes
have proven to be valuable to Islamic fund managers, who
have been benefiting from the standardized screening meth-
odologies and growing number of Shari'ah-compliant secu-
rities, as well as to those investors searching for portfolio
diversification and ethical investment opportunities (IFSB,
2015).
SRI is a broad term that encompasses any investment
strategy that fulfills the investors' financial objectives along
with their concerns about the environmental, social, and
governance (ESG) issues (Mu~noz, Vargas, & Marco, 2014). In
essence, SRIs have dual objectives: to generate financial
returns and nonfinancial utility (ESG benefits). Along these
lines, Islamic investing can be categorized as a subset of

https://doi.org/10.1016/j.bir.2019.02.002
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2214-8450/Copyright © 2019, Borsa Istanbul Anonim Şirketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND
license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
208 _
W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218
socially responsible investing. However, the main difference
between the two is the guiding principles that dictate the
screening criteria. The screening criteria of Islamic investing
are based on religious guidance, whereas socially responsible
investing relies solely on what society or a group of people
perceive as ethical, sustainable, and promoting good gover-
nance. Because both these types of investments are guided by
different principles, at times, an investment can be considered
to be ethical, but it may not be Islamic.
Islamic investing norms screen out businesses engaged in
immoral activities such as production of weapons and gambling
(on the basis of qualitative criteria) and firms that exceed a certain
level of leverage and interest-bearing investments (on the basis
of) quantitative criteria. Large non-compliant firms are generally
excluded from the pool of investable assets. This restricts the
Shari'ah-compliant investable universe and increases the vola-
tility of the portfolio because of its underdiversification, pre-
ponderance of smaller firms, and sector concentration (Hussein
& Omran, 2005).2 Yet some studies have shown that levered
firms also tend to have lower current returns but volatile stocks
(Black, 1976; Christie, 1982). On the positive side, the low
leverage and asset-backed nature of Islamic equities imply that
the real and financial sectors are closely linked, limiting exposure
to volatility spillovers (Majdoub & Mansour, 2014). In short, the
viability of Islamic equity as a diversifier to conventional equity
has been scrutinized in the literature, with a range of findings.3
Considering the significance of the investment universe and
its implications for asset allocation, this study explores
whether there is a cost attached to investing in a sustainable/
ethical manner from the Islamic and/or sustainability per-
spectives. This question has been examined before. Opponents
argue that such an investment strategy will always deliver
inferior risk-adjusted performance because it suffers from
underdiversification and suboptimal mean-variance in the
portfolio (Markowitz, 1991). However, a growing body of
literature is yielding mixed results (Belghitar, Clark, &
Deshmukh, 2014). Most of these papers argue that these in-
vestment strategies are on par with the performance of their
conventional counterparts.4
2
As of March 2015, the Dow Jones Islamic Market World Index has only
2590 components, compared to the global universe of 7257 components in the
Dow Jones Global Index. Islamic equity indexes are typically focused on
growth and small-cap equities, while conventional indexes are oriented toward
value and mid-cap equities (Girard & Hassan, 2008). The effect of the con-
centration on small firms and certain sectors on performance is debatable.
Hussein and Omran (2005) argue that basic materials, consumer cyclicals,
industrials, telecommunication industries, and small firms are the driving
forces in the positive abnormal returns of Islamic index.
3
In the mainstream conventional financial market, studies on global stock
return co-movements and time-varying world market integration have been
conducted by Bekaert and Harvey (1995), Bekaert, Hodrick, and Zhang
(2009), and Baele, Bekaert, and Inghelbrecht (2010), among others.
4
The number of Islamic asset classes has increased over the years as in-
vestors have become more religiously conscious. This implies that the mean-
variance would not be substantially affected. Also, in the early days of Islamic
investment, these asset classes formed a very small portion of the overall
universe, contributing to higher screening costs.
This study revisits the debate on the notion of “doing well
while doing good” by examining the performance of two in-
vestment strategies: sustainable investing and Islamic invest-
ing. Specifically, it compares the performance of sustainable
equity, Islamic equity, and Islamic sustainable equity (as the
mixture of two approaches) to the global equity market
benchmark. The samples of this study are derived from four
major indexes offered by Dow Jones: the Dow Jones Islamic
Market World Index (DJ Islamic), the Dow Jones Sustain-
ability World Index (DJ Sustainability) and the Dow Jones
Islamic Market Sustainability Index (DJIS), with the Dow
Jones Global Index (DJ Global) serving as a market
benchmark.
This paper extends the literature in several ways. First,
we examine the risk-adjusted returns and efficient frontiers
of both the Islamic and sustainability indices not only at
the level of individual equity asset class but also at the
portfolio level of “mixed” global asset classes. Second, we
examine the factors driving these indices in the form of
factor premium (market, size, value and momentum)
within the factor model. In that case, we apply Bayesian
model averaging in order to estimate the factor contribu-
tion within the appropriate model. Third, we examine the
performance during different economic conditions across
different regimes, corresponding to investors' preference
for both strategic and dynamic asset allocations. The
regime changes are determined based on Markov switching
analysis. These regimes include the subprime crisis, the
Dotcom crisis, economic expansion, equity bullish and
bearish period, high default and low default premium, as
well as high term premium and low term premium. Fourth,
since most of the previous studies have analyzed these
indices at the portfolio level and the volatility aspects of
these indices are largely ignored, we examine the volatility
dynamic of these indices by using multivariate generalized
autoregressive conditional heteroskedasticity (MGARCH)
analysis. Finally, to accommodate the needs of investors
with respect to their varying investment horizons, we
assess the co-movements among the indices across multiple
timescales (4, 8 to 512 and 1024 days) using Wavelet
analysis. This method of analysis would enable us to
identify diversification opportunities across different hori-
zons of investment, if any, between the indices.
Precisely, besides investigating the performance, this paper
addresses several unexplored issues: a) how different are the
global portfolio's efficient frontiers that comprise the four
types of equities?; b) what are the driving factors behind these
index performance differences?; and c) do the performance
and volatilities of these four indices vary across time-periods
and regimes? To answer such questions, we use novel meth-
odologies such as wavelet coherence, MGARCH, Bayesian
model averaging, Markov switching and efficient frontier
analyses.
We report three new findings. First, the most efficient
frontier is that of DJ Islamic portfolio, except during the Dot-
com crisis. This is in sharp contrast to the traditional portfolio
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W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218
theory which argues that the screened portfolios suffer from
diversification issues.
Second, the main driver of DJ Islamic is value and size
investing followed by momentum investing.5 This suggests
that DJ Islamic comprises of small-value stocks which possess
the two best qualities: size and value. These results are similar
across DJIS and the DJ Sustainability. On the other hand,
value and momentum are more important in case of DJ Global.
Third, there is a high degree of co-movements of the 4
indices across multiple timescale (4, 8 to 512 and 1024 days)
over 1996e2014. These findings indicate minimal diversifi-
cation opportunities for those who wish to invest in these
indices. The lack of diversification is evident in not only short
run but long run as well. These results are not in line with the
extant literature. For instance, Saiti et al., (2016) report no
contagion between Islamic and conventional index whereas
Najeeb, Bacha, and Masih (2015) argue that the co-movement
is contingent on the time-scale.
In the next section, we briefly discuss the literature fol-
lowed by the description of data and methodology in section 3.
We elaborate our findings in section 4 and conclude in section
5.
2. Literature review
2.1. Comparative studies in performance
The literature on ethical and Islamic investing can be
broadly classified into three strands. The first claims that these
portfolios are bound to underperform a conventional bench-
mark/portfolio (see Abdullah, Hassan, & Mohamad, 2007 and
Mansor & Bhatti, 2011 for Islamic indexes). For instance,
Abdullah et al. (2007), using a range of performance meas-
uresdsuch as the Adjusted Sharpe Index, Treynor Index,
Adjusted Jensen Index, Modigliani Measures, and the Infor-
mation Ratiodcompare the performance of 14 Islamic and 51
conventional Malaysian unit trusts from January 1992 through
December 2001. Their findings suggest that Islamic funds
generated lower returns than conventional funds. Mansor and
Bhatti (2011) report similar findings. However, these indexes
suffer from higher moments of the return distribution.6 Similar
results on a sample of 116 French SRIs are reported by
Capelle-Blancard and Monjon (2014), who document the
underperformance of these funds over 2004e07.
The second strand of studies, which forms the majority of
the literature, argues in favor of outperformance.7 Hussein and
Omran (2005) examine the performance of the Dow Jones
Islamic Index against its conventional counterpart. Using
monthly samples from 1995 to 2003, they report superior
returns on the Islamic index. Similarly, using the sample from
5
To make our results clearer, we present the evidence of factor premiums in
Fig. 2.
6
These performance measures rely on the first two moments only (mean and
standard deviation) only and ignores other moments (skewness and kurtosis).
7
For Islamic indexes, see Hussein and Omran (2005) and Islam and Habib
(2014). For SRI indexes, seeCollison et al. (2008).
209
India and Malaysia, Islam and Habib (2014) compare the
performance of Islamic index with its counterpart. Their
findings reveal that the Islamic index in both countries
managed to outperform their conventional peers. For the case
of SRIs, Collison, Cobb, Power, and Stevenson (2008), using
the sample of FTSE4Good indexes from 1996 to 2005,
conclude that these indexes outperformed the conventional
benchmarks.
The third strand of literature finds that the difference in
performance is negligible.8 Focusing on Islamic indexes,
BinMahfouz and Kabir Hassan (2013) examine the compara-
tive performance of the family of Dow Jones index-
esdincluding the Dow Jones Islamic Index, the Dow Jones
Islamic Sustainability Index, the Dow Jones Sustainability
Index, and the Dow Jones World Indexdagainst the MSCI
(Morgan Stanley Capital International) Index and suggest that
there is no significant performance difference between the
screened and the unscreened indexes based on the Sharpe
ratio, as well as single and multi-factor models.9
Focusing on SRIs, Sauer (1997) and Statman (2000)
compare the performance of the Domini Social Index to the
S&P 500, using the conventional performance measures such
as the Sharpe ratio and the capital asset pricing model
(CAPM). Both studies find no performance difference between
the SRIs and their conventional peers. Similarly, Statman
(2006) reports that other prominent indexes such as Calvert's
Social Index, Citizen's Index, and Dow Jones Sustainability
US Index do not exhibit any significant difference. More
recently, Ortas, Moneva, and Salvador (2014), using SRIs
from Europe, report no significant performance difference
between the SRIs and their conventional peers. Their sample
consists of Dow Jones Sustainability Stoxx and EuroStoxx
indexes.
The findings on underperformance of ethical/Islamic assets
are broadly due to three factors. First, as mentioned, such
portfolios suffer from the lack of instruments for diversifica-
tion. As a result, it is argued, the mean-variance portfolio will
always be suboptimal (Markowitz, 1991). The second reason
that has been put forth is that these portfolios are subset of the
larger universe and hence will always underperform. Under-
performance could also be due to the investment restrictions in
certain prohibited lines of business. For instance, portfolios
would not be able to benefit from profitable opportunity that is
in direct or indirect contradiction to ethical and/or Islamic
principles (Nainggolan, How, & Verhoeven, 2015). Finally,
these investments strategies also suffer from extra costs in the
8
For Islamic indexes, see Girard and Hassan (2008); Hassan, Antoniou, and
Paudyal (2005); BinMahfouz and Kabir Hassan (2013); Ho et al. (2014). For
SRIs, see Sauer (1997); Statman (2000, 2006); Schr€oder (2007);Ortas et al.
(2014).
9
Ho et al. (2014) examined 12 conventional and Islamic indexes from eight
different countries. Based on the Sharpe ratio, Treynor index, and other per-
formance measures, they argue that the performance of Islamic indexes is very
much dependent on the time period. For instance, the comparative perfor-
mance of these indexes during the dot-com crisis is mixed. While Islamic
indexes managed to do better than their conventional counterparts during the
global financial crisis, both indexes generated negative returns.
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W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218
form of screenings by Shari‘ah Advisory Councils (Islamic
investments) and the Ethical Advisory Boards (socially
responsible investments).
As for the findings on outperformance of ethical/Islamic
assets, the literature claims that these stocks reduce the po-
tential conflict between stakeholders and the managers that
may arise due to corporate fraud and/or environmental di-
sasters. These reduced conflicts may result in higher net pre-
sent values (Heal, 2005). However, these benefits can be
reaped only in the long term (Renneboog, Ter Host, and Zhang
2008). On the other hand, Allen, Carletti, and Marquez (2007)
find that firms that design policies so as to take care not only of
shareholders but also all stakeholders yield more value for
investors through increased financial performance.
Advocates that support the “no performance difference”
notion argue that markets are efficient and hence any value
proposition, whether in form of religious and or ethical values,
will not be able to affect stock prices. In other words, stock
prices already reflect the premium or discount of these firms
(Bebchuk, Cohen, & Wang, 2013)dalthough some also argue
that these indexes provide safer haven during the crisis period.10
2.2. Factor premiums and regime changes
As discussed, this study investigates the contributing fac-
tors to both sustainable and Islamic equities to assess the
differences in factor exposures. Analyzing the contributing
factors is important given the strand of literature documenting
the superiority of factor-based asset allocation relative to
asset-classesebased asset allocation (Bender et al. 2010, 2013;
Clarke, de Silva, & Murdock, 2005; Page & Taborsky, 2011).
This study also investigates the performance across
different regimes. Many empirical studies show that the
returns of various asset classes interact in complicated ways
with different macroeconomic regimes, along with a very
different distribution of asset returns (Ang & Bekaert, 2002;
Calvet & Fisher, 2005; Detemple, Garcia, & Rindisbacher,
2003; Honda, 2003; Lettau, Ludvigsson, & Wachter, 2005).
As a result, and with the expansion of new market data, the
shape of the classical mean-variance frontier (MVF) and the
location of the efficient portfolios have changed drastically
(Sch€ottle & Werner, 2006). The more efficient and desirable
risk-reward combinations of the state-dependent frontier can
be achieved only by systematically adjusting allocations as the
economy switches back and forth between different states
(Clarke & de Silva, 1998). In particular, studies have exam-
ined how the presence of regimes in means, variances, and
correlations of asset returns can be translated into explicit
dynamics of the Markowitz mean-variance frontier (Guidolin
& Timmermann, 2005a; 2005b; 2006a; 2006b; 2006c, 2007).
To the best of our knowledge, there is no prior study that
has investigated the performance of either sustainable or Is-
lamic equities within the mixture of the global asset classes
10
For Islamic indexes, see Al-Khazali et al. (2014) and Ho et al. (2014). For
SRI indexes, seeNofsinger and Varma (2014).
_
portfolio, nor is there any prior study that has assessed the
performance, taking into account regime changes, multi-
horizon investments, and factor premium exposures. This
study attempts to fill the gap by examining the performance of
sustainable equities and Islamic equities incorporated within
the global asset classes portfolio, along with their performance
across regimes as well as their factor premium exposures.
3. Data and methodology11
3.1. Background on the Dow Jones Sustainability World
Index and the Dow Jones Islamic Market Sustainability
Index
Among the first global equity indexes was the Dow Jones
Sustainability World Index (DJ Sustainability), launched in
1999 in the move toward integrating sustainability into the
capital market. There are currently 12 broad market, 10 blue-
chip, 3 specialty/screened, and 8 diversified sustainability in-
dexes that track the financial performance of leading
sustainability-driven companies worldwide. The first global
Islamic sustainability index, the Dow Jones Islamic Market
Sustainability Index (DJIS), was launched in 2006. Both DJ
Sustainability and DJIS are concentrated in leading SRI
markets, such as the United States, the United Kingdom, and
Switzerland. DJIS has higher average market capitalization
($41.5 billion) despite having a smaller universe of constituent
equities (106 components) relative to other indexes. Tech-
nology and health care are the dominant sectors in DJIS,
representing 28.97 percent and 20.56 percent of the sector
allocation, respectively, as at January 2015. By contrast, the
financial sector is featured prominently in both the Dow Jones
Global Index and the Dow Jones Sustainability World Index.
3.2. Performance of sustainable and Islamic equities
within the global asset classes portfolio
The first part of this study measures the performance of
sustainable and Islamic equities, including their relative per-
formance against the global equity benchmark. The study
analyzes the performance of a particular index within the
portfolio of global asset classes. In other words, it assesses the
performance of a particular global portfolio that include sus-
tainability equities, and compares it to the performance of
another global portfolio that include Islamic equities, or the
global equities benchmark.
This study examines the various aspects of four Dow Jones
indexes: the Dow Jones Global Index (DJ Global) (as the
11
The choice of Dow Jones Index is a natural one for several reasons. First, it
is the only index to have Islamic index, Islamic sustainable index, Sustainable
Index and conventional index. As all the data comes from a single index
provider, the comparison becomes easier as there is a uniformity in not only
the selection of stocks but also the screening of stocks. It has the longest
available data of Sustainable index, Islamic index, and Islamic sustainable
index. The length of data increases the reliability of results. Last, but not the
least, most of the papers on Islamic index have used the Dow Jones data.
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W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218
Table 1
Global asset classes and proxies.
Asset classes Proxies
Riskless asset Citigroup 3-month T-bill
Emerging markets equity Dow Jones Emerging Total Stock Market Index
Global bond JPM Global Aggregate Bond Index
Global REITs S&P Global REITs
Global private equity LPX Private Equity Index
Global hedge fund HFRX Composite Index
Commodity S&P GSCI Commodity Index
Gold S&P GSCI Gold Spot Index
Note: GSCI ¼ Goldman Sachs Commodity Index; REIT ¼ real estate in-
vestment trusts.
market benchmark), the Dow Jones Islamic Market World
Index (DJ Islamic), the Dow Jones Sustainability World Index
(DJ Sustainability), and the Dow Jones Islamic Market Sus-
tainability Index (DJIS). For the global portfolio, the analysis
includes the global asset classes that are used in the standard
global asset allocation framework (see Table 1). The dataset
spans from 1998 to 2013. Data are collected from Datastream
and Bloomberg.
3.3. Performance at different regimes: Markov switching
analysis
Firstly, we examine the performance of sustainable and
Islamic equities within the global portfolio across different
regimes using the Markov switching method.12 To identify the
macroeconomic regimes, the analysis uses expansion and
recession periods as defined by the National Bureau of Eco-
nomic Research (NBER) dating panel. The study examines the
ranking of returns of each asset class across different regimes.
It specifically analyzes the performance across much broader
types of regimes, concentrating on factor premiums. The
rationale is that the factor-based allocation concentrates on
factors that carry risk premiums as multiple distinct sources of
returns. A number of distinct premiums across multiple asset
classes may include the equity premium, term structure pre-
mium, default premium, exchange rate premium, funding
premium, and so on (Pastor and Stambaugh 2003; Lustig,
Roussanov, & Verdelhan, 2011; Asl & Etula, 2012; Adrian,
Etula, and Muir 2012). Because each factor premium varies
at different points in time (Arshanapalli, Coggin, and Doukas
1998; Oertmann, 1999; Ahmed, Lockwood, and Nanda 2002;
Amenc, Malaise, Martellini, & Sfeir, 2003), the analysis uses
the switching model with two regimes, where investors may
reallocate their assets when the available factor premium
12
In a layman terms, this model is designed to endogenously capture regime
shifts based on the data. In other words, it allows the data to endogenously
define different regimes. Moreover, Markov switching modelling can identify
more than two regimes based on the data. This modelling is powerful and
useful as it captures regime change based on data and reduces the error where
the regime is imposed exogenously by the researchers which may be wrong in
most of the cases, except for US or other developed countries where the
identification of regime shifts are more sophisticated and hence reliable.
211
exhibits a high or low return (for further discussions, see the
Supplementary Material, available online).
3.4. Sector and factor exposures: Bayesian model
averaging (BMA)
Next, to measure the exposures of sustainability and Is-
lamic equities to both sector premiums (which represents
idiosyncratic risks) and factor premiums (which represents
systematic risks) and to select the significant variables from
among the large possible candidate regressors, the Bayesian
model averaging (BMA) approach is used13 (for details, see
the Supplementary Material, available online).
3.5. Diversification benefits in different investment
horizons: Wavelet analysis
Further, to identify the degree of diversification benefits
from either sustainable or Islamic equities, taking into account
the presence of multiple horizons in investmentdwhich is of
particular interest to dynamic investorsdthe analysis uses
Wavelet Coherence analysis (see the Supplementary Material,
available online).
3.6. Dynamic volatility: multivariate GARCH model and
dynamic conditional correlations (DCC)
Finally, to understand how correlations and volatility
change over time and when they are strong or weak is a
persuasive motivation for the use of the MGARCH-DCC
models,14 particularly in the financial markets. The DCC
(dynamic conditional correlation) modeling allows the anal-
ysis to pinpoint changes (both when and how do they occur) in
the interdependence between time-series variables (for more
information, please see the Supplementary Material, available
online).
4. Empirical findings and analysis
4.1. Risk-return profile of global asset allocation
portfolio and efficient frontier
Table 2 reports the risk-return profile of global
asset allocation portfolio (tangency portfolio), which includes
the DJ Global, DJ Islamic, DJIS, and DJ Sustainability
13
Given competing theories and the nature of the empirical evidence, one is
always uncertain about the correct model. The BMA approach has the
advantage of using many more regressors than the traditional model selection
approach. As an alternative to selecting a single model, model averaging
considers and estimates all the possible candidate models, with a weighted
average as the estimate of the effect of interest.
14
The MGARCH models are used to estimate the DCC for a financial time
series. The models' obvious advantage is that it captures the time-varying
correlations. However, the main merit of DCC in relation to other time-
varying estimating methods is that it accounts for changes in both the mean
and variances of the time. In other words, DCC allows for changes in both the
first moment (mean) and the second moment (variance).
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W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218
Indexes, for each of the global portfolios. The analysis de-
termines the regimes that allows the study to perform the
spanning tests of the long-term mean variance, as well as the
state-dependent mean variance. From the start of the obser-
vations in 1998, two main recession periods (from the NBER
dating panel) are observed: March 2001 to November 2001
(the dot-com crisis); and December 2007 to June 2009 (the
global financial crisis, GFC). These are referred to as bearish
periods. Periods other than the bearish ones are categorized as
the bullish period.
Table 2 has two panels: panel an examines overall and
bullish periods, and panel b examines bearish periods. The
findings for overall period, based on the risk and return of the
tangency portfolio, reveal that the DJ Islamic Index has the
highest Sharpe ratio, followed by the DJ Global, DJIS, and the
DJ Sustainability Indexes. In other words, DJ Islamic is a
better alternative compared to the four indexes included in the
global portfolio of asset classes. These results are in line with
Hussein and Omran (2005) and Islam and Habib (2014). More
precisely, Islamic equities feature a lower level of leverage,
corresponding to the low leverage effects and volatility feed-
back hypothesis, particularly during market downturns. The
low leverage of DJ Islamic can offer greater diversification
benefits, with higher returns, given that it is not constrained by
sustainability screening criteria. DJ Sustainability provides the
maximum average return during the bullish period, implying
the strong linkage between financial performance and ESG
materiality.
In the case of the first bearish period (the dot-com crisis),
DJ Islamic is the worst performer, whereas DJ Global and the
DJ Sustainability provided the best returns of all the indexes.
These results are not surprising. As we shall see later, the
technology sector is one of the main driving factors of the
performance of the DJ Islamic Index. Since the technology
sector was hit badly during the dot-com crisis, DJ Islamic
performance during the crisis was correspondingly poor.
However, during the global financial crisis, the Dow Jones
Islamic Market Sustainability Index (DJIS) and the Dow Jones
Islamic Market World Index (DJ Islamic) managed to perform
Table 2
Risk and return of global asset allocation portfolio.
a. All periods and a bullish period All periods
Portfolio with mixed asset classes
Monthly average return (%)
DJ Global 0.2975
DJ Islamic 0.3024
DJ Islamic Sustainability 0.2945
DJ Sustainability 0.2854
Portfolio with mixed asset classes b. Bearish periods
Dot-com crisis
Monthly average return (%)
DJ Global 0.068
DJ Islamic 0.185
DJ Islamic Sustainability 0.152
DJ Sustainability 0.092
Note: Full sample ¼ 1998e2015; the dot-com crisis ¼ March 2001eNovember 2001; the global financial crisis ¼ December 2007eJune 2009. Periods other than
the bearish ones are categorized as the bullish period. DJ ¼ Dow Jones.
_
better as compared to DJ Global and DJ Sustainability. This
superior performance can be traced to the fact that both these
indexes screen out banks and the other financial institutions,
which were badly affected by the crisis. Furthermore, these
indexes managed do better because their screening criteria
exclude the highly leveraged stocks that formed the majority
of the financially unhealthy firms in that period. These results
are in line with those who argue that the Islamic indexes are
expected to perform better during the economic recession
because the constituent stocks of these indexes manage to
meet their liabilities due to their lower debt. Similar results
were reported by some other recent studies (Al-Khazali, Lean,
& Samet, 2014; Ho, Rahman, Yusuf, & Zamzamin, 2014).
The analysis further constructs efficient frontiers of these
indexes during different time periods (see Fig. 1). The efficient
frontier portfolio of DJIS is close to that of DJ Global over
1998e2013 and during periods of economic expansion. While
it had a less efficient frontier during the dot-com crisis because
of high concentration in technology sector, its frontier was
more efficient during the global financial crisis because of
lower financial leverage. On the other hand, the portfolio
construction of DJ Islamic turns out to be the most efficient
across all the periods except for the dot-com crisis period. The
efficient frontiers of DJIS and DJ Islamic suggest that these
indexes do not suffer from lack of diversification. These re-
sults sharply contradict the theoretical literature on the mean-
variance portfolio. In other words, the efficient frontiers sug-
gest that the underperformance of these indexes may not be
due to lack of diversification.
4.2. Drivers of performance differences: sector and
factor premiums
To examine the main performance drivers of the indexes,
they are further broken down at the sector level. The estima-
tion, based on the Bayesian model averaging of 70 sector
premiums, reveals that the basic materials, recreational prod-
ucts, personal products, and technology sectors are significant
drivers of the performance of the DJIS (see Table S1, available
Bullish period
Monthly standard deviation Monthly average return (%) Monthly standard deviation
2.21 0.717 2.27
2.16 0.704 2.14
2.21 0.718 2.26
2.31 0.737 2.44
Global financial crisis
Monthly standard deviation Monthly average return (%) Monthly standard deviation
1.58 0.024 3.87
1.69 0.125 3.78
1.68 0.129 3.83
1.67 0.005 3.90
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W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218
Fig. 1. Efficient frontiers.
online). Excluding basic materials, these sectors resemble the
drivers of DJ Sustainability, which also includes full-line in-
surance and banks. On the other hand, industrials, technology,
oil & gas, and commercial vehicles drive the performance of
DJ Islamic, whereas Industrials, Technology, Health care and
Specialty Retailer are the major drivers of DJ Global. The
performance of DJ Sustainability during the global financial
crisis is not surprising given that full-line insurance and banks,
which together are the main drivers of this index during the
bullish period, were badly hit by the crisis.
The analysis further examines how certain premiums can
influence the performance of the four indexes. The literature
suggests that there are two main strategies to achieve superior
returns. The first strand argues for asset-based allocation
(Brown, Garlappi, & Tiu, 2010), while the second advocates for
factor-based allocation (Dewandaru, Masih, Bacha, & Masih,
2015). Recent literature documents the superiority of factor-
based asset allocation because some factors have been able to
earn long-term risk premiums, and these premiums reflect the
exposure to systematic risk (Bender et al., 2013). A number of
distinct premiums across multiple asset classes may include the
equity premium, term structure premium, default premium,
exchange rate premium, funding premium, and so on. There are
three main different styles of factor-based allocations: size
investing (Annaert, Van Holle, Crombez, & Spinel, 2002; Van
Dijk, 2011); value investing; and momentum investing
(Asness, Moskowitz, & Pedersen, 2013; Cakici, Fabozzi, &
Tan, 2013; Yeh & Hsu, 2011). The strategy based on the size
213
follows the principle that stocks with low market capitalization
provide superior returns as compared to firms with high market
capitalization. Value strategies exploit the principle of investing
in underpriced stocks. Underpriced stocks are identified based
on a certain measure, such as dividend yield, price-to-book
ratio, and/or price-to-earnings ratio. The momentum style of
investing is based on the premise that past winning stocks are
expected to outperform in the future.
Fig. 2 examines these four types of premiums for the four
indexes. The results suggest that the market premium is a very
important explanatory variable: it affects the performance of
all the indexes with a 100 percent posterior inclusion proba-
bility. In addition to the market premium, the performance of
DJ Islamic is driven mainly by value and size premiums,
followed by the momentum premium. This implies that DJ
Islamic consists of small and value stocks, which possess the
two best qualities (size and value) for which a premium is
given to offset the associated risk. Similar patterns are
observed across DJIS and the DJ Sustainability. However,
value and momentum are more important in the case of DJ
Global. Overall, the results are in line with the large empirical
literature that suggests that size (Aksu & Onder, € 2003;
Bagella, Becchetti, & Carpentieri, 2000); value (Fama &
French, 1992, 1996; Petkovaa and Zhang 2005); and mo-
mentum factors (Jegadeesh and Titman 1993; 2001) are
among the most important determinants of performance.
The result that DJ Islamic, DJIS, and DJ Sustainability
consist of small stocks is in line with the empirical literature
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W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218
Fig. 2. Factor premiums.
on Shari'ah-compliant investments (Hassan & Girard, 2011;
Hussein, 2004) and SRIs (Humphrey & Lee, 2011). The re-
sults for DJ Islamic and DJIS are not surprising because most
large capitalized firms would be screened out, given that these
firms are likely to be more leveraged and also to receive in-
come from prohibited sources, as they are often well diversi-
fied (Hoepner, Rammal, & Rezec, 2011). The presence of
value stocks in DJ Islamic and DJIS is evident from the
presence of value sectors like industrial and basic industries,
which are also one of the main drivers of their performance
(see Table S1, available online).
4.3. Performance across different economic conditions
As mentioned, this study assesses the return ranking among
various asset classes in much broader types of regimes, which
is of interest to investors who use dynamic strategies across
multiple regimes. A strand of literature underscores the
importance of factor premium regimes. The probability and
timing of these factor regimes are estimated with Markov
switching analysis. The equity premium is computed as the
return of the S&P 500 composite index minus the three-month
US T-bill rate. The term structure premium is calculated as the
yield on 20-year US Treasuries minus the three-month US
Treasuries yield. The high-yield spread is computed as the
return on the Barclays Capital US Corporate High-Yield index
minus the US Corporate AAA index return. A higher high-
yield spread indicates a lower default premium, and vice versa.
The results of estimation on factor premium in different
regimes reveals the following. The bearish equity premium has
a negative average return and high volatility, while the bullish
premium has a positive return and low volatility. The bearish
regime covers the periods of August 1998 to December 1998;
December 1999 to February 2003; December 2007 to August
2009; March 2010 to October 2010; and August 2011 to
November 2011. The findings for the bearish regime are un-
derstandable, as these periods can be linked to a few major
events, such as the Russian default in August 1998; the dot-com
bubble burst in 1999e2001; Enron's collapse in 2002; the global
financial crisis in 2007e2009; and the euro crisis in 2010.
The bearish regime of high-yield spread covers the periods
of August 1998 to November 1998; September 2000 to
November 2001; May 2002 to April 2003; June 2007 to
October 2009; March 2010 to July 2010; and August 2011 to
January 2012. Again, these periods can be related to a few
_
crises, which are similar to the findings in the equity premium.
This can be discerned from the fact that a lower high-yield
spread indicates a higher default premium in the market
(Clarke et al., 2005).
Finally, the term premium is an inflation premium, which
depends on the sector (such as the sensitivity of the technology
sector to inflation). The low term premium regime covers the
periods of January 1998 to October 1998; February 2000 to
February 2001; and November 2005 to August 2007. This is a
regime when an average of yield difference between long-term
and short-term treasuries is lower relative to that in another
regime. For example, the pattern for the period of 2005e2007
is understandable because the yields at longer maturities
stayed at surprisingly low rates despite of the rise in short-term
interest rates stemming from a series of policy tightenings by
the Federal Reserve begun in 2004.
The analysis compares the returns of these indexes with
other asset classes during different regimes. Using Markov
switching analysis, the results in Fig. 3 imply that the DJ Is-
lamic and the DJIS are ranked 6 and 9 among 11 asset classes
during the full sample period. Not surprisingly, these indexes
are ranked lowest in the dot-com crisis, as is evident from Table
2, panel b. During the global financial crisis, these two indexes
did not do too badly as compared to other asset classes, as they
are ranked 6 and 7. The results from the equity bullish premium
and the low default premium seem to be most promising, as
they are among the top asset classes in these regimes.
Overall, Islamic and Islamic sustainability equity investing
offered competitive risk-return profiles particularly during
economic expansions, equity bullish periods, and the global
financial crisis. This supports the principle that it is possible to
do well while doing good.
4.4. Dynamic conditional correlations and volatility
Fig. 4 examines the dynamic conditional correlations and
the volatility aspects of these indexes derived using
MGARCH-DCC. The conditional correlation suggests that all
the indexes were strongly correlated throughout the sample
period, except for the period of mid-2006.
4.5. Degree of diversification across multiple time scales
Finally, the Wavelet Coherence suggest (see Fig. S1,
available online) that there is a high degree of co-movement of
 _
W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218 215

Fig. 3. Equity returns under different regimes.

Fig. 4. Conditional correlations.

the four indexes across multiple time scales (4 days, 8e512
days, and 1024 days) over 1996e, 2014. The results corre-
spond to some recent studies on Islamic and conventional
index coherency, but not others. For instance, Saiti, Bacha, and
Masih (2016) did not find any significant contagion among the
conventional and Islamic indexes. On the other hand, Najeeb
et al. (2015) argue that the correlation among the indexes
depends on the time horizon. Overall, this study's results
indicate that these indexes provide minimal diversification
opportunities, not only in the short term but also in the long
term.
5. Conclusion
Because dynamic investing strategies are gaining promi-
nence, it is important to evaluate established equity indexes in
terms of their performance and volatility (during different time
periods), the drivers of their performance in terms of industry
as well as factor premiums, dynamic correlation and coher-
ence across different time horizons. To achieve this objective,
this study made use of the DJ Islamic, DJ Sustainability, and
DJIS Indexes. For comparison and benchmark purposes, it
used the DJ Global Index.
The results can be summarized as follows. First, DJIS has a
higher Sharpe ratio than DJ Sustainability (full sample) at the
portfolio level and ranks second during periods of economic
expansion. Even during the global financial crisis, its perfor-
mance was comparable to other indexes. Second, the DJIS
efficient frontier portfolio is close to the DJ Global efficient
frontier portfolio over the full sample and during economic
expansions. Although DJIS had a less efficient frontier during
the dot-com crisis, its frontier was more efficient during the
global financial crisis. Third, the basic materials, recreational
products, personal products, and technology sectors are sig-
nificant drivers of the performance of DJIS. Fourth, the per-
formance of DJIS is also driven mainly by market, value, and
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W. Azmi et al. / Borsa Istanbul Review 19-3 (2019) 207e218
size premiums. Fifth, compared to other global asset classes,
DJIS performed relatively well during periods of economic
expansion (with an average monthly return of 1.02 percent)
and the global financial crisis (with an average monthly return
of 1.60 percent), but was adversely affected by the dot-com
crisis. DJIS also performed better than other non-equity asset
classes during the equity bullish period (with an average
monthly return of 1.11 percent) and had positive returns during
low default and high term premium regimes. Sixth, there is
high degree of co-movement of the four indexes across mul-
tiple time scales (4 days, 8e512 days, and 1024 days) over the
entire sample period. Finally, all four indexes exhibit similar
volatility patterns over the whole period of study.
This study demonstrates that Islamic sustainability equity
investing has offered competitive risk-return profiles, partic-
ularly during economic expansions, equity bullish periods, and
the global financial crisis. Its frontier is also efficient as
compared to other indexes and its volatility is similar to that of
other indexes. The findings support the notion that it is
possible to do well while doing good. These findings can be
instrumental in strengthening the universality and accept-
ability of Islamic finance.
6. Policy implications
Given the sustainability trends and empirical evidence pro-
vided in this study, the Islamic finance industry should proac-
tively participate in mainstream sustainability investing. There
are significant market opportunities for Islamic finance industry.
The socially responsible investment (SRI) market offers access
to over $33 trillion in assets (having grown 486 percent since
1995) and facilitates the scale required to improve the efficiency
of Islamic funds. Pension funds that integrate environmental,
social, and governance (ESG) issues into their investments and
$36 billion in pension assets from Gulf Cooperation Council
(GCC) countries can be potentially channeled to the Islamic
asset management industry. There are also opportunities to
integrate the global Hal al real sector with sustainability
investing. The extension of the Dow Jones Sustainability In-
dexes and the development of customized domestic Islamic
sustainability indexes in major Islamic finance jurisdictions are
expected to broaden market opportunities. Islamic financial
institutions should consider adopting globally recognized prin-
ciples such as the United Nations Principles for Responsible
Investment (UN PRI)15 and corporate sustainability reporting,
and participate in United Nations Environment Programme
(UNEP) Financial Initiative.16 Given that sustainable invest-
ment performance would also depend on unique strategies to
outperform market benchmarks, Islamic financial institutions
should strengthen their investment strategies and capacity in
15
See https://www.unpri.org/about/the-six-principles.
16
The UNEP Finance Initiative is a global partnership between the United
Nations Environment Programme and the financial sector. Over 200 in-
stitutions, including banks, insurers, and investors, work with UNEP to bring
about systemic change in finance to support a sustainable world. See http://
web.unep.org/greeneconomy/what-we-do/unep-finance-initiative.
sustainable investing. Industry bodies can also encourage
clauses on responsible investment to be included in Islamic fund
management contracts.
Policy and regulatory initiatives to facilitate this drive
include:
 Promoting transparency and disclosure from institutional
investors, fund managers, and companies on integrating
environmental, social, and governance (ESG) issues into
their investments;
 Providing fiscal incentives to improve profitability of
sustainable businesses;
 Conducting investment performance reviews over longer
time horizons;
 Extending the United Nations Principles for Responsible
Investment to include distinctive Islamic principles.
Specifically for portfolio managers, the results have several
implications. The option of Islamic and Islamic sustainability
stocks provide them additional opportunity to diverse their
portfolio without sacrificing on the financial grounds. More-
over, these options also provide them a set of safer haven
during economic downturn. However, the findings has to be
interpreted with respect to other considerations. More specif-
ically, the results highlight that the links and co-movements of
indices are contingent on the time horizon, regime and risk/
return profiles and targets.
Conflict of interest
None.
Appendix A. Supplementary data
Supplementary data to this article can be found online at
https://doi.org/10.1016/j.bir.2019.02.002.
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