Performance Evaluation of Islamic Mutual Funds Relative to Conventional Funds: Empirical Evidence from Saudi Arabia

Abstract

Saudi Arabia constitutes more than 20% of the global Islamic capital market. More than 80% of the mutual funds listed on Saudi Arabian stock market are Shari’ah compliant funds. This article reviews and extends previous research on the performance of Islamic mutual funds (IMFs) by evaluating the relative performance of IMFs and conventional funds during the global economic crisis from April 2007 to June 2011 in the context of the Saudi Arabian capital market. Standard CAPM regression and Treynor and Mazuy (1966) models are used to compare the market timing and stock selection abilities of IMFs and conventional funds by using monthly returns data on 159 mutual funds listed on the Saudi Arabian stock market from 2007 to 2011. The empirical results provide evidence of better performance of IMFs relative to conventional funds during the economic crisis. In addition, although, there is no evidence of relative superiority in market timing ability, managers of IMFs appears to have better stock selection ability during the economic crisis. The combination of superior stock selection ability of IMFs and the negative market timing ability of conventional funds suggests that IMFs offer better hedging opportunity to investors during periods of economic downturn. All investors, regardless of ethical or religious orientation, can enjoy the benefit of hedging by holding a proportion of investment portfolio in IMFs. Similarly, managers of conventional funds can improve the risk adjusted performance by following similar screening criteria as IMFs during economic slowdowns.

Keywords: capital markets, Islamic mutual funds, performance evaluation, market timing ability, stock selection ability

JEL Classification: G24, G11, G12