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Is Islamic Equity Index efficient than India’s National Index?
A Study on Nifty 50 and SHA 50
Dr. Ranjit Singh
Assistant Professor
Department of Business Administration
Assam University (A Central University)
Siilchar-788011
Assam, India
Ms. Abida Begum Sultana Mazumder
Assistant Professor
Department of Management
North Eastern Hill University
Tura Campus,
Meghalaya, India
Email: [email protected]
&
Ms. ChanchalaTiwari
Tapsi Singh Sr. Secondary School
Chirand Saran
Bihar, India
Email: [email protected]
Is Islamic Equity Index efficient than India’s National Index?
A Study on Nifty 50 and SHA 50
Abstract
The objective of the current study is to investigate the efficiency of SHA50
Index and Nifty50 Index, if any. The study is based on secondary data collected
from the BSE website and NSE website. Statistical tools of Kolmogorov–
Smirnov Test, One Sample Run test and Auto Correlation test have been used
for the study. It is found that the considered markets are not efficient and
defythe Efficient Market Hypothesis. Thus, it is inferred that there is a
possibility of earning more than the average market return by use of technical
analysis in the market.
Key words: Efficient market hypothesis, Ethical fund, Islamic Index, Shariahh
Compliant Stocks
Introduction
Shariahis the body of Islamic law. The term means "way" or "path". It is the
legal framework within which the public and some private aspects of life are
regulated for those living in a legal system based on Islam. It is a system of
several laws. These laws are primarily based on the Qur'an. It also has
strictures regarding finance and commercial activities permitted for Muslims.
Thus, for Muslims, certain categories of equity shares of companies have been
prescribed for investment. It is popularly called by the Muslims as the portfolio
of ‘clean’ stocks. The Shariah explains in detail the Islamic concepts of money
and capital. It also explains the relationship between risk and profit. It further
goes on elaborating the social responsibilities of financial institutions and
individuals. The purpose of this prohibition is to prevent exploitation from the
use of money and to share profit and loss. According to Shariah money should
be used for a proper economic purpose. It should not be treated as a
commodity on which a return can be made by reference to time. Islamic
scholars agree that money is simply a means of exchange. It is not an asset.
Therefore, it should not grow over time. However, capital can earn the returns
derived from the productive use of capital.
It is also forbidden for any Islamic institution or investment fund to deal
in the following goods:
(a) Alcoholic drinks;
(b) Pork, ham, bacon and related by-products;
(c) Dead animals (i.e., those not slaughtered according to the rules of the
Shariah)
(d) Gambling machines;
(e) Anti-social and immoral goods such as tobacco, pornography, drugs,
etc.;
(f) Gold and silver, except for spot cash; and
(g) Armaments and destructive weapons.
It should be noted that there is a prohibition imposed by the
Shariahupon the Muslims to buy certain category of equity shares that are not
Shariah complaint. So, there is a need to clearly identify the equity shares
which are Shariah compliant and which are not. It is also required to identify
the Shariah compliant stocks in order to enable the players in the financial
market to design a suitable product for the large numbers of Muslims.
Otherwise a vast majority of the Islamic population is excluded from the stock
market due to the religious constraints.
There are number of Shariah compliant mutual funds all over the world.
These are designed considering the principles laid down in Shariah. These are
also called by the Muslims as ‘ethical fund’ or ‘socially responsible fund’
(DeLorenzo, 2001).
Islamic investment funds operate by investors contributing money
isinvested so that profit can be earned in a manner compliant with Shariah.
The validity of the units, shares or certificates issued in the fund is subject to
two conditions. First, they must carry a pro rata profit actually earned by the
fund, instead of a fixed return being tied up with their face value. Second, the
amounts pooled must be invested in Shariah-compliant companies. All
financial institutions that offer Shariah-based services or products will have a
Shariah committee or board. These boards are comprised of Islamic scholars
and practitioners. They provide the Islamic financial institutions with guidance
and supervision. These boards often submit a Shariah audit for the annual
report of the Islamic institution. Then they issue Shariah compliance
certificates. The Shariah advisory board works closely with the bankers and
lawyers to structure instruments. This is done in order to meet Shariah and
commercial requirements. Standard documentation has been developed by the
financial institutions covering their main areas of activities. However, they will
need to refer back to the board whenever there is a deviation to ensure that no
inadvertent breach of Shariah or the compliance certificate has occurred. Thus
Islamic investment means a joint pool wherein the investors contribute their
surplus money for the purpose of its investment to earn halal profits in strict
conformity with the precepts of Shariah. The subscribers of the Fund may
receive a document certifying their subscription and entitling them to the prorata profits actually earned by the Fund (Usmani, 2007).
Ethical investing is the use of ethical and social criteria to select, built
and manage investment portfolios (Cowton, 1994). However, the economic
viability of Islamic investing is a controversial issue. Proponents of Islamic
investing in particular and ethical investing in general argue that screening
potential investment opportunities with both financial and ethical criteria
makes positive social and economic contributions (Sauer, 1997). Whereas the
opponents of Islamic investing argue that Islamic funds exclude one or more
company groups from their portfolio for nonfinancial reasons like companies
involved in some other business not approved by the Shari’ah, such as
companies manufacturing, selling or offering liquors, pork, haram meat, or
involved in gambling, night club activities, pornography, etc. This may affect
the viability of portfolio (Hakim and Rashidian, 2004). The strategy for ethical
investment can either be positive or negative. The former being supportive of
companies that are particularly approved of in terms of their products,
activities or business methods.The latter aims to avoid investing in companies
which are involved in unacceptable products or countries, or whose business
methods are regarded as unethical. Negative criteria are more usual than
positive criteria, with investors starting with a complete listing of quoted
companies, and then excluding the unethical minority (Wilson, 1997).
In the 1990s, as an outcome of trade with the Middle East countries and
financial crisis in Muslim countries, a major breakthrough took place in
Islamic rulings. This was also related to equity investment. Since then Islamic
equity funds have started to operate. It is also known that the prohibitions of
the Shariah law have been applied historically in varying degrees in Muslim
communities to prevent un-Islamic practices. But it was noticed that in the late
20th century there were a number of Islamic banks formed to apply these
principles to private or semi-private commercial institutions within the Muslim
community (Rammal and Zurbruegg, 2007). It has been estimated that there
is huge wealthwith the Muslim communities to be invested in the stock
market(Hakim and Rashidian, 2004). This amount is growing every year
(Hakim and Rashidian, 2004).
After 1990, a numbers of Islamic equity funds were launched. In 1996,
there were about 29 specialist Islamic funds. The asset under management was
valued at US$800 million. By March 2002, the number of funds rose to 105
with total assets of US$3.3 billion(Siddiqi, 2002).
Islamic Equity Investment
Islamic investing also termed by some "ethical investing", "green
investing", "faith investing" and "socially responsible investing" has much in
common with modern forms of investing (DeLorenzo, 2001).
A widely publicized area of Islamic finance was the development of
“screening” methods to identify “Shariahcompliant” stocks. These screens
exclude stocks of companies with significant forbidden activities as per the
principles of Shariah. The screens also exclude stocks of companies with
excessive debt (generally, more than one third of total capital) or interest
income (Siddiqi, 2002). The philosophy behind this screening is to avoid
trading in debt embedded securities. Debt is not allowed to be traded other
than at par. Therefore, companies having debt capital in excess of one third of
its market capitalization are no longer Shariah compliant (Kamso, 2013). A
typical Islamic equity portfolio includes cross-sectoral holdings. It ranges from
technology, telecommunications, engineering, steel, transportation, healthcare,
utilities, construction and real-estate (Siddiqi, 2002).
Shariah exclude stocks whose core activities are not related to any of the
following like interest based banking activity or any other interest related
activity, alcohol, gambling, tobacco, arms manufacturing, hotel and leisure
industry, life insurance, pornography, packaging and processing of any activity
related to pork, pork production, conventional financial services (banking,
insurance, etc). However, the list is not exhaustive, but indicative only.
The issues arising out of screening of equity shares for framing the
Islamic indexare similar. But different Islamic indices usedifferent criteria to
screen shares(Hassan, 2002). Dow Jones Islamic Indices uses the criteria like
all of the following must be less than 33%- total debt divided by trailing 24month average market capitalization, sum of a company’s cash and interestbearing securities divided by trailing 24-month average market capitalization
and accounts receivables divided by trailing 24-month average market
capitalization (Shariah Screening Criteria, 2013).
Of late, theincreasing demand for Islamic equity investment worldwide is
felt. Realizing the growing need for Islamic equity investment,the Independent
Global Index Company, launched the first Islamic equity index series at the
end of 1998. It is known as FTSE Global Islamic Index Series (GIIS).
Subsequentlyin February 1999, the first Dow Jones Islamic market index
(DJIMI) was launched (Moran, 1999).
It was decided by the policy makers that if a financial product can be
developed considering the stocks listed in the stock exchange and that are
Shariah complaint; it will lead to the inclusion of the Muslim investors into the
stock market. Therefore, in the year 2010 Bombay Stock Exchange in
association with TASIS had launched SHA 50 index. Later on National Stock
Exchange has also launched CNX Nifty Shariah index and CNX 500 Shariah
index. Although later on SHA 50 was discontinued by the Bombay Stock
Exchange and it was replaced by S&P BSE 500 Shariah.
Advocates of ethical as well as Islamic investing argue that a company
that adopts and implements an effective corporate responsibility policy is better
positioned in comparison to other companies. It avoids any environmental
andsocial crises. It helps a company to avoid its reputation damage, higher
production costs, lost production, higher security costs, and increased
insurance premiums (Sauer, 1997).
Opponents of Islamic investing highlight the adverse costs and effects
that Islamic screening of shares may involve. They argue that the hidden costs
associated with implementing Islamic screening adversely affect investment
performance. Therefore, it should not be ignored (Sauer, 1997).
Temper, (1991) is of the view that unscreened benchmarks may
outperform ethical investment. This is because using Islamic investing criteria
to screen shares may cause additional screening and monitoring costs. It also
leads to the availability of a smaller investment universe as well as restricted
potential for diversification. Temper, (1991) further added that Islamic
screening tends to eliminate large firms from the investment universe. Thus,
the remaining firms for the investment tend to be smaller and have more
volatile returns. It is also difficult to achieve diversification as Shariah
principles eliminates or favours certain industries.
However, Langbein and Posner (1980) argue that Islamic investment may
involve higher riskbut at the same time not necessarily yielding significantly
bad returns. This is because Islamic investors too do not invest in clearly
unprofitable stock.
Efficient Market Hypothesis
In finance, the efficient-market hypothesis (EMH) says that financial
markets are "informationally efficient". This hypothesis says that an investor
cannot consistently achieve returns in excess of average market returns on a
risk-adjusted basis, given the information at the time the investment is
madeavailable. There are three forms of EMH. These are: "weak", "semi-strong",
and "strong". The weak-form of EMH claims that prices on traded assets
already reflect all past publicly available information. The semi-strong-form of
EMH claims that prices reflect all publicly available information and that prices
instantly change to reflect new public information. The strong-form of EMH
claims that prices instantly reflect even hiddeninformation (Wikipedia, 2013)
EMH is an idea partly developed in the 1960s by Eugene Fama. It states
that it is impossible to beat the market because prices already incorporate and
reflect all relevant information. This is also a highly controversial and often
disputed theory. Supporters of this model believe it is pointless to search for
undervalued stocks or try to predict trends in the market through fundamental
analysis or technical analysis (Investopedia, 2013).
According to the EMH, stocks always trade at their fair value on stock
exchanges. It makes impossible for investors to purchase undervalued stocks.
It also makes impossible for them to sell stocks for inflated prices. Thus, it is
impossible to outperform the overall market through expert stock selection or
market timing. It says that the only way an investor can possibly obtain higher
returns is by purchasing riskier investments (Investopedia, 2013).
Review of Literature
Ethical investment goes back to the attempts of some religious
institutions to avoid the so-called sin industries such as gambling and tobacco
(Murninghan, 1992). Mueller (1991) found that the risk-adjusted returns of
unrestricted investments are 1.03% higher than Islamic funds. Luther et al.
(1992) on the basis of risk-adjusted measures, found weak evidence to suggest
that Islamic unit trust outperform the market. They also found that Islamic
trusts are mainly skewed towards small market capitalization and tend to
invest in low dividend yield firms. Mallin et al. (1995) argued that Islamic funds
have their own characteristics. It may make the comparison with benchmarks
such as FTSE somewhat misleading. They also found that beta is lower for the
Islamic funds.Mallin et al. (1995) and Singh and Das, (2013) both have found
that on a risk-adjusted basis, there is weak performance of Islamic funds.
Statman (2000) found that the risk-adjusted returns of S&P 500 were slightly
higher than those of the DSI but the difference was not significant. On the
other hand, DSI is somewhat riskier than the S&P 500.
Hussein (2004) has shown that returns from the FTSE Global Islamic
Index are significantly different from its index counterpart FTSE AllWorld
Index. Another study by Beikand Wardhana(2009) has reckoned that Jakarta
Islamic Index though affected by financial tremors in the short term, but show
strong resistance and consistency in the long run in comparison to its US
Counter Parts. Other studies performed by McMicken(1997) and Hee
(2002)show that Islamic indices prevalent in the southeast Asia capital markets
gave higher returns and are less volatile. Also according to the TASIS research
report (2010), the Shariah 50 has outperformed the SENSEX and the BSE 500
both. Over this period, annualized volatility for the SHA 50 was also less than
both SENSEX and the BSE 500(TASIS Research, 2010). Shachmurove,
BenZion, Klein and Yagil(2001) conducted a moving average comparison of TelAviv 25 and S & P 500 Stock Indices.
Singh and Das, (2013) found that the returns for the SHA 50 are not only
higher, but are also less volatile than those of the Nifty 50 in India.
Despite the growing interest in Islamic finance, theempirical studies
about Islamic equity investing are very few. Hassan (2002) found that Dow
Jones Islamic Market Index [DJIMI] returns are normally distributed and the
DJIMI has remarkable market efficiency. Using co-integration and causality
analysis, Hakim and Rashidian (2004) found that the DJIMI does not correlate
with either Wilshire 5000 index or the three month Treasury bill. They also
showed that the changes in the DJIMI are not caused by the Wilshire 5000 or
the three month Treasury bill. They concluded that the filtering criteria
adopted to eliminate non compliant companies leads to an Islamic index with a
unique risk-return characteristics. It is not affected by the broad equity
market.
A comparison of the raw and risk-adjusted performance showed that the
Islamic index out performs the FTSE AllWorld index over a certain period. On
the other hand, the Islamic index yielded statistically significant positive
abnormal returns in the bull market period. However, it underperformed the
counterpart index in the bear market period. It was also found that the Islamic
screening does not have an adverse effect on the FTSE Global Islamic Index
performance (Hussein, 2004).
Hassan, Antoniou and Paudyal (2005) found that Islamic investors apply
both
Shariah
and
financial
criteria
while
evaluating
investments.
Rahman,Yahya and Nasir (2010) investigated the 642 companies listed on the
Bursa Malaysia in 2006. These companies are approved Shariah’s compliant
companies by the Shari’ah Advisory Council of the Kuala Lumpur Stock
Exchange [KLSE]. As for the level of debt criterion, the results showed that
44.07% of the companies listed under the KLSESI are highly geared. However,
only 17% of the companies listed under the KLSESI were found to be highly
liquid. The results also indicated that if both criteria are compared
concurrently, only 198 out of 565 companies listed under the KLSESI conform
to the criteria set up by the DJIM.
Objectives of the Study
The objective of the present study is given as follows:
To investigate the randomness, if any, in the movement of the SHA50
Index and Nifty50 Index thereby negating their efficient form
Hypothesis of the Study
The following hypothesis is considered for the present study:
H0=There is no randomness in the movement of the two indexes that is the
SHA50 and S&P Nifty 50
Justification of Considering SHA50 and Nifty 50
Both SHA50 and S&P Nifty 50 is an index constituted of 50 companies.
Both of them have the base value of 1000, though the base year for Nifty is
1995 and that of SHA50 is 2008. Besides it has been also researched by TASIS
that Nifty has more number of Shariahh compliant companies Listed in NSE
(TASIS Research, 2010).
Research Methodology
1. Data: The data for the SHA50 have been collected from the BSE website
and that of the S&P Nifty 50 have been extracted from NSE website and
yahoofinance.com. The closing prices for SHA 50 and Nifty 50 have been
considered. The period of the study has been considered for a period
three years that is 1st January 2008 – 31st December, 2010.
2. Type of study: The study is descriptive in nature.
3. Tools of data analysis: Statistical tools such as Kolmogorov–Smirnov
Test, One Sample Run test and Auto Correlation test have been used
using Microsoft Excel and SPSS 17.0 to arrive at logical conclusions.
Analysis and Findings
The analysis and findings of the study is presented in the following
paragraphs:
Kolmogorov-Smirnov Test
Firstly, the distribution pattern of the share prices for both the indices
was investigated by performing the One Sample Kolmogorov–Smirnov Test.
Table 1
Kolmogorov-Smirnov Test for SHA 50 and Nifty 50
N
Normal Parameters(a,b)
Most Extreme Differences
Mean
Std. Deviation
Absolute
Positive
SHA 50
733
868.8965
221.86432
.086
.071
Nifty 50
741
4646.8523
968.16807
.107
.085
Negative
-.086
2.336
.000
Kolmogorov-Smirnov Z
Asymp. Sig. (2-tailed)
-.107
2.900
.000
Source: Compiled by authors
In the table 1, it has been observed that the significant value for both the
indices is 0.000. It is below 0 .05, alluding that the distribution is not normal
and therefore that the share prices does not follow a random behaviour.
One Sample Run test
Since the Share prices do not follow a Normal distribution, it becomes
manifest that nonparametric test such as One Sample Run test can be
performed to investigate if the two indices follow randomness. The test values
against which the runs are determined are considered to be the Mean, Mode &
Median.
The test showed the following results for Nifty 50 and SHA50:
Table 2
Run test with Mean
Test Value(a)
Cases < Test Value
Cases >= Test Value
Total Cases
Number of Runs
Z
Asymp. Sig. (2-tailed)
Nifty 50
4646.8523
302
439
733
19
-25.871
.000
SHA50
808.8965
367
366
733
13
-26.205
.000
Source: Compiled by authors
Test Value(a)
Cases < Test Value
Cases >= Test Value
Total Cases
Number of Runs
Z
Asymp. Sig. (2-tailed)
Table 3
Run test with Mode
Nifty 50
4875.05
370
371
733
27
-25.328
.000
Source: Compiled by authors
SHA50
868
367
366
733
13
-26.205
.000
Note: Since there are multiple modes, the mode with the largest data value is
used
Table 4
Run test with Median
Test Value(a)
Cases < Test Value
Cases >= Test Value
Total Cases
Number of Runs
Z
Asymp. Sig. (2-tailed)
Closing prices for Nifty 50
4875.05
370
371
733
27
-25.328
.000
Closing prices SHA50
868
367
366
733
13
-26.205
.000
Source: Compiled by authors
In the tables 2,3 and 4; it has been observed that the significant value for
run tests considering the mean , median and mode of both the indices is 0.000
which is below 0 .05 alluding that the distribution is not normal and therefore
that the share prices does not follow a random behaviour.
Thus the null hypothesis is accepted.
Auto Correlation test
To further confirm the relation of the prices on the preceding prices auto
correlation is performed. The prices of the SHA50 show that there is a high
correlation of 0.99 and that of the Nifty 50 shows a high auto correlation of
0.99. This again confirms the hypothesis that both the indices do not follow a
random behaviour.
Conclusion
It is been clearly witnessed from the above performed One Sample Run
test that both the markets defy the random walk theory and therefore in turn
the EMH. The findings suggest that prices do not adjust instantaneously to the
infusion of new information in the market.
This clearly indicates that the
technical trading can be very apt fully applied in both the markets to predict
future trends in the share prices and thereby increasing the possibility of
earning more than normal returns. Actually this is the paradox of the EMH
because both Technical and Fundamental analysis is required to make the
market efficient. Wealthof papers and classical studies has been conducted
that props the present hypothesis. Ellinger (1955) republished in 1971; Lo and
MacKinlay (1999) showed for a weekly U.S. stock indexes that past prices may
be used to forecast future returns to some degree. This fact is the starting point
in any technical analysis. In another study Lo, Mamaysky and Jiang (2000)
showed that technical analysis provides abnormal returns. Frankel and Froot
(1987) reject the Efficient Market Hypothesis (EMH) in the foreign exchange
market too. More direct support for technical analysis has been given by Pruitt
and White (1989) and Shachmurove, BenZion, Klein and Yagil(2001).
Thus, it is seen that previous researchers have also not found the
presence of efficient market hypothesis in the stock market. So, the present
study once again established that efficient market hypothesis is not applicable
in case of Islamic index too.
Limitation of the study
Though the present study makes a comparison between the Nifty50 and
SHA50, it should be noted that the SHA 50 was launched in 27 Dec, 2010 and
the remaining values of the share prices, receding back to 1 Jan, 2008 have
obtained via back testing, and therefore might not reflect the real share prices.
The study also makes no attempt to investigate a pattern or trend in the
movement of the share prices over the period of three years considered.
Scope of Further Research
More research can be performed on the index, three or five years forward,
because then its real values and not the back tested values would be available.
Similar studies can be undertaken by considering S&P BSE 500 SHARIAHH
index which is recently launched by BSE replacing SHA50.
The present study also makes no attempt to investigate the behaviour of
the SHA 50 in the bearish market. Such a work would be beneficial so that a
better understanding of its performance is available. Besides various methods
of technical trading such as moving average, filter tests can also be performed.
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