Does the Application of Smart Beta Strategies Enhance Portfolio Performance? The Case of Islamic Equity Investments

Traditionally, passive portfolios are structured using an easy to implement market capitalization method albeit highly skewed towards large cap stocks. The introduction of smart beta strategies has allowed passive investors to structure equity portfolios using alternative strategies such as fundamentalweighting, equal-weighting, and low-risk weighting strategies. This paper investigates whether constrained portfolios such as Shari’ah-compliant equity portfolios (SCEPs) can benefit by adopting smart beta strategies. The sample consists of equities from the USA, Canada, Australia, Europe, Middle East, Indonesia, and Malaysia for the period January 2003 to December 2016. The empirical findings suggest that smart beta SCEPs outperform not only conventional market capitalization weighted portfolios but also SCEPs following a market capitalization-weighted strategy. Higher risk-adjusted returns and lower drawdown as a result of following smart beta strategies highlight the importance of considering smart beta portfolio weighting strategies for passive investors. The supremacy of smart beta strategies indicates the value proposition for investors and fund managers alike. We also found that geographical location affects the performance of smart beta SCEPs; countries with a Muslim majority report higher cardinality and lower drawdowns. The results remained robust with alternative Shari’ah screening guidelines and empirical estimation methodology