The Power of Religion : Islamic Investing in the Lab

Faith-based mutual funds have recently become a growing corner of the mutual fund industry, where morality and ethics is thought to exert an influence on investors’ decisions. While Islamic funds have grown, it is not entirely clear whether investors are drawn to these funds due to their own religious preferences, or differences in the financial metrics. This paper fills the gap in the literature, by providing an express linkage between religious preferences (as measured by an incentivized dictator game) and investment in an Islamic fund. Using a lab experiment in a Muslim majority country (Pakistan), we create two types of funds: a “traditional” fund that generates profits for the investor, and an “Islamic” fund that is identical to the traditional fund in every way, except for a small (1% of profits) matched donation to an Islamic institute (a local mosque). The experiment controls the risk and return of the funds allowing us to compare the extent to which investors with religious preferences are likely to accept less convenient returns and risk to pursue the investment in line with their religious preferences. We find that investment in the Islamic fund is driven by religious preferences, with investors willing to take greater reductions in returns (and increases in risk) for the sake of investing in funds that align with their personal beliefs. Further treatments implement a socially responsible fund, and find a similar pattern of investment, indicating that Islamic investing and socially responsible investing are driven (at least in part) by religious and social preferences respectively. When pitted directly against each other, investors prefer religious investments over socially responsible investments, suggesting that the motivation behind investment behaviour is different