Impact of Ethical Screening on Risk and Returns: the Case of Constructed Moroccan Islamic Stock Indexes

Despite the increasing attention given to Islamic investment, there is still existing few empirical papers that examined the performance and volatility of Islamic Funds and indices in comparison to their conventional unscreened counterparts. These studies provide mixed evidence with regards to risk and returns of Islamic funds and indices. This paper aims to expand the literature on this subject by studying the Moroccan case considering the recent introduction of Islamic finance in the country towards the end of 2015. Since there is still no Shariah compliant indices in Morocco, we first applied four Shariah screening methodologies of some of the world leading equity index providers (i.e. Dow Jones, FTSE, S&P and MSCI) to screen the public listed companies in Casablanca Stock Exchange for Shariah compliance. Next, we constructed four Islamic float-weighted indexes for which we modeled the dynamic volatility using an extension of the AutoRegressive Conditional Heteroskedasticity models, namely EGARCH(1,1). The findings show that the screening process resulted in a well diversified universe of Shariah compliant stocks (25.6%) to invest in. Furthermore, it is found that constructed Islamic indices outperformed the broad-based Moroccan All Shares Index (MASI) during the considered period of analysis (January 2013 to December 2014) and their long run volatility is higher. This indicates that investors in Shariah-compliant stocks do not sacrifice financial performance for their risky investment. The estimates of the model show that volatility for the MASI is more persistent and takes longer time to die, and the leverage effect is positive for all indices meaning that volatility of indexes' returns is influenced more by good news than bad news, a result that is in contrast to other studies for developed countries.