ANALYSING THE CHARACTERISTICS AND PERFORMANCE OF ISLAMIC FUNDS: A CRITICAL REVIEW OF THE MALAYSIAN CASE

Abstract

This study provides a critical review of the characteristics and performance of Islamic funds in Malaysia with the main objectives of identifying the return and risk profile of Islamic funds and examining the Islamic funds’ performance and valuation methods. The study was conceived on the back of the impressive growth of the Islamic fund industry amid abundant evidence and a common perception that Islamic funds generally underperform conventional funds.
The study is designed to address four main areas, namely to analyse the return and risk characteristics of Islamic funds; to examine the performance trend of Islamic funds; to investigate the impact of Shariah-compliance requirements on Islamic funds’ performance; and, to explore the actual Islamic fund operation by fund management companies through the perception of those involved in the actual practice.
To ensure that the study is undertaken thoroughly, the study employed the methodological triangulation technique, of which, the findings are deduced from three methods of analysis namely literature review, quantitative analysis, and qualitative analysis based on primary data collected through interviews.
The findings of the study are deemed both intriguing and thought provoking. The study found that the existing Islamic funds have been created largely by mimicking conventional funds whilst economic motive, rather than religious motive, is arguably the main reason behind the creation of Islamic funds. Islamic funds are distinguished from conventional funds based on their Shariah identities, particularly with regards to stock selection and Shariah-compliance supervision. In general, relative to conventional funds, Islamic funds are characterised by a lower return but with higher volatility, have limited numbers of profitable stocks or industries whose returns are strongly and positively correlated, have a smaller fund size and low fund subscription rate, and are mainly invested in heavyweight stocks involved in defensive industries. Interestingly, although the Shariah-screening may expose Islamic funds’ portfolio to have high investment concentration in small-capitalised stocks, the study found that Islamic funds which invest mainly in large-capitalised stocks could outperform conventional funds and the market index. The analysis of Islamic fund performance is also sensitive to the benchmark used for performance comparison. The study also found that Shariah requirements affect Islamic funds’ performance adversely by incurring additional Shariah-related costs and introducing new Shariah non-compliance risks which are peculiar only to Islamic funds. In addition, the study revealed that there is a huge gap in terms of Shariah understanding and adoption of Shariah principles in the creation of Islamic funds.
It is noted that despite the finding of Islamic funds’ underperformance, it can be argued that the evidence does not in any way represent a disadvantage of Islamic funds, considering that the underlying philosophy of the funds is not merely to maximise monetary return, but rather, to attain other non-pecuniary motives including adherence to religious principles and achievement of the objectives of the Shariah (maqasid al-shariah).
With regards to Islamic fund performance valuation, the study found that the popular methods used by Islamic fund managers are the peer group comparison and the tracking error techniques instead of the traditional risk-adjusted return valuation models.
The study also found that active fund management is probably the best strategy for Islamic funds in Malaysia as compared to the simple buy-and-hold or passive fund management strategy.