Modern portfolio theory with sharia: a comparative analysis

Abstract

Despite Muslims comprising a quarter of the world’s population, almost none of the $100 trillion in professionally managed global assets are sharia compliant. Constraints such as ESG and SRI are common among pension funds, endowments and sovereign wealth funds. Typical constraints include alcohol, tobacco, weapons and environmentally damaging activities. Such securities are excluded from morally constrained portfolios. Sharia applies the same, but adds one more key constraint: securities with debt-related features. Otherwise, sharia is identical to most ethical constraints. This study shows the results of constructing optimized, multi-asset, globally allocated portfolios while respecting sharia. The construction of these portfolios follows contemporary regulatory standards and professional best practices that evolved from investment theory. Results indicate multi-asset sharia portfolios have at least equal return and risk characteristics to conventional peers, or are perhaps in some ways superior. Many Muslims profess to care about sharia, including with their savings. This study provides insight for professional asset managers in applying sharia with modern portfolio theory, which could substantially enhance wealth and asset managers seeking business in this sector.