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

Muhammad Wajid Raza, Muhammad Tahir Suleman and Adam Zaremba

International Journal of Islamic and Middle Eastern Finance and Management, 2023, vol. 16, issue 5, 996-1008

Abstract: 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.

Keywords: Political risk; International portfolio diversification; Shariah-compliant portfolios; Performance evaluation; Shariah-compliant investments (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eme:imefmp:imefm-08-2022-0317

DOI: 10.1108/IMEFM-08-2022-0317

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