Combining Momentum, Value, and Quality for the Islamic Equity Portfolio: Multi-style Rotation Strategies using Augmented Black Litterman Factor Model

Ginanjar Dewandaru, Rumi Masih, Obiyathulla Bacha and A. Mansur M. Masih
Authors registered in the RePEc Author Service: Abul Mansur Mohammed Masih

MPRA Paper from University Library of Munich, Germany

Abstract: This study constructs active Islamic portfolios using a multi-style rotation strategy, derived from the three prominent styles, namely, momentum, value, and quality investing. We use the stocks that are consistently listed in the U.S. Dow Jones Islamic index for a sample period from 1996 to 2012. We also include two macroeconomic mimicking portfolios to capture the premiums of industrial production growth and inflation innovation, accommodating the economic regime shifts. Based on the information coefficients, we find the six-month momentum and the fractal measure as momentum factors; the enterprise yield (gross profit/TEV) and the book to market ratio as valuation factors; the gross profit to total assets, the return on capital, and the scaled total accruals as quality factors. We further construct active portfolios using the augmented Black Litterman (ABL) factor model to avoid the factor alignment problem, with the factor views predicted using Markov Switching VAR, MIDAS, and Bayesian Model Averaging. The out-of-sample performance of our portfolios can produce information ratios of 0.7 – 0.8 over the composite indices, and information ratios of 0.42 – 0.48 over the style indices, with the annualized alphas of 10 – 11%. Even when we put the constrained tracking error of 1% over the benchmark, our portfolios still produce information ratios of 0.9 – 1.2 before transaction costs, and 0.6 – 0.8 after transaction costs. We provide intuitive explanations for each premium changing over time, and suggest the promising strategy for Islamic equity investors to outperform the market.

Keywords: Islamic equity; portfolio strategy; multi-style rotation; Black Litterman factor model; forecast (search for similar items in EconPapers)
JEL-codes: G11 G12 G17 (search for similar items in EconPapers)
Date: 2014-06-28
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Combining momentum, value, and quality for the Islamic equity portfolio: Multi-style rotation strategies using augmented Black Litterman factor model (2015)
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