Building an efficient sharia compliant portfolio

Constructing an investment portfolio that is capable of meeting an investors long-term investment objectives is not a simple task. There are thousands of different investment funds to choose from in the UK alone, let alone an ever-expanding selection of overseas funds. Additionally picking sharia compliant funds is difficult as the choice is more limited and quality of funds varies massively.

One of the most unknown features of investing is that the assets you hold are the rock bed of a portfolio and they massively shape the risk, return and behaviour of the portfolio.Selecting the assets and the weights attached to each of those assets in a portfolio is known as “strategic asset allocation”. The strategic asset allocation is responsible for 90% of a portfolios return; no other factor including stock selection, fund manager or market timing has as much influence on a portfolio as the assets that sit in the heart of that investment!

Many studies have been performed to identify the best asset allocation for a particular unit of risk for conventional assets though this is less common for sharia compliant assets. Edale has taken nine years of data from index providers MSCI and Dow Jones  put them through our number crunching portfolio optimiser to find out what the best mix of assets is for a low to high risk investor.

The study identifies that a lower risk investor should have a larger portion of their investment allocated to a sukuk and the most aggressive investor should be allocated to emerging market equities. This study echoes the findings of conventional efficient frontier studies. The chart below shows that as an investor increases their tolerance to risk, in this case measured as volatility, they should reduce the allocation to sukuk, replacing that weighting with developed market equities and as they become an aggressive investor developed markets should be replaced with emerging market equities. Interesting to note no one asset class has exclusive reign in a portfolio. This is due to the fact that equities, both developed market and emerging market, behave differently to Sukuk in the global investment markets so complement each other having a diversifying effect.

CAPM strategic asset allocation for Islamic assets
CAPM strategic asset allocation for Islamic assets


Lessons for investors. This simple study highlights that investors should consider mixing the assets they hold in their portfolio. As the world is not a constant and the past does not predict the future then a static allocation to different assets is not recommended. The wise investor will consider investing to different assets and employing a professional fund manager to move the portfolio around as market conditions change to optmise the mix of assets to favour the prevailing market conditions. This is commonly know an multi asset investing.

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