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Borsa Istanbul Review 21-2 (2021) 105e124
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Full Length Article

Does an Islamic-SRI portfolio really matter? Empirical application of

valuation models in Indonesia
Abdul Qoyum a,*, Rizqi Umar Al Hashfi b, Alyta Shabrina Zusryn c, Hadri Kusuma d, Ibnu Qizam e
a
Faculty of Islamic Economics and Business, State Islamic University Sunan Kalijaga, Jl. Laksda Adisucipto, Yogyakarta, Indonesia
b
Research Associate, Pusat Kajian Ekonomi Dan Bisnis Syariah (PKEBS), Universitas Gadjah Mada, Indonesia
c
Faculty of Economics and Management, Universitas Yarsi, Indonesia
d
Faculty of Economics, Islamic University of Indonesia, Indonesia
e
Faculty of Islamic Economics and Business, State Islamic University Sunan Kalijaga, Indonesia
Received 24 December 2019; revised 5 August 2020; accepted 5 August 2020
Available online 14 August 2020

Abstract

This study empirically investigates the comparative performance of four portfoliosd Indonesia Shariah Stock Index (ISSI), socially
responsible investing (SRI), conventional, and Islamic-SRI portfoliosdin Indonesia, of which the last integrates an Islamic portfolio into an SRI
portfolio (henceforth, ISRI or the ISRI portfolio), to test whether the ISRI portfolio matters by addressing the two specific issues: first, the degree
to which investment performance from the ISRI portfolio is different from the other portfolios; second, whether the ISRI portfolio has better
time-varying performance than the other portfolios. Overall, this study provides evidence that the ISRI portfolio outperforms the other three
types. Investing in the ISRI portfolio provides more flexibility in term of investment style. Hence, integrating Islamic screening into SRI/
environmental, social, and governance screening is a reasonable way to implement Islamic values in “modern” investment. The relevant policies
should be adjusted.
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Copyright © 2020, Borsa Istanbul Anonim Şirketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-
ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Keywords: ESG/SRI; Fama-French; Islamic-SRI portfolio; Portfolio performance; Sharia stock screening

1. Introduction the same year, SRI, predominantly led by the US and the
European markets, had USD 21.358 trillion in global assets
Over the past three decades, socially responsible investing under management, in which approximately USD 8.572 tril-
(SRI) and the Islamic finance industry have undergone a lion was placed in the US, and USD 13.608 trillion was in
resurgence. Given the promising growth rate of these two Europe (Erragragui et al., 2018a). Even though the SRI has far
sectors in the financial market, the role of SRI and Islamic more in assets than Islamic finance industry, the growth of
finance are particularly important (Bennet & Iqbal, 2013). both sectors shows the same trend. Both markets are very
According to the Islamic Financial Services Industry (2017), important for fund managers as well as investors who are
the total assets in Islamic finance were around USD 1.89 concerned with financial returns and ethical benefits (Azmi
trillion in 2016, with a growth rate of 15-20% per annum. At et al., 2019). The two markets have developed significantly
since these stock indices were introduced in 1999 (Hanif,
2020).
* Corresponding author. SRI and Islamic indices consist of firms that comply with a
E-mail addresses: [email protected] (A. Qoyum), rizqiumar5@gmail. specific standard and are subject to a stock screening mecha-
com (R.U. Al Hashfi), [email protected] (A.S. Zusryn), 883120104@ nism. To be included in SRI, a firm must follow environ-
uii.ac.id (H. Kusuma), [email protected] (I. Qizam). mental, social, and governance (ESG) criteria. The selection
_
Peer review under responsibility of Borsa Istanbul Anonim Şirketi.

https://doi.org/10.1016/j.bir.2020.08.002
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2214-8450/Copyright © 2020, Borsa Istanbul Anonim Şirketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND
license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
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A. Qoyum et al. / Borsa Istanbul Review 21-2 (2021) 105e124

criteria of the SRI index usually depend on the business ac- many Islamic finance scholars propose the integration of ESG
tivities carried out by a company that prioritizes ethics and into Islamic finance. However, a recurrent concern among
morals, which, inter alia, mean that it is not engaged in the academics and practitioners of Islamic finance concerns the
alcohol, gambling, and tobacco industries. In addition, in extent to which ESG/SRI is compatible with it.
running a business, companies must pay attention to social In addition, the existence of Islamic ethically based stock
justice, environmental sustainability, and alternative energy indices, i.e., Islamic stocks and also SRI, offers many choices
(Chatzitheodorou et al., 2019; Statman, 2006). Stock portfo- for investors who want to invest in firms that pay strong
lios that abide by SRI criteria in Indonesia are in the SRI- attention to ethical and moral values in running their business.
Kehati index. Brzeszczy nski and McIntosh (2014, p. 335) According to Bennett and Iqbal (2013), investors who invest in
define SRI investment as “the investment strategy that com- Islamic and SRI stocks expect not only economic returns but
bines financial return with other social and environmental also social impacts based on investor confidence. The growth
benefits, thus linked with an investor's social, ethical, of Islamic and SRI shares is largely driven by investor de-
ecological, and economic concerns.” Hence, ESG investment mand. Therefore, the interest of financial institutions in Is-
integrates financial benefit (return and risk) with the environ- lamic and SRI shares is expected to satisfy their demand.
ment, society, and governance values to realize sustainable Few previous papers focus on ESG/SRI issues and Islamic
development (Bilbao-Terol et al., 2016; Junkus & Berry, finance and it is important to revisit Islamic stock screening
2015). combined with ESG values, so in this paper we study this
To qualify as an Islamic firm, it must comply with sharia double screening (Islamic SRI). Discussions on ESG and Is-
screening criteria to ensure that the company has no conflict lamic finance basically started with Wilson (1997), when the
with sharia, and investors can confidently buy, hold, and sell ethical investment was introduced as the basis of ESG/SRI and
the stock. This screening enables the equity to be relabeled Islamic finance. This research was later developed by many
from conventional to Islamic (Kafou & Chakir, 2017). Ac- other researchers, most of whom focus on theoretical studies
cording to Adam and Bakar (2014), sharia screening is con- (Bennett & Iqbal, 2013; Lewis, 2010) and on empirical studies
ducted to eliminate stock that is believed to be unacceptable regarding a comparison between SRI and Islamic portfolios
for Islamic investors. The main criteria of Islamic firms are (Abdelsalam et al., 2014a; Al-Awadhi & Dempsey, 2017;
that core business activities are not involved in gambling, BinMahfouz & Kabir Hassan, 2013; Hayat & Kabir Hassan,
excessive uncertainty ( gharar), and payment of interest (riba). 2017) and a comparison between Islamic SRI (two screen-
Jaballah et al. (2018) explain that screening also involves ings, i.e., Islamic screening and SRI screening) and Islamic
financial aspects, that is, corporate debt is limited to be portfolios (Azmi et al., 2019; Elias, 2017; Erragragui et al.,
considered positively by investors, and a low level of corporate 2018; Erragragui & Revelli, 2016). The theoretical research
debt indicates a lower risk of bankruptcy. addresses the basic principles and similarities between ESG or
Nevertheless, at present, there is a great deal of debate SRI and Islamic finance (Islamic screening). Meanwhile,
among academics in Islamic finance over the best model for empirical research compares SRI and Islamic portfolio per-
Islamic stock screening. Derigs and Marzban (2008) argue that formance, concluding that Islamic stocks have better perfor-
many screening standards lead to different results. Another mance than SRI (Abdelsalam et al., 2014b; Hayat & Kabir
criticism is that the Islamic stock screening method (as applied Hassan, 2017), but Al-Awadhi and Dempsey (2017) have the
in sharia stock screening) focuses more on negative screening. opposite results.
Therefore, Masih, Kamil, and Bacha (2018) argue that the Other studies, conducted by Elias (2017), Erragragui et al.,
integration of ESG into Islamic stock screening is an urgent 2018, and Erragragui and Revelli (2016), investigate the
task in the development of Islamic capital markets. This view comparative performance of Islamic SRI (double screening)
is supported by Moghul and Safar-Aly (2014), Bennett and portfolios and Islamic portfolios, suggesting that the use of
Iqbal (2013), and Paltrinieri et al. (2020) concerning the ESG/SRI and sharia screening simultaneously has no impact
importance of integrating ESG elements (SRI indicators) into on portfolio returns and financial costs for investors. In
the screening of Islamic stocks. contrast, Azmi et al. (2019) find that integrating Islamic
The integration of SRI into Islamic finance is seen as screening with SRI provides higher rewards to the investor,
essential because many sharia-listed firms in Indonesia create especially during either economic booms or subprime crisis
environmental damage. In addition, as reported in a report by periods or bullish equity markets.
Human Rights Watch, regional oil companies are involved in This paper contributes to the ongoing debate by analyzing
issues related to the Rohingya ethnic group (Erragragui & the comparative performance of Islamic SRI and Islamic
Revelli, 2016), convincingly based on a report on civil law portfolios, SRI portfolios, and conventional portfolios in
in federal court (Paranque & Erragragui, 2016). In this case, Indonesia from 2011 to 2019. More precisely, this study makes
the ESG/SRI index has barred “a regional oil company” being a contribution to the literature on the development of Islamic
listed, yet such companies often remain in the Islamic index- stock screening that focuses not only on the sharia values but
dthis is certainly of great importance for the future of Islamic also on the environmental and social aspects. The main
finance. It is concerning when a company that is excluded question we explore is whether Islamic-SRI portfolios (inte-
from the ESG because of social justice issues (ethnic grating ESG values into Islamic screening) really matters. This
cleansing) is still included in an Islamic index. For this reason, study focuses on Indonesia, because of its key role in Islamic
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A. Qoyum et al. / Borsa Istanbul Review 21-2 (2021) 105e124 107

finance after Malaysia, especially in terms of the Islamic Vernengo, 2010, p. 17). The basic paradigm underlying all
capital market. In addition, Indonesia has its own sharia these theories is efficient markets (EMH) and rational
advisory board; thus, it can modify its sharia-screening stan- behavior, which take the investor's standpoint, in which in-
dards to specific standards, relying on the ijtihad1 of its Is- vestment is concerned only with the yield (return), risk, and
lamic scholars. liquidity.
This study extends the literature in several ways. First, we However, according to many financial experts, at present,
employ many robust models in finance, namely, the capital the underlying assumptions of modern finance go beyond the
asset pricing model (CAPM), and the three-factor Fama- economic realities, in which the market is imperfect, and,
French (3FF), four-factor Carhart (4F-Carhart), and five-factor therefore, irrational behavior often occurs (Giamporcaro &
Fama-French (5FF) models. In general, previous research only Viviers, 2014). In addition, modern finance has inherited his-
uses one model, such as CAPM (Charfeddine et al., 2016b; torical clashes between science and religion, so the focus is on
Syed, 2017), 3FF (BinMahfouz & Kabir Hassan, 2013; Reddy separation between free markets and moral issues. They argue
et al., 2017), 4F-Carhart (Galema et al., 2008; Hong & that social responsibility applies only if the business makes a
Kacperczyk, 2009; Mollet & Ziegler, 2014), and a multi- profit. Given this argument, investment takes one crucial
factor model (3FF and 4F-Carhart) with industry effects aspect into account in addition to return, risk, and liquidity,
(Erragragui & Revelli, 2016). The use of a 5FF model to test i.e., sustainability (see Fig. 1).
portfolio performance is still limited. The application of many Thus, stakeholder theory emerged, according to which, in
models is expected to provide convincing results on the addition to focusing on shareholders, the company is has a
viability of Islamic SRI for Indonesian investors and for the responsibility to the stakeholders, including customers, sup-
policymakers to develop Islamic SRI screening in Indonesia. pliers, government, society, and the environment. Stakeholders
Second, we compare all types of indices in Indonesia: Is- are defined as individuals or groups of people who can be
lamic Market (Indonesia Shariah Stock Index/ISSI), conven- influenced by the activities of a company in achieving its
tional market (Index Harga Saham Gabungan/IHSG), SRI goals. In this way, the conventional mindset of a company to
Stock (SRI-Kehati), to Islamic-SRI Stock. Third, we present maximize shareholder wealth turns into maximizing the
the results in both decile and quintile portfolios, with equally wealth of all stakeholders. This is one of the most fundamental
and value-weighted returns over 26 quarters. The results of changes in financial capitalism; it is now concerned about
this analysis reinforce observations about the degree to which shareholders, taking a new direction toward sustainability.
the returns are sensitive to different portfolio settings, which Therefore, SRI investment, currently developing in Western
offers investors a more comprehensive perspective. Fourth, we countries, is a breakthrough in which the quality of investment
examine the factors that drive portfolio performance, such as a can be improved by investors. The goal is for investments to
market risk premium, size, the book-to-market value, profit- contribute not only to increased profit but also to the preser-
ability, and momentum. vation of nature and the environment and improvement in
The structure of this paper is as follows. Sections 2 and 3 social conditions and good governance. This means that the
present the theoretical foundation and hypothesis develop- risk-return and liquidity mechanism through which financial
ment and research methodology, respectively, while in section benefits are generated is a necessary but not a sufficient con-
4, the study elaborates on the findings and analysis, and sec- dition (Sun et al., 2011). Supported by “grassroots pressure”
tion 5 outlines our conclusions and the implications. and “religious organizations” (von Wallis & Klein, 2015),
most investors, taking modern business perspectives, argue
2. Theoretical foundation and hypothesis development that sustainability is an important aspect of finance. Taking it
further, many financial experts adopt modern theories such as
2.1. Finance paradigm and Stakeholders theory the theory of legitimacy and stakeholder theory to underpin
their basic arguments about the importance of ESG/SRI ele-
SRI was initially regarded as a form of ethical investment ments in financial activities (Lokuwaduge & Heenetigala,
with roots in Jewish, Christian, and Islamic traditions (Fu 2017).
et al., 2020). Theoretically, the development of SRI from the
perspective of financial theory can be traced back to its initial 2.2. Previous studies
concept. The SRI concept was developed because of changes
in the paradigm in finance. Since the 1950s, the dominant Empirically, three groups of studies discuss both Islamic
paradigm of finance as a “scientific discipline,” which reached and ESG screening on portfolio performance. First, Miglietta
its peak in the 1970s, was explained in grand theories such as and Forte (2011), in a qualitative study, find that Islamic
the efficient market hypothesis (EMH), the CAPM theory, screening and SRI have many similarities based on which the
Markowitz's portfolio theory, Modigliani-Miller's arbitrage integration could easily be achieved. Second, concerning
principles, and the Black-Scholes-Merton model (Caldentey & comparison of portfolio performance, El-Masry et al. (2016)
examined the differences in investment portfolio perfor-
mance in the Islamic stock sector and ESG. They suggest that
1
Ijtihad is the process of legal reasoning based on the Qur'an and Sunnah the Islamic portfolio performs better than the ESG portfolio. In
through which the Islamic scholar retionalizes of deriving the law. addition, they also show that, in a crisis, the Islamic portfolio
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shows better resilience than the ESG portfolio. These findings 2.3. Hypothesis development
are consistent with Erragragui et al. (2018) and Castro et al.
(2020), implying that performance differs between the Is- Despite some philosophical and conceptual similarities be-
lamic portfolio and SRI in bear or bull markets. By contrast, tween SRI and Islamic stocks, no significant attempt has been
Abdelsalam et al. (2014a) find no difference in performance undertaken to detect differences in performance between
between the Islamic and ESG portfolios, nor do BinMahfouz Islamic-SRI, SRI, conventional, and Islamic portfolios in
and Kabir Hassan (2013). Indonesia, which is known as a hub of Islamic finance. Some
The study of ESG and Islamic investment also addresses empirical studies have found that Islamic investments have better
the nature of risk, which, in modern finance, is always asso- performance than conventional investments (Abdullah et al.,
ciated with returns. Al-Awadhi and Dempsey (2017) find that 2007; Alam & Rajjaque, 2010; Arouri et al., 2013; El-Masry
Islamic investment has lower risk than conventional ESG. In et al., 2016; Mansor & Bhatti, 2016; Peillex & Ureche-Rangau,
addition, Ashraf and Khawaja (2016), Erragragui et al. (2018), 2012; Shaikh et al., 2019b). Other researchers find that Islamic
and Mansor et al. (2019) also posit that Islamic investment has investments underperform relative to their conventional coun-
lower risk than SRI. These studies indicate that Islamic in- terparts (Al-Awadhi & Dempsey, 2017; Hoepner et al., 2011;
vestment based on Islamic screening is more stable and has Merdad et al., 2010), while still other empirical studies conclude
lower risk than conventional ESG, and some screening criteria that there is no difference in performance between Islamic and
also take aspects of financial ratios (debt to equity ratio) into conventional investments (Abdelsalam et al., 2014b; Albaity &
account. Ahmad, 2011; Ashraf & Khawaja, 2016; BinMahfouz & Kabir
Meanwhile, several other studies explore the relationship Hassan, 2013; Charfeddine et al., 2016b; Girard & Hassan,
between ESG and Islamic stocks and governance and effi- 2008; Hashim, 2008; Hassan et al., 2010; Hayat & Kraeussl,
ciency. Hayat and Kabir Hassan (2017) conclude that Islamic 2011). Given these findings of insignificant performance differ-
companies have better governance than conventional com- ences, the majority suggest that blending Islamic finance with
panies. Meanwhile, regarding ESG and Islamic stocks, ESG is viable.
Abdelsalam et al. (2014a) show that SRI shares are more It is believed that sharia screening can improve investment
efficient than Islamic stocks. In contrast, Ali et al. (2018) find returns because the constituents of sharia-compliant firms have
that Islamic stocks are more efficient than their conventional to satisfy some screening criteria, both qualitative and quan-
counterparts. titative. The qualitative screening ensures that the core busi-
By contrast, Chowdhury and Masih (2015) contend that ness of the firm complies with sharia (Hashim et al., 2017);
there is an opportunity for portfolio diversification between thus, it improves stakeholder satisfaction. The stakeholders of
Islamic stocks and ESG. This is due to differences in trends a firm consist of investors, suppliers, employees, customers,
between Islamic stocks and ESG shares, giving investors the the government, community, political groups, and trade asso-
opportunity to benefit from diversification (Charfeddine et al., ciations (Donaldson & Preston, 1995). Hence, from the
2016b). Likewise, Paltrinieri, Floreani, Kappen, Mitchell, and perspective of stakeholder theory, sharia screening as well as
Chawla (2019), in testing the correlation and comovement ESG screening have a positive impact.
among Islamic, SRI, and conventional indices, suggest that Sharia screening has some financial criteria, one of which is
cointegration exists between Islamic, SRI, and conventional the debt to equity ratio (DER), which has a direct link with the
stock indices and comovements with mutual causality. financial performance of the firm. Pok (2012) reveals that a
Erdogan et al. (2020) conducted a study on the effect of sharia-compliant company is financially healthy if it is
macroeconomic variables on the Islamic capital market, sug- reviewed based on its financial ratios. In the light of the capital
gesting that volatility spillovers occurred. In other research, structure theory, namely the pecking order theory proposed by
Dharani et al. (2019) investigate the performance of sharia and Myers (1984), a firm's capital structure is the result of the
conventional portfolios, finding that both types of portfolios firm's financing requirements over time and its attempt to
have similar performance, but the sharia portfolio has a lower minimize problems with information asymmetry (Majiuf,
level of risk. Finally, the results indicate that the volatility of 1984). This theory ranks sources of financing based on the
the sharia portfolio is lower during a crisis period. degree to which they are affected by information asymmetry.
Third, a strand of studies place more emphasis on inte- The first funding source is internal finance, and the second is
grating ESG into Islamic finance. Paranque and Erragragui external funds (especially debt). The use of internal financing
(2016), for example, contend that from those concerned with minimizes asymmetry problems at the firm, which is beneficial
all three aspects of ESG, only governance has a positive for performance.
impact on investment returns, while environmental and social Trade-off theory also postulates that the firm's capital
aspects do not have a significant impact on portfolio perfor- structure is determined by the beneficial use of debt. By
mance (Erragragui & Revelli, 2016). This does make sense issuing debt, the company can gain an interest tax shield, thus
since governance is a variable that has a direct relationship increasing firm value; however, the trade-off for an offsetting
with managers, so it is not surprising that it has a significant cost of debt is bankruptcy (Kraus & Litzenberger, 1973). The
impact (Elias, 2017). In contrast, Azmi et al. (2019) find that higher a firm leverage ratio is, the greater the potential for
integrating Islamic with SRI portfolios provides higher re- bankruptcy will be (Haugen & Senbet, 1978). Therefore, from
wards to investors under different market conditions. this perspective, an Islamic portfolio, which consists of sharia-
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A. Qoyum et al. / Borsa Istanbul Review 21-2 (2021) 105e124 109

compliant firms, has better performance than a purely ESG comply with sharia parameters (e.g., no riba/usury, no ghoror/
firm, because of the differences in screening methods (i.e., uncertainty, and no maysir/gambling) and ESG parameters (e.g.,
sharia screening), two aspects of which relate to normative and awareness of the environment, addressing social problems, and
(quantitative) financial criteria. having high-quality governance). Therefore, from the stake-
Some researchers, such as Moghul and Safar-Aly (2014) and holder theory perspective, a firm that performs these procedures
Bennett and Iqbal (2013), have suggested that Islamic screening will do better, as supported by Feldman et al. (1997), Pava and
should be integrated with the ESG aspect. The current Islamic Krausz (1996), and Yuen et al. (2017); they found that ethical
finance perspective holds that sharia screening criteria are not screening, whether Islamic or ESG, improves the reputation of
enough because they tends to point to negative screenings, that is, the firm, thus providing higher value for stockholders, less risky
rejecting companies whose operations contradict sharia princi- business, and a lower cost of capital.
ples. As sharia-compliant firms, they must have a significant Capelle-Blancard and Monjon (2014) offer empirical evi-
impact on the environment and society. This means that their dence that greater screening intensity slightly reduces financial
financial metrics, that is, risk, return, and liquidity, are not enough performance. The reason is that investors do not have the
(Sun et al., 2011). From a modern business perspective, sustain- flexibility to construct their portfolio freely because they are
ability is an essential element of finance. To take this issue further, restrained by screening criteria. Therefore, portfolio perfor-
many Islamic finance experts use legitimacy theory and stake- mance varies. Nevertheless, Hassan et al. (2010) find no sig-
holders' theory as a basis of their arguments on the importance of nificant performance differences between Islamic and
ESG aspects in Islamic screening activities (Lokuwaduge & conventional portfolios. In addition, they find a similar reward
Heenetigala, 2017). Based on the legitimacy and stakeholder in risk and diversification in both types of funds. According to
theories, Islamic firms that also fulfill ESG standards will obtain Miglietta and Forte (2011), Islamic screening has more spe-
benefits in terms of stakeholder trust; thus, the company's repu- cific characteristics than ESG standards. Thus, portfolio con-
tation will improve. Therefore, by implementing ESG, Islamic struction based on the two criteria can provide better
firms will improve productivity, cost-saving, and reputational risk performance. In addition, the Islamic ESG portfolio has
(Barman, 2018). financial-ratio screening so it has more potential for better
Nevertheless, this integration of these two aspects of finance financial performance than for an ESG-screened firm. Thus,
must be tested to evaluate their impact on the portfolio returns, as following the majority of views in the literature, we posit the
studied by Paranque and Erragragui (2016), Erragragui and following hypotheses:
Revelli (2016), and Erragragui et al. (2018). Paranque and
H1a. The Islamic-SRI portfolio has significantly different in-
Erragragui (2016) found that the application of Islamic and
vestment performance from other portfolios.
ESG screening had no adverse impact on portfolio performance.
However, when these screenings were divided into three com- H1b. The Islamic-SRI portfolio has time-varying performance
ponents (environmental, social, and government), they that outperforms other portfolios.
concluded that only governance had an impact on portfolio
performance. They also argue that because of the insignificant 3. Research methodology
impact of double screening, integrating Islamic screening with
ESG is a good future agenda. Next, Erragragui and Revelli (2016) 3.1. Data and sample
discussed the cost of being Islamic and socially responsible. They
suggest that there is no direct impact on returns from the appli- Our sample encompasses stocks that have the following
cation of ESG screening on sharia-compliant stocks in criteria: consistently registered in the IDX from 2011 to 2019,
2007e2011. Their findings were consistent with their previous a company with a non-negative equity book value, active
research that found only governance to have a direct effect on trading, and no suspended shares. The data are obtained from
portfolio performance if ESG screening was applied to Islamic Thomson-Reuters Datastream.
stocks (Erragraguy & Revelli, 2015). The other components, or Following these criteria, researchers screened all shares in
even when ESG is considered as a whole, showed insignificant the IDX, yielding a sample totaling 302, of which 151 shares
differences in performance. Hence, these results recommend that are registered on the ISSI, 17 shares on SRI, and 11 shares on
the integration of ESG aspects into Islamic screening have more both indices (Islamic-SRI, abbreviated interchangeably as
impacts on the Islamic capital market for society. Furthermore, ISRI or the ISRI portfolio). Meanwhile, all 302 shares are
motivated by the fact that Islamic screening criteria and ESG entered into a conventional portfolio because it has no re-
have similarities in both their basic philosophy and practical strictions on whether the shares must meet ethical or moral
sides, Elias (2017) specifically examined the financial perfor- standards. Table 1 lists the number of portfolio constituents by
mance of self-composed Islamic portfolios with varying ESG, industry in more detail.
revealing no impact on performance. Based on these stock classifications, researchers calculate
The Islamic ESG portfolio theoretically should have better the average portfolio return with the same weighted (equally
performance for two main reasons. First, in Islamic ESG, port- weighted) and weights based on market capitalization (value-
folio constituents must perform two screening procedures, weighted). The average portfolio return is calculated based on
qualitative and quantitative. On the qualitative side, firms must the stock average using the log return method (Table 2).
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Table 1 market portfolios. The higher the b1i is, the higher the systemic
Classification of shares by industry. risk will be. If the value is b1i > 1, then an asset has a higher
Industrial Classification ISSI ISRI SRI Conven systemic risk than the market portfolio and vice versa. Assets
Agriculture 4 1 1 9 can be individual or a group of assets in a portfolio.
Basic & chemical industry 28 1 1 48 Several studies are examining portfolio performance. For
Consumer goods 21 3 3 30 developed countries, the study uses data available from the
Finance 5 24
French library (Belghitar et al., 2014; Erragragui & Revelli,
e e
Infrastructure, utilities, & transportation 4 2 3 20
Mining 14 1 1 29 2016; Galema et al., 2008). Rmt is proxied by the average
Various industries 16 1 1 27 market value-weighted return in each country, whereas Rft is
Property, real estate, & building construction 29 1 1 42 represented by the US one-month Treasury bill rate. Mean-
Trade, services, & investment 35 1 1 37 while, based on other research on developing countries
Total 151 11 17 302
adapted to the context in each of these countries (Cos‚kun
Note: Indonesian Shariah Stock Index (ISSI), socially responsible investment et al., 2017; Foye, 2018; Shaikh et al., 2019a), monthly
(SRI), Islamic SRI (ISRI), conventional (Conven) portfolios.
returns on the Pakistan Stock Exchange 100 index (PSX-100),

Table 2
Method of calculating portfolio returns.
No. Return Return
calculation method calculation equation
 
1 Stock Return Pst
rst ¼ 1n
Pst1
rs : stock return s in period t; Pst : closing price of shares s in period t; Pst1 : closing price of shares s in period t - 1.
2 Portfolio Return 1X n

The equally weighted average ri ¼ rs

n s¼1
(E-W) ri : portfolio return; n: number of shares in the portfolio
3 The value-weighted average Pn
ri ¼ r1 u1 þ r2 u2 þ / þ rs us
(VeW) s¼1
us : the weight of shares in a portfolio based on market capitalization

3.2. Empirical models and Karachi Interbank Offered Rate (KIBOR) are used as
proxies for market returns and risk-free rates. Fama-French
To assess portfolio performance, we use the following asset Three-Factor (3FF) Model.
pricing models: the CAPM, 3FF, 4F-Carhart, and 5FF. Some research tests the validity of the CAPM theory and
explores factors other than systematic risk (Fama & French,
3.2.1. Capital asset pricing model (CAPM) 1992; Fama & MacBeth, 1973). The general conclusion of
Asset valuation is an important aspect of investment de- the study is that the relationship between excess return and
cisions. The CAPM is the first asset-valuation model, and it beta is too weak (too flat) due to measurement error problems.
relates the expected return to systemic risk, as measured by The problem creates ai that is too high and bi that is too low,
beta (Sharpe, 1964). The relationship between expected return which leads to a biased estimator (Bodie et al., 2011).
and beta is linear, and can be calculated as follows: Therefore, Fama and French (1996) proposed a three-factor

 model to include the market risk premium, size, and value,
EðRi Þ ¼ Rf þ Rm  Rf bi which are calculated as follows:
where E(Ri) is the expected return on an asset or portfolio; Rf Rit  RFt ¼ ai þ bi ðRMt  RFt Þ þ si SMBt þ hi HMLt þ εit
is the rate of return on risk-free assets; Rm is the market
portfolio return; and bi is systemic risk index. where SMBt refers to differences in portfolio returns that have
Lintner (1965) tested the CAPM theory with the regression a small market capitalization (small) and large market capi-
model as follows: talization (big); HMLt denotes differences in portfolio returns,

 that is, high book-to-market (high) and low book-to-market
Rit  Rft ¼ ai þ b1i Rmt  Rft þ mit (low).
The addition of size and value factors is based on Fama-
where Rit  Rft is the excess return of an asset or portfolio; French findings, that is, first, portfolio returns of companies
Rmt  Rft is market risk premium; b1i is the beta market of an with large market capitalization, lower than the companies
asset or portfolio; and mit is an unobserved factor. with small market capitalization, and second, portfolio returns
In the CAPM, the market risk premium is the single factor with high book-to-markets that have higher returns. By adding
of excess returns. The value of b1i measures asset sensitivity to these two factors, the bias in arranging the portfolio based on
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size and a level of risk exposure can be controlled so that the Table 4
estimation of the 3FFM is more efficient than the CAPM Portfolio using the four-factor models of Fama-French and Carhart.
(Fama & French, 2004; Grauer & Janmaat, 2010). A signifi- Factor Component factor
cantly positive value of si indicates higher portfolio exposure Small minus big SMB ¼ ðSH þ SN þ SLÞ =3  ðBH þ BN þ BLÞ =3
for companies with small market capitalization. Likewise, a (SMB)
significantly positive value of hi indicates that the portfolio is High minus low HML ¼ ½ðSH  SLÞ þ ðBH  BLÞ =2
(HML)
more exposed to companies that have a high book-to-market Up minus down UMD ¼ ½ðSU  SDÞ þ ðBU  BDÞ =2
ratio. In addition, the values of si and hi show a portfolio (UMD)
composition based on market capitalization and book-to- Note: See notes to Table 3.
market. Like Shaikh et al. (2019a), who examined devel-
oping countries with a relatively small number of registered
companies, this study uses a 2  3 configuration. underlying the model is the Miller and Modigliani equation
modified by Fama and French (2016) as follows:
3.2.2. Carhart four-factor model P∞
Multifactor modeling continuously develops to accommo- Mt EðY1þt  dB1þt =ð1 þ rÞt Þ
¼ t¼1
date the proposed new factors, namely, momentum by Carhart Bt Bt
(1997); thus, the new model is called the four-factor Carhart
(4F-Carhart). What underlies this model is that investment where Mt is stock market value; Bt Bt Bt refers to the book
managers obtain a higher return on portfolios of up-stocks value of equity; Y1þt is the equity earnings for the period 1 þ
(high momentum) than on portfolios of down-stocks (low t, which reflects profitability; dB1þt ≡ B1þt B1þt1 reflects
momentum). The model is calculated as follows: changes in the book value of equity, which represents the
future; r is the internal rate of return, that is, the expected
Rit  RFt ¼ ai þ bi ðRMt  RFt Þ þ si SMBt þ hi HMLt þ mi UMDt return of the shareholders.
þ εit If all components of the equation are constant except for
Mt and rr; the lower the value Mt is or the higher the book-to-
market (Bt =Mt ) ratio is, the higher r will be. Similarly, if Mt ,
where UMDt is the premium of momentum, namely, the dif-
Bt , dan dB1þt (future investment flows) are fixed, the higher Y1þt
ference between portfolio returns with high momentum (up)
is, the higher the cash flow the investor expects, and the higher r
and low momentum (down). The formation of a 4F-Carhart
will be. Likewise, the higher the dB1þt is, the lower r will be.
portfolio is the same as 3FF plus the momentum factor
Based on this explanation, the 5FF is constructed as follows:
(UMD).
Rit  RFt ¼ ai þ bi ðRMt  RFt Þ þ si SMBt þ hi HMLt þ ri RMWt
3.2.3. Fama-French five-factor (5FF) model
þ ci CMAt þ εit
Several studies have concluded that the 3FF and 4F-Carhart
models (see Table 4) do not fully explain asset pricing, so
additional factors are needed. Empirical studies conclude that where RMWt is the difference between portfolio returns with
profitability (Novy-Marx, 2013) and investment growth high (robust) and low (weak) profitability; CMAt is the dif-
(Titman et al., 2004) account for the pattern of asset prices. ference between portfolio returns with low (conservative) and
For this reason, Fama and French (2015) added profitability high (aggressive) investment growth rates.
and investment to their 3FF, making it into 5FF. The theory The 5FF model has configurations for the three portfolios:
2  3, 2  2, and 2x2x22 (Fama & French, 2015). Like one
study conducted on developing countries with a small number
of registered companies (Shaikh et al., 2019b), this study uses
Table 3 a 2  3 configuration.
Portfolio in the Fama-French three-factor model.
In applying portfolio management, the asset pricing models
Factor Component factor are used to measure portfolio performance determined by the
Small minus big SMB ¼ ðSH þ SN þ SLÞ =3  ðBH þ BN þ BLÞ =3 average return. Performance evaluation with an average return
(SMB) is less reliable, so a risk-adjusted return needs to be calculated
High minus low HML ¼ ðSH þ BHÞ =2  ðSL þ BLÞ =2
(HML)
(Bodie et al., 2011). The method used most often to calculate
risk-adjusted returns was developed by Jensen (1968). The
Notes: Small-high (SH), small-neutral (SN), small-low (SL), big-high (BH),
big-neutral (BN), and big-low (BL). SMB and HML, respectively, are formed apparent indicator is the value (alpha), which is an abnormal
based on market capitalization and the book value of equity to market capi- return not explained by the asset pricing model. If the positive
talization (book-to-market) at the end of December one year earlier. Small (S) value is significantly different from zero, then a portfolio has
and big (B) portfolios are grouped based on the median value of market better performance than the market portfolio and vice versa.
capitalization while high (H), neutral (N), and low (L) are grouped based on
However, if ai does not differ from zero, the portfolio has the
cut-off percentile values of 30% down and 40% middle respectively, The top
30% of the book-to-market, SH, SN, SL, BH, BN, and BL portfolio returns are same performance as a market portfolio.
calculated using the VW average based on the market capitalization in the Some previous studies used valuation models such as the
previous year. CAPM (Charfeddine et al., 2016b; Syed, 2017), 3FF
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(BinMahfouz & Kabir Hassan, 2013; Reddy et al., 2017), 4F-

Carhart (Galema et al., 2008; Hong & Kacperczyk, 2009; Mollet Table 6
The adjusted R2 values of portfolio based on several models.
& Ziegler, 2014), and multifactor (3FF and 4F-Carhart) by adding
industry effects (Erragragui & Revelli, 2016). Meanwhile, the use ISSI SRI ISRI Conventional
of the 5FF model (see Table 5) to test portfolio performance is still E-W VeW E-W VeW E-W VeW E-W VeW
limited. Therefore, this study uses the CAPM, 3FF, 4F-Carhart, CAPM 0.521 0.830 0.776 0.842 0.650 0.706 0.531 0.946
and 5FF models to test the performance of sharia-compliant 3FF 0.721 0.827 0.784 0.886 0.699 0.729 0.805 0.953
(Islamic Index), SRI, Islamic SRI, and conventional portfolios. 4F-Carhart 0.728 0.827 0.786 0.885 0.714 0.735 0.804 0.952
5FF 0.729 0.824 0.784 0.885 0.692 0.724 0.824 0.952
Henceforth, choosing the best model will be based on the
highest adjusted R2 value (Shaikh et al., 2019b). To estimate Notes: This table shows the adjusted R2 of portfolio based on CAPM, 3FF, 4F-
Carhart, and 5FF. The ISSI, ISRI, SRI, and conventional portfolios are formed
the asset pricing model, this study uses the ordinary least using the equally weighted average (E-W) and value-weighted average
squares (OLS) method with Newey-West robust standard er- (VeW) methods.
rors to overcome heteroskedasticity and autocorrelation. This
method was previously used in several studies (BinMahfouz & critical meaning related to the best methods for measuring
Kabir Hassan, 2013; Fama & French, 2015; Reddy et al., portfolio performance because many previous studies use only
2017; Shaikh et al., 2019b). mainstream models of performance, such as CAPM
(Charfeddine et al., 2016a; and; Syed, 2017), 3FF (BinMahfouz
4. Results and discussion & Kabir Hassan, 2013; and; Reddy et al., 2017), and 4F-Carhart
(Galema et al., 2008; Hong & Kacperczyk, 2009; Mollet &
4.1. Result and discussion Ziegler, 2014). According to Azimli (2020), augmenting
CAPM with other factors such as SMB and HML is more
Table 6 reports the values of the adjusted R2 of the portfolio appropriate because they improve the pricing performance.
based on CAPM, 3FF, 4F-Carhart, and 5FF. The testing of Tables 7 and 8 show the results of portfolio testing using
portfolio performance with several factor models shows that portfolio performance with the 4F-Carhart and 5FF models.
the highest values of adjusted R2 is 4F-Carhart and 5FF These findings reveal that, overall, the ISRI portfolio has
models. This can be seen from the values of adjusted R2 with better returns than the ISSI, SRI, and conventional portfolio.
4F-Carhart, which has a higher average value (ISSI ¼ 0.728; For the market beta, which is calculated from the risk pre-
SRI ¼ 0.786; and ISRI ¼ 0.714) than CAPM (ISSI ¼ 0.521; mium, the study has an interesting finding. ISRI has a higher
SRI ¼ 0.776; and ISRI ¼ 0.650) and 3FF (ISSI ¼ 0.721, market beta: 0.948 for ISRI, which is higher than ISSI (0.897)
SRI ¼ 0.784, and ISRI ¼ 0.699). The 5FF model also per- and the conventional portfolio (0.849). This indicates that, in
forms better, indicated by the adjusted R2, which is higher in terms of equity returns, the ISRI portfolio, made up of Islamic
the three types of portfolio, namely, the ISSI portfolio, SRI and ESG-compliant stocks, generates a higher return. Despite
portfolio, and conventional portfolio; thus, the two models are its higher performance, ISRI has a beta lower than 1. Thus,
the most suitable for measuring portfolio performance. ISRI has lower systemic risk than the market portfolio. If
These findings have two crucial meanings: first, it supports market conditions are bullish, ISRI's performance is indeed
some arguments (see Chan et al., 1991; Fama & French, 1992; lower than the market portfolio, but higher than ISSI and the
Rosenberg et al., 1985) that some variables have an impact on conventional portfolio.
performance other than market return, as stated by Sharpe In terms of investment style, the ISRI portfolio is less
(1964) and Lintner (1965). Second, these findings have a sensitive to firm size. This finding contradicts some previous

Table 5
Formation of the portfolio in the Fama-French five-factor model.
Factor Component factor
Small minus big (SMB) SMBB=M ¼ ðSH þ SN þ SLÞ =3  ðBH þ BN þ BLÞ =3
SMBOP ¼ ðSR þ SN þ SWÞ =3  ðBR þ BN þ BWÞ =3
SMBINV ¼ ðSC þ SN þ SAÞ =3  ðBC þ BN þ BAÞ =3
SMB ¼ ðSMBB=M þ SMBOP þ SMBINV Þ =3
High minus low (HML) HML ¼ ½ðSH  SLÞ þ ðBH  BLÞ =2
Robust minus weak (RMW) RMW ¼ ½ðSR  SWÞ þ ðBR  BWÞ =2
Conservative minus aggressive (CMA) CMA ¼ ½ðSC  SAÞ þ ðBC  BAÞ =2
Notes: small-high (SH), small-neutral (SN), small-low (SL), big-high (BH), big-neutral (BN), big-low (BL), small-robust (SR), small-weak (SW), big-robust (BR),
big-weak (BW), small-conservative (SC), small-aggressive (SA), big-conservative (BC), big-aggressive (BA). SMB, HML, RMW, and CMA for each are formed
on the basis of capitalization, the book value of equity to market capitalization (book-to-market), operating profit (OP), and investment (INV) at the end of
December one year earlier. OP is calculated from [income - (cost of goods sold þ administrative costs, general, and sales þ interest costs)]/book value of equity.
INV of asset growth from total assets at the end of year t - 2 to t - 1. Grouping small (S) and big (B) portfolios based on the median value of market capitalization
while high (H), neutral (N), low (L); robust (R), neutral (N), weak (W); and conservative (C), neutral (N), aggressive (A) grouped according to the percentile cut-
off values, i.e., respectively 30% down, 40% middle, 30% above from book-to-market (B/M), OP, and INV. Returns on SL, SN, SH, BL, BN, BH, SR, SW, BR,
BW, SC, SA, BC, and BA portfolio are calculated using the VW average based on the previous year's market capitalization.
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Table 7
Results of portfolio performance based on 4F-Carhart models.
ISSI SRI ISRI Conventional
E-W VeW E-W VeW E-W VeW E-W VeW
RMt  RFt 0.897*** (10.62) 0.940*** (12.25) 1.070*** (11.80) 1.059*** (14.98) 0.948*** (10.26) 0.868*** (9.87) 0.849*** (11.22) 0.973*** (22.36)
SMBt 0.411*** (4.11) 0.0522 (0.89) 0.193 (1.92) 0.234b (3.01) 0.108 (1.23) 0.151a (2.12) 0.443*** (5.26) 0.100a (2.36)
HMLt 0.258*** (4.37) 0.0121 (0.33) 0.0508 (0.87) 0.127a (2.58) 0.177a (2.16) 0.119a (2.23) 0.231*** (5.46) 0.0174 (0.77)
UMDt 0.113 (1.69) 0.0518 (1.12) 0.0909 (1.32) 0.0376 (0.67) 0.177a (2.49) 0.108 (1.84) 0.0418 (0.79) 0.0199 (0.72)
ai 0.00220 (1.09) 0.0000696 (0.04) 0.00267 (1.19) 0.00610*** (4.47) 0.0023 (0.83) 0.00150 (0.68) 0.00144 (0.90) 0.00201a (2.03)
N 78 78 78 78 78 78 78 78
Adj.R2 0,728 0827 0,786 0,885 0,714 0735 0,804 0,952
Notes: This table shows the coefficient values and t-statistics from the results of testing the performance of the 4F-Carhart portfolio model. The ISSI, ISRI, SRI,
and Conven portfolios are formed using the equally weighted average (E-W) and value-weighted average (VeW) methods.
a
Significant at the 5% level.
b
Significant at the 1% level.

Table 8
Results of portfolio performance based on 5F-Carhart model.
Islamic Index SRI Islamic SRI Conventional
E-W VeW E-W VeW E-W VeW E-W VeW
RMt  RFt 0.945*** (9.84) 0.943*** (12.20) 1.010*** (8.95) 1.024*** (11.65) 0.960*** (8.48) 0.858*** (8.58) 0.879*** (12.42) 0.991*** (21.63)
SMBt 0.464*** (4.69) 0.0636 (1.08) 0.178 (1.42) 0.235a (2.46) 0.0615 (0.58) 0.176a (2.23) 0.491*** (7.07) 0.104a (2.49)
HMLt 0.158b (3.05) 0.00754 (0.20) 0.0963 (1.75) 0.0830 (1.44) 0.215b (3.15) 0.0605 (1.08) 0.162*** (4.45) 0.0182 (0.77)
RMWt 0.00709 (0.10) 0.0125 (0.23) 0.0907 (1.09) 0.0309 (0.61) 0.0222 (0.28) 0.0367 (0.61) 0.0171 (0.31) 0.00934 (0.31)
CMAt 0.0769 (0.93) 0.0310 (0.41) 0.0449 (0.46) 0.0757 (1.15) 0.0938 (0.92) 0.0018 (0.02) 0.0490 (0.77) 0.0141 (0.32)
ai 0.00331 (1.41) 0.000217 (0.12) 0.000959 (0.46) 0.00493*** (3.61) 0.0027 (0.86) 0.00134 (0.57) 0.00224 (1.37) 0.00227a (2.20)
N 78 78 78 78 78 78 78 78
Adj.R2 0.729 0.824 0.784 0.885 0.692 0.724 0.824 0.952
Notes: This table shows the coefficient values and t-statistics from the results of testing the portfolio performance of the 5FF model. The ISSI, ISRI, SRI, and
Conven portfolios are formed using the equally weighted average (E-W) and value-weighted average (VeW) methods.
a
Significant at the 5% level.
b
Significant at the 1% level.

studies, such as Girard and Hassan (2008) and Hassan et al. conventional portfolio)dbut all the coefficients are statisti-
(2010), who find that the Islamic portfolio is more prevalent cally insignificant. Meanwhile, profitability (RMW) and in-
at small and growing companies. BinMahfouz and Kabir vestment (CMA) factors in the 5FF model (see Table 8) are
Hassan (2013) also find no difference in the results between insignificant, so they are not the risk factors that affect the
Islamic and conventional portfolios. From this perspective, performance of ISSI, SRI, ISRI, and conventional portfolio.
ISRI investors have more flexibility to choose the constituent Conventionally, the purpose of investment in forming a port-
stocks in their portfolio. folio is to generate a return, namely, the highest return with
In addition, based on the coefficient values of HML, ISRI reasonable risk or lower risk with the same return. In view of these
has the highest value (0.215), compared with ISSI (0.158), SRI findings, we suggest that the ISRI portfolio not only considers
(0.0963), and conventional portfolios (0.162). These findings Islamic values as its main feature but also has strong awareness of
indicate that the ISRI portfolio outperforms the others. HML is ESG values. Therefore, in a neutral situation, ceteris paribus, ISRI
measured with a B/M ratio that shows the firm's prospects. might be better than other portfolios because it has three types of
According to stakeholder theory (Lokuwaduge & Heenetigala, screening criteria: it is shariah compliant, ESG compliant and
2017), Islamic ESG firms generally have better prospects return oriented (see Al-Awadhi & Dempsey, 2017; Ashraf &
because of their good relationships with all the stakeholders. Khawaja, 2016; Erragragui et al., 2018).
In addition, Islamic ESG firms normally have better applica- Hence, theoretically screening on two sets of criteria (Is-
tion of good governance. Hence, because it has good prospects lamic and SRI) creates better investor returns. However, ac-
and governance, the portfolio has better performance (El- cording to Capelle-Blancard and Monjon (2014), more intense
Masry et al., 2016; Erragragui & Revelli, 2016). screening can reduce the independence of investors in
In terms of momentum (UMD), the composition of ISRI is composing portfolios, leading to lower portfolio performance.
less exposed to downward stock portfolios, that is, stocks with Our empirical evidence, by contrast, suggests that ISRI has
low cumulative returns. The coefficient of ISSI is 0.177, better returns, for two reasons. First, quantitatively, screening
compared to the other portfolios (i.e., 0.113 for the ISSI for either sharia compliance or SRI ensures better firm quality.
portfolio, 0.0909 for the SRI portfolio, and 0.0418 for the Second, qualitatively, both Islamic and SRI screening indicate
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better firm reputation. Thus, from the stakeholder theory calculation in the 26 quarters from 2013 to 2019. Although, in a
perspective, investor confidence is higher with such as specific quarter, the performance of ISRI is lower, for example,
Feldman et al. (1997), Pava and Krausz (1996). Yuen et al. in quarter 19 (the alpha of ISRI is 0.084, compared with
(2017) find that ethical screening, whether Islamic or ESG, 0.029 for SRI, 0.002 for ISSI, and 0.026 for the conven-
improves the reputation of the firm. Therefore, it gives tional portfolio), in quarter 20 (alpha for ISRI is 0.125, 0.022
stockholders more value and less risk. for SRI, 0.041 for ISSI, and 0.112 for conven), and in quarter
The analysis, further, examines how consistent the portfolio 21 (alpha for each portfolio: 0.001 for ISRI, 0.005 for SRI, 0.006
performance is over different time horizons. In doing so, we also for ISSI, and 0.028 for conven); overall, however, ISRI has
tested the consistency of the results by looking at 26 quarters from higher-quality returns, as shown by its alpha and beta.
January 2013 to June 2019, totaling 1568 trading days. The values Table 9 reports the performance of the portfolios for 26
of alpha and beta are estimated employing 4F-Carhart and 5FF quarters more clearly. Based on the 4F-Carhart with equally
with industry effects. To estimate the model, we use OLS with weighted methods, in 25 quarters the beta of the ISRI portfolio
Newey-West robust standard errors to address heteroskedasticity outperforms that of the other portfolios. With value-weighted
and autocorrelation concerns. methods, all quarters show that the beta of ISRI also exceeds
Splitting the portfolio into a different time horizons is critical that of the other portfolios. In terms of its alpha, Table 9 also
for consistency, and the validity of the previous results suggests documented that overall ISRI has higher alpha. Hence, based
that ISRI performs better than the ISSI, SRI, and conventional on the 4F-Carhart, we conclude that ISRI can be interesting for
portfolios, as found by Erragragui et al. (2018), which uses a investors or mutual funds because this portfolio provides a
shorter period of observation than this study. It means that this consistently higher return in many different quarters. From this
study provides a longer overview of portfolio performance. Figs. perspective, we can summarize that ISRI has better resilience
2 and 3 report the alpha and beta of the ISRI, ISSI, SRI, and than the other portfolios.
conventional portfolios for different time horizons from 2013 to The same findings are also documented with the 5F-Carhart,
2019. Overall, the figures reveal that the ISRI portfolio has a as reported in Table 10. As with the 4F-Carhart, ISRI has higher
higher alpha than the other portfolios for both 4F-Carhart and alpha and beta than the other portfolios, especially ISSI and the
5FF. These interesting findings reveal that ISRI outperforms the conventional portfolio. These findings support the basic idea in
other portfolios (ISSI, SRI, and conven), based on the previous studies, such as Lewis (2010), Bennett and Iqbal (2013),

Fig. 1. Investor's need for investment.

Fig. 2. Alpha of portfolio (ISRI, ISSI, SRI, and Conven).

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A. Qoyum et al. / Borsa Istanbul Review 21-2 (2021) 105e124 115

Fig. 3. Beta of portfolios (ISRI, ISSI, SRI, and Conven).

BinMahfouz and Kabir Hassan (2013), Abdelsalam et al. 1. Estimating parameter abi (estimated alpha) and
(2014b), Erragragui and Revelli (2016), Hayat and Kabir εbit (residual ) from the industry portfolio regression on 4F-
Hassan (2017), Al-Awadhi and Dempsey (2017), Elias (2017), Carhart or 5FF as follows:
and Erragragui et al. (2018), all of which conclude that inte- X
j
grating Islamic and ESG screening does not create any costs for Rind  RFt ¼ ai þ bi Xit þ εit
investors. By investing in an ISRI portfolio, investors gain ben- i¼1
efits in terms of both financial returns and ethical compliance.
Overall, ISRI is empirically supported and offers more
where Rind  RFt is the value-weighted excess return of
competitive risk-return profiles, particularly during some
portfolios in nine industries; Xit consists of RMt  RFt , SMBt ,
different economic cycles: bull and bear markets. This supports
HMLt , UMDt , RMWt , and CMAt.
the principle that it is possible to do well while doing good (Azmi
et al., 2019). Therefore, based on this finding, we confirm H1a,
2. Determining industry effects (zk ), by adding up abi and εbit
that is, the ISRI portfolio has different performance from the other
from each of the nine industry regression equations. Upon
portfolios, and H1b, which states that its time-varying perfor-
obtaining zk , PCA analysis is performed to estimate the
mance outperforms that of the other portfolios.
loading factor (q) with the following equation:
4.2. Robustness check p1 ¼ q11 z1 þ q12 z2 þ / þ q19 z9
p2 ¼ q21 z1 þ q22 z2 þ / þ q29 z9
In this section, we perform a number of robustness tests. ///////////
First, we add industry effects to the multifactor model as a p9 ¼ q91 z1 þ q92 z2 þ / þ q99 z9
robustness check, as conducted in previous studies (Derwall
3. Next, choosing three components ( p) that have the highest
et al., 2005; Erragragui & Revelli, 2016). Second, we calcu-
Eigenvalue;
late the fitted value of portfolio performance. Industry effects
4. Adding three factors to the 4F-Carhart and 5FF models.
are determined using principal component analysis (PCA) to
identify other factors in the industry portfolio that are not
Tables 11 and 12 shows the estimated results of the 4F-Car-
explained by the 4F-Carhart model. They use excess returns of
hart and 5FF models with industry effects. Three components
industry portfolios determined by 4F-Carhart model. This
(P1-3) significantly affect portfolio returns, so industry effects
study confirms the classification of industry portfolios based
contribute to the appraisal of performance. The existence of in-
on nine industries on the Indonesian Stock Exchange and to
dustry effects controls for the composition of the portfolio
estimate industry effects not explained by 4F-Carhart, or 5FF.
concentrated in certain industries. Thus, the estimation results
The following are the steps for determining industry effects:
will be more robust.
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Table 9
Performance of ISRI, SRI, ISSI, and conventional portfolios based on 4F-Carhart with industry effects.
Equally weighted portfolio 4F-Carhart with industry effects
Quarter Obs. ISRI SRI ISSI CONVEN
alpha beta alpha beta alpha beta alpha beta
1 60 0.009 1.124*** 0.017 1.189*** 0.015 0.854*** 0.033 0.734***
2 63 0.043 0.832*** 0.019 0.930*** 0.029 1.003*** 0.096** 0.892***
3 61 0.098 1.177*** 0.047 1.205*** 0.005 0.973*** 0.05 0.973***
4 60 0.025 1.056*** 0.004 1.143*** 0.043 0.928*** 0.068* 0.841***
5 60 0.047 1.394*** 0.057 1.308*** 0.012 0.859*** 0.084*** 0.675***
6 59 0.004 1.046*** 0.005 1.107*** 0.061** 0.853*** 0.055 0.761***
7 60 0.064* 1.131*** 0.043* 1.153*** 0.018 0.871*** 0.045 0.782***
8 63 0.074 1.188*** 0.096** 1.258*** 0.022 0.828*** 0.062** 0.768***
9 62 0.037 1.051*** 0.002 1.041*** 0.033 0.694*** 0.098*** 0.709***
10 61 0.006 1.139*** 0.023 1.178*** 0.053* 0.583*** 0.058* 0.699***
11 60 0.085 1.340*** 0.088 1.265*** 0.096** 0.761*** 0.092*** 0.741***
12 61 0.094 1.026*** 0.049 1.070*** 0.003 0.797*** 0.066** 0.573***
13 61 0.046 0.796*** 0.054 0.700*** 0.018 0.546*** 0.058 0.375***
14 63 0.102* 0.953*** 0.091** 0.980*** 0.018 0.693*** 0.029 0.634***
15 59 0.039 0.991*** 0.019 1.034*** 0.021 0.753*** 0.063 0.744***
16 63 0.052 1.069*** 0.04 1.059*** 0.034 0.578*** 0.01 0.531***
17 62 0.041 1.126*** 0.019 1.110*** 0.082** 0.526*** 0.124** 0.782***
18 52 0.08 0.985*** 0.03 1.010*** 0.059 0.800*** 0.156*** 0.720***
19 62 0.084 0.798*** 0.029 0.919*** 0.002 0.624*** 0.026 0.742***
20 62 0.125** 0.939*** 0.022 0.980*** 0.041 0.581*** 0.112*** 0.567***
21 62 0.001 0.919*** 0.005 1.010*** 0.006 0.589*** 0.028 0.762***
22 52 0.115 1.011*** 0.057 1.017*** 0.048 0.689*** 0.172*** 0.812***
23 62 0.009 0.937*** 0.003 1.056*** 0.012 0.884*** 0.056 0.795***
24 62 0.082 0.967*** 0.066 1.065*** 0.000 0.838*** 0.143*** 0.759***
25 61 0.058 1.376*** 0.068 1.248*** 0.015 0.706*** 0.082** 0.636***
26 55 0.021 1.343*** 0.059 1.340*** 0.02 0.886*** 0.091* 0.559***
Value-weighted portfolio 4F-Carhart with industry effects
1 60 0.035 1.032*** 0.001 1.174*** 0.041 1.011*** 0.015 0.701***
2 63 0.096 0.888*** 0.056** 1.026*** 0.020 0.982*** 0.066 0.876***
3 61 0.077 0.974*** 0.059 1.119*** 0.044 1.012*** 0.143** 0.760***
4 60 0.001 1.012*** 0.028 1.181*** 0.016 1.107*** 0.047 0.494***
5 60 0.034 1.197*** 0.009 1.198*** 0.045* 1.162*** 0.014 0.551***
6 59 0.019 0.984*** 0.025 1.128*** 0.004 0.974*** 0.038 0.798***
7 60 0.016 1.270*** 0.005 1.239*** 0.020 1.169*** 0.006 0.543***
8 63 0.007 1.054*** 0.041* 1.215*** 0.007 1.071*** 0.107*** 0.541***
9 62 0.024 1.228*** 0.019 1.154*** 0.016 1.088*** 0.058 0.767***
10 61 0.084 1.210*** 0.048* 1.240*** 0.029 1.111*** 0.090* 0.539***
11 60 0.009 1.305*** 0.047 1.254*** 0.041 1.107*** 0.061 0.625***
12 61 0.075 0.809*** 0.033 1.125*** 0.030 0.929*** 0.005 0.663***
13 61 0.072 1.130*** 0.034 1.056*** 0.028 0.893*** 0.069 1.195***
14 63 0.067 1.120*** 0.005 1.170*** 0.034 0.963*** 0.026 0.875***
15 59 0.025 1.108*** 0.031 1.111*** 0.030 0.975*** 0.068 0.938***
16 63 0.072 1.238*** 0.027 1.147*** 0.085** 1.107*** 0.088 0.794***
17 62 0.008 1.224*** 0.048** 1.144*** 0.000 0.986*** 0.116** 0.992***
18 52 0.032 1.244*** 0.042* 1.143*** 0.017 1.114*** 0.046 0.794***
19 62 0.076* 0.920*** 0.005 1.077*** 0.056** 0.882*** 0.017 0.992***
20 62 0.078 1.220*** 0.004 1.173*** 0.064** 1.000*** 0.008 0.914***
21 62 0.109* 0.965*** 0.012 1.065*** 0.070* 0.844*** 0.045 1.100***
22 52 0.012 0.915*** 0.032 1.055*** 0.000 0.901*** 0.097 0.984***
23 62 0.009 0.912*** 0.019 1.109*** 0.035 0.851*** 0.023 0.954***
24 62 0.011 0.929*** 0.023 1.109*** 0.020 0.896*** 0.107 0.891***
25 61 0.010 1.551*** 0.029 1.326*** 0.010 1.222*** 0.097 0.439**
26 55 0.023 1.349*** 0.035 1.267*** 0.014 1.135*** 0.072 0.549***
Notes: This table reports alpha and beta, divided into 26 quarters from January 2013 to June 2019 for each equally weighted and value-weighted portfolio. To
obtain alpha and beta, we use daily excess portfolio return, 4F-Carhart model with industry effects and conduct regression analysis by OLS with Newey-West
robust standard error to relax heteroskedasticity and autocorrelation assumptions.
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Table 10
Performance of ISRI, SRI, ISSI, and conventional portfolios based on 5F-Carhart with industry effects.
Equally weighted portfolio 5F-Carhart with industry effects
Quarter Obs. ISRI SRI ISSI CONVEN
alpha beta alpha beta alpha beta alpha beta
1 60 0.003 1.172*** 0.002 1.212*** 0.018 0.870*** 0.034 0.759***
2 63 0.039 0.797*** 0.018 0.928*** 0.029 1.026*** 0.091** 0.967***
3 61 0.110 1.197*** 0.054 1.215*** 0.013 0.863*** 0.055 0.909***
4 60 0.038 0.999*** 0.003 1.148*** 0.036 0.860*** 0.057 0.778***
5 60 0.064 1.079*** 0.061* 1.157*** 0.006 0.845*** 0.066** 0.625***
6 59 0.016 1.124*** 0.015 1.154*** 0.044 0.843*** 0.051 0.738***
7 60 0.065** 1.113*** 0.052** 1.161*** 0.023 0.922*** 0.043 0.780***
8 63 0.072 1.183*** 0.095** 1.227*** 0.005 0.860*** 0.075** 0.800***
9 62 0.03 1.006*** 0.007 1.027*** 0.009 0.709*** 0.077** 0.768***
10 61 0.015 1.066*** 0.017 1.181*** 0.042 0.656*** 0.045 0.728***
11 60 0.074 1.304*** 0.081 1.225*** 0.068 0.781*** 0.074** 0.752***
12 61 0.098** 1.076*** 0.050 1.070*** 0.003 0.799*** 0.060** 0.636***
13 61 0.041 0.979*** 0.052 0.946*** 0.015 0.688*** 0.066* 0.531***
14 63 0.075 0.878*** 0.061 0.915*** 0.031 0.724*** 0.023 0.690***
15 59 0.008 1.141*** 0.016 1.164*** 0.018 0.816*** 0.081** 0.725***
16 63 0.018 1.190*** 0.022 1.180*** 0.014 0.677*** 0.006 0.640***
17 62 0.043 1.125*** 0.005 1.144*** 0.043 0.609*** 0.143*** 0.883***
18 52 0.082 1.026*** 0.036 1.054*** 0.051 0.947*** 0.139*** 0.875***
19 62 0.061 0.851*** 0.016 0.956*** 0.006 0.694*** 0.034 0.722***
20 62 0.065 0.897*** 0.012 1.028*** 0.032 0.570*** 0.101*** 0.625***
21 62 0.023 0.784*** 0.014 0.927*** 0.014 0.649*** 0.005 0.857***
22 52 0.127 1.125*** 0.074 1.091*** 0.059 0.739*** 0.179*** 0.898***
23 62 0.013 1.016*** 0.011 1.105*** 0.013 0.876*** 0.048 0.817***
24 62 0.077 1.093*** 0.06 1.166*** 0.009 0.877*** 0.139*** 0.819***
25 61 0.023 1.401*** 0.044 1.292*** 0.013 0.803*** 0.079*** 0.667***
26 55 0.051 1.295*** 0.078 1.338*** 0.006 0.961*** 0.072 0.599***
Value-weighted portfolio 5F-Carhart with industry effects
1 60 0.039 1.053*** 0.007 1.176*** 0.043 1.063*** 0.027 0.625***
2 63 0.097 0.716*** 0.058** 0.943*** 0.020 0.927*** 0.069 0.942***
3 61 0.067 1.025*** 0.048 1.150*** 0.049 1.012*** 0.143** 0.753***
4 60 0.021 1.010*** 0.026 1.209*** 0.026 1.105*** 0.047 0.447***
5 60 0.031 0.880*** 0.001 1.120*** 0.040* 0.958*** 0.026 0.729***
6 59 0.007 1.080*** 0.001 1.184*** 0.022 1.029*** 0.013 0.695***
7 60 0.01 1.195*** 0.010 1.188*** 0.016 1.163*** 0.017 0.563***
8 63 0.046 1.226*** 0.069*** 1.300*** 0.013 1.128*** 0.129*** 0.470***
9 62 0.025 1.133*** 0.006 1.116*** 0.009 1.038*** 0.046 0.840***
10 61 0.051 1.116*** 0.042 1.206*** 0.013 1.085*** 0.084 0.554***
11 60 0.029 1.301*** 0.033 1.221*** 0.050 1.095*** 0.038 0.714***
12 61 0.075 0.961*** 0.029 1.124*** 0.027 1.019*** 0.02 0.666***
13 61 0.083 1.154*** 0.032 1.078*** 0.038 0.933*** 0.071 1.113***
14 63 0.044 1.133*** 0.004 1.144*** 0.035 0.948*** 0.034 0.957***
15 59 0.001 1.237*** 0.019 1.180*** 0.011 1.105*** 0.054 0.724***
16 63 0.065 1.273*** 0.030 1.168*** 0.069* 1.155*** 0.075 0.712***
17 62 0.018 1.128*** 0.037 1.102*** 0.003 0.960*** 0.08 1.018***
18 52 0.017 1.147*** 0.020 1.123*** 0.020 1.103*** 0.013 0.747***
19 62 0.067* 0.919*** 0.006 1.069*** 0.044* 0.932*** 0.03 0.916***
20 62 0.022 1.142*** 0.004 1.182*** 0.025 0.968*** 0.02 0.873***
21 62 0.130** 0.953*** 0.009 1.062*** 0.081** 0.870*** 0.003 1.051***
22 52 0.032 0.990*** 0.026 1.058*** 0.008 0.974*** 0.081 0.927***
23 62 0.032 0.847*** 0.021 1.050*** 0.025 0.856*** 0.066 1.002***
24 62 0.016 0.986*** 0.024 1.129*** 0.020 0.947*** 0.101 0.815***
25 61 0.034 1.374*** 0.003 1.269*** 0.000 1.169*** 0.067 0.495***
26 55 0.012 1.264*** 0.017 1.239*** 0.037 1.130*** 0.027 0.537***
Notes: See notes to Table 9.
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Table 11
Results of portfolios-performance testing based on the 4F-Carhart model with industry effects.
Var. ISSI SRI ISRI Conven
E-W VeW E-W VeW E-W VeW E-W VeW
RMt  RFt 0.897b (13.67) 0.940b (15.17) 1.070b (12.04) 1.059b (14.77) 0.948b (12.01) 0.868b (10.36) 0.849b (15.34) 0.973b (27.10)
SMBt 0.411b (4.84) 0.0522 (0.94) 0.193 (1.82) 0.234b (3.07) 0.108 (1.34) 0.151a (2.11) 0.443b (6.18) 0.100a (2.53)
HMLt 0.258b (3.92) 0.0121 (0.33) 0.0508 (0.87) 0.127b (2.77) 0.177a (2.64) 0.119a (2.36) 0.231b (5.03) 0.0174 (0.79)
UMDt 0.113 (1.81) 0.0518 (1.26) 0.0909 (1.38) 0.0376 (0.65) 0.177b (3.10) 0.108 (1.92) 0.0418 (0.88) 0.0199 (0.76)
P1 0.0287 (1.04) 0.0610a (2.62) 0.0535 (1.93) 0.0163 (0.71) 0.142b (6.24) 0.0353 (1.49) 0.0406a (2.42) 0.0188a (2.20)
P2 0.0831a (2.37) 0.0313 (1.43) 0.0131 (0.29) 0.00144 (0.05) 0.0604 (1.67) 0.00306 (0.09) 0.0412 (1.51) 0.0142 (1.04)
P3 0.142b (3.84) 0.0613 (1.70) 0.0203 (0.38) 0.0432 (0.71) 0.0200 (0.49) 0.0793 (1.23) 0.120b (3.98) 0.0586a (2.37)
ai 0.00217 (1.18) 0.00105 (0.61) 0.00295 (1.22) 0.00579b (3.98) 0.00202 (0.84) 0.00132 (0.60) 0.00182 (1.26) 0.00225a (2.36)
N 78 78 78 78 78 78 78 78
Adj.R2 0.783 0.851 0.787 0.884 0.786 0.742 0.848 0.960
Notes: This table shows the coefficient values and t-statistics from the results of testing the performance of the 4FF model with industry-adjustment. The ISSI,
ISRI, SRI, and Conven portfolios are formed using the equally weighted average (E-W) and value-weighted average (VeW) methods.
a
Significant at the 5% level.
b
Significant at the 1% level.

Table 12
Results of portfolio performance testing using the 5FF model with industry effects.
Var. ISSI SRI ISRI Conven
E-W VeW E-W VeW E-W VeW E-W VeW
RMt  RFt 0.945** (12.33) 0.943** (14.15) 1.010** (9.72) 1.024*** (12.23) 0.960** (10.44) 0.858** (9.17) 0.879** (15.64) 0.991** (22.66)
SMBt 0.464** (5.59) 0.0636 (1.12) 0.178 (1.48) 0.235** (2.75) 0.0615 (0.70) 0.176* (2.29) 0.491** (8.11) 0.104* (2.45)
HMLt 0.158** (2.70) 0.00754 (0.19) 0.0963 (1.80) 0.0830 (1.90) 0.215** (4.22) 0.0605 (1.15) 0.162** (4.36) 0.0182 (0.78)
RMWt 0.00709 (0.12) 0.0125 (0.26) 0.0907 (1.07) 0.0309 (0.59) 0.0222 (0.41) 0.0367 (0.62) 0.0171 (0.38) 0.00934 (0.33)
CMAt 0.0769 (1.08) 0.0310 (0.50) 0.0449 (0.48) 0.0757 (1.13) 0.0938 (1.18) 0.00187 (0.03) 0.0490 (0.86) 0.0141 (0.35)
P1 0.00434 (0.17) 0.0622** (2.79) 0.0822** (3.52) 0.00581 (0.27) 0.156** (5.75) 0.0480 (1.81) 0.0231 (1.42) 0.0130 (1.58)
P2 0.0914* (2.47) 0.0306 (1.37) 0.0377 (0.95) 0.00687 (0.26) 0.0828* (2.01) 0.00041 (0.01) 0.0392 (1.39) 0.0172 (1.20)
P3 0.181** (4.37) 0.0751* (2.48) 0.0338 (0.73) 0.104* (2.08) 0.0322 (0.68) 0.0623 (1.20) 0.128** (4.15) 0.0388 (1.57)
ai 0.00367 (1.87) 0.00164 (0.85) 0.000741 (0.38) 0.00400** (3.21) 0.0024 (1.04) 0.00113 (0.47) 0.00299 (1.94) 0.00247* (2.43)
N 78 78 78 78 78 78 78 78
Adj.R2 0.823 0.869 0.821 0.908 0.804 0.757 0.880 0.960
Notes: See notes to Table 11.

The bi values in the 4F-Carhart and 5FF models do not b i and b

where Rbit is the predicted value of portfolio returns; a bi
differ after being controlled by industry factors. ISRI still are the predicted alpha and beta in the 4F-Carhart and 5FF
provides higher returns and risks (for 4F-Carhart, bi at 0.948, with industry effects regression, representing return perfor-
and for 5FF, the coefficient of bi is 0.960) than the other mance and systemic risk. Second, we calculate the quarterly
portfolios. As reported in Tables 11 and 12, the bi values for average fitted values with the following equation:
the ISSI portfolio are 0.897 (4F-Carhart) and 0.945 (5FF),
1 X
n
whereas, for the conventional portfolio, the bi is 0.849 (4F- Rbiq ¼ Rbit
Carhart) and 0.879 (5FF). These findings suggest that the ISRI n t¼1
portfolio has better performance. Hence, accommodating
sharia principles in sustainable investment provides the ben- where Rbiq is quarterly average fitted values of portfolio; n is
efits of better diversification. the number of trading days for each quarter.
Table 13 documents the fitted value of portfolio perfor- The results of the fitted-value estimation show the
mance. Based on quarterly estimated alpha and beta controlled following. The ISRI portfolio has higher fitted values in almost
by 4F-Carhart and 5FF with industry effects, we generate the all quarters than the ISSI and conventional portfolio. For
quarterly average fitted value of each portfolio. First, we es- example, in quarter 1, the fitted value of the ISRI portfolio is
timate the daily predicted return for each portfolio with the 0.210, higher than that of the ISSI (0.144) and conventional
following equation: (0.066) portfolios. This empirical finding suggests that Islamic

 investors can consider ESG or SRI values in their investment
bi þ b
Rbit ¼ a b i Rmt  Rft activities. These findings support previous research suggesting
that ethical investment has a significant influence on stock
market performance (Lusyana & Sherif, 2017). In addition,
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Table 13
Fitted-value portfolios based on 4F-Carhart and 5F-Carhart with industry effects.
Fitted-Value 4FF Model
Quarter E-W VeW
ISRI SRI ISSI CONVEN ISRI SRI ISSI CONVEN
1 0.210 0.229 0.144 0.066 0.239 0.271 0.207 0.086
2 0.106 0.097 0.081 0.149 0.098 0.081 0.101 0.126
3 0.257 0.253 0.188 0.251 0.259 0.249 0.247 0.227
4 0.056 0.045 0.045 0.115 0.044 0.025 0.052 0.093
5 0.143 0.161 0.097 0.021 0.168 0.197 0.142 0.041
6 0.015 0.003 0.016 0.087 0.001 0.020 0.012 0.065
7 0.045 0.060 0.027 0.046 0.064 0.088 0.047 0.025
8 0.038 0.026 0.032 0.102 0.025 0.005 0.034 0.080
9 0.032 0.045 0.017 0.055 0.049 0.072 0.034 0.034
10 0.255 0.251 0.187 0.250 0.257 0.247 0.245 0.226
11 0.350 0.350 0.255 0.314 0.358 0.353 0.338 0.290
12 0.156 0.174 0.106 0.029 0.182 0.211 0.155 0.050
13 0.054 0.068 0.033 0.040 0.072 0.097 0.055 0.019
14 0.002 0.010 0.007 0.078 0.013 0.035 0.001 0.056
15 0.082 0.097 0.053 0.021 0.102 0.128 0.082 0.000
16 0.093 0.083 0.072 0.140 0.084 0.066 0.087 0.117
17 0.047 0.061 0.028 0.045 0.065 0.089 0.048 0.024
18 0.063 0.078 0.040 0.034 0.082 0.108 0.064 0.013
19 0.028 0.017 0.026 0.096 0.015 0.006 0.025 0.074
20 0.091 0.106 0.059 0.015 0.112 0.138 0.091 0.006
21 0.114 0.106 0.087 0.154 0.107 0.090 0.108 0.132
22 0.146 0.138 0.109 0.175 0.140 0.125 0.139 0.153
23 0.040 0.054 0.023 0.049 0.058 0.082 0.042 0.028
24 0.018 0.032 0.008 0.064 0.035 0.058 0.021 0.043
25 0.177 0.171 0.132 0.197 0.174 0.160 0.170 0.174
26 0.096 0.087 0.074 0.142 0.087 0.070 0.091 0.120
Fitted-Value 5FF Model
1 0.215 0.232 0.153 0.075 0.239 0.264 0.211 0.090
2 0.110 0.105 0.083 0.148 0.087 0.083 0.096 0.123
3 0.265 0.265 0.195 0.255 0.243 0.249 0.242 0.224
4 0.059 0.051 0.045 0.113 0.035 0.028 0.047 0.089
5 0.146 0.161 0.103 0.028 0.170 0.191 0.147 0.045
6 0.017 0.008 0.015 0.084 0.006 0.017 0.008 0.062
7 0.046 0.057 0.030 0.041 0.069 0.083 0.052 0.021
8 0.040 0.032 0.032 0.099 0.016 0.008 0.029 0.076
9 0.031 0.042 0.020 0.051 0.055 0.068 0.038 0.030
10 0.263 0.263 0.194 0.253 0.241 0.246 0.241 0.223
11 0.361 0.364 0.265 0.321 0.339 0.351 0.333 0.287
12 0.160 0.175 0.113 0.037 0.183 0.205 0.159 0.054
13 0.054 0.065 0.036 0.035 0.078 0.092 0.060 0.015
14 0.003 0.006 0.005 0.074 0.020 0.031 0.005 0.053
15 0.083 0.096 0.057 0.015 0.107 0.123 0.087 0.004
16 0.096 0.090 0.073 0.139 0.074 0.068 0.083 0.114
17 0.047 0.058 0.031 0.040 0.071 0.085 0.053 0.020
18 0.064 0.076 0.043 0.028 0.087 0.103 0.069 0.009
19 0.030 0.022 0.025 0.093 0.007 0.003 0.020 0.070
20 0.092 0.105 0.064 0.009 0.116 0.133 0.096 0.010
21 0.119 0.113 0.089 0.154 0.096 0.092 0.104 0.128
22 0.151 0.147 0.112 0.176 0.128 0.126 0.134 0.149
23 0.040 0.051 0.026 0.045 0.063 0.077 0.046 0.024
24 0.018 0.028 0.010 0.060 0.041 0.054 0.025 0.039
25 0.183 0.180 0.136 0.198 0.161 0.161 0.165 0.171
26 0.100 0.094 0.075 0.141 0.077 0.072 0.086 0.116
Notes: This table reports the performance of ISRI, SRI, ISSI, and conventional portfolios, which are divided into 26 quarters from January 2013 to June 2019 for
each equally weighted and value-weighted portfolio. To obtain the fitted value, we use the equation in the regression based on 4FF-Carhart model with industry
effects and 5FF-Carhart model with industry-adjustment factors. The fitted value is important to verify the performance of the ISRI portfolio compared to the other
portfolios.
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this integration, according to Marwan and Haneef (2019), not three metrics of value simultaneously: it is sharia compliant,
only ensures the sustainability of the Islamic finance industry ESG compliant, and is return oriented. Fifth, based on the
but also fill the gap between its theory and practice. calculation of portfolio performance in 26 time horizons, the
These findings from either an equally weighted or value- study finds that, overall, the ISRI portfolio still has better
weighted portfolio give investors more flexible options for performance than the ISSI, SRI, and conventional portfolios.
selecting the best portfolio from both moral and rational per- Sixth, the results of fitted-value estimation reveal that the ISRI
spectives when ISRI has more financial benefits. Second, a portfolio has higher fitted values in almost all quarters than the
value-weighted portfolio is better with the ISRI portfolio than ISSI and conventional portfolios. These empirical findings
the equally weighted portfolio. This makes sense because ISRI suggest that Islamic investors can take ESG or SRI values into
normally includes big-cap stocks. Thus, when they are account in their investment activities.
selected as the constituent stocks in the portfolio, more stable Overall, the current study suggests that the ISRI portfolio
returns are generated. Hence, the fitted values, as reported in outperforms the other portfolios. This means that the ISRI
Table 13, provide more convincing results related to the portfolio offers more competitive risk-returns in different
viability of combining Islamic and SRI, thereby achieving market conditions: bull and bear markets. This supports the
better performance. principle that it is possible to do well while doing good (Azmi
et al., 2019), an idea about ESG/SRI values proposed by the
5. Conclusion United Nations Principles for Responsible Investment (UN-
PRI) to be integrated into Islamic screening supported by
Because of strong demand for the integration of Islamic many Islamic finance experts. These findings are also
screening and SRI values, supported by the extensive growth consistent with the triple bottom line concept expressed by
of the Islamic finance and ESG market, this study, first, Elkington (1998), Standard ISO 26000, the Paris agreement in
identifies the best valuation model to use with the ISRI port- 2015, the 2030 Agenda for Sustainable Development Goals,
folio compared with the other portfolios, then investigates the and the Directive 2014/95/EU and sustainable value creation
degree to which the portfolio performance (risk-factor de- (SVC) highlighted by Chandler (2016).
terminants) of ISRI is different from that of the other portfo- This study makes several contributions to the existing
lios, and, further, examines whether the time-varying literature on Islamic finance theory and the empirical practice
performance of the ISRI portfolio is better than that of the of Islamic investment. Previous studies evaluate the perfor-
other portfolios, applying different time horizons. To achieve mance of Islamic investment compared with other investments
these objectives, employing four asset-valuation models, that using only one valuation model, whereas this study applies
is, CAPM, 3FF, 4F-Carhart, and 5F-Carhart, we construct the several comparative models, such as CAPM, 3FF, 4F-Carhart,
four types of portfolios: an ISSI portfolio, SRI portfolio, and 5FF. Hence, our results provide broader and more
conventional portfolio, and ISRI portfolio. comprehensive insights for academics and practitioners. In
Based on comprehensive testing, the results of this study addition, our study is set in Indonesia for one reason, that is, it
can be summarized as follows. First, we conclude that 4F- has its own sharia standards formulated by its sharia advisory
Carhart and 5FF are better asset pricing models than CAPM council. Thus, the results of the analysis are more specific
and 3FF, as factors other than the market premium, as stated in because there are no different characteristics in the market. In
CAPM, determine portfolio performance. Second, 4F-Carhart addition, this study broadens the coverage in Islamic finance
and 5FF models show that, overall, the ISRI portfolio, which literature on ESG, Islamic finance, and portfolio performance
encompasses sharia-compliant and ESG-compliant stocks, has in terms of the tools and instruments used. Thus, our findings
better performance than the ISSI, SRI, and the conventional are more reliable, so they offer optimal results. Finally, the
portfolios. These findings are consistent with those of Azmi results of this study lay a foundation for a more detailed
et al. (2019). Second, despite its higher performance, the evaluation of stakeholder theory from the perspective of the
systemic risk of ISRI is lower than the market portfolio. If Islamic worldview. The stakeholder theory can be applied as
market conditions are bearish, ISRI's performance is higher an umbrella theory of Islamic screening that has been prac-
than the market portfolio and higher than either the ISSI or ticed in Indonesia, but with modifications. Stakeholders of
conventional portfolio. Third, from the perspective of invest- Islamic firms include not only customers and supplier, as in
ment style, ISRI is also less sensitive to firm size. Thus, this conventional investment but also God, therefore mankind has
result provides a different view from previous studies, such as greater responsibility when doing business.
Girard and Hassan (2008), Hassan et al. (2010), and On the practical side, the results of this study suggest that
BinMahfouz and Kabir Hassan (2013). Fourth, our findings the ISRI portfolio can be used as a reference for investors
support the stakeholder theory (Lokuwaduge & Heenetigala, because it has better performance than the ISSI, SRI, and
2017) in which a firm's objective is not only to generate conventional portfolios. In fact, the ISRI portfolio has more
returns but also to contribute to the environment and society. benefits for the betterment of society and environmental sus-
Accordingly, the ISRI portfolio has better performance tainability. Therefore, at the micro-level, ISRI provides better
because the activities of its constituent firms are in line with returns, but at the macro level, it also complies with the ob-
stakeholder expectations. Therefore, ceteris paribus, the ISRI jectives of sharia values. These findings also support previous
portfolio is better than the other portfolios because it covers findings in which ESG performance has a positive relationship
 _
A. Qoyum et al. / Borsa Istanbul Review 21-2 (2021) 105e124 121

with corporate financial performance (Albertini, 2013; Nizam trust funds. Managerial Finance, 33(2), 142e153. https://doi.org/10.1108/
et al., 2019). 03074350710715854
Adam, N. L., & Bakar, N. A. (2014). Shariah screening process in Malaysia.
This study is also expected to provide a reference for policy Procedia - Social and Behavioral Sciences, 121, 113e123. https://doi.org/
makers developing ISRI screening, which, because of its 10.1016/j.sbspro.2014.01.1113
importance, provides investment options that focus not only on Al-Awadhi, A. M., & Dempsey, M. (2017). Social norms and market out-
sharia principles but also on ESG; thus, it also leads the Is- comes: The effects of religious beliefs on stock markets. Journal of In-
lamic capital market in continuously raising its own quality, ternational Financial Markets, Institutions and Money, 50, 119e134.
https://doi.org/10.1016/j.intfin.2017.05.008
manifested not only as a faith- or religiously-based instrument Alam, N., & Rajjaque, M. S. (2010). Shariah-compliant equities: Empirical
but also as an indispensable tool of socioeconomic and human evaluation of performance in the European market during credit crunch.
development (Zain & Sori, 2020). Journal of Financial Services Marketing, 15(3), 228e240. https://doi.org/
10.1057/fsm.2010.19
Declaration of Competing Interest Albaity, M., & Ahmad, R. (2011). Return performance, leverage effect, and
volatility spillover in Islamic stock indices evidence from DJIMI, FTSEGII
and KLSI. Investment Management and Financial Innovations, 8(3), 12.
There is no conflict of interest. Albertini, E. (2013). Does environmental management improve financial
performance? A meta-analytical review. Organization & Environment,
26(4), 431e457. https://doi.org/10.1177/1086026613510301
APPENDIX. Ali, S., Shahzad, S. J. H., Raza, N., & Al-Yahyaee, K. H. (2018). Stock market

Appendix A. Capital Asset Pricing Model (CAPM) Estimation Result

ISSI SRI ISRI Conven
E-W VeW E-W VeW E-W VeW E-W VeW
RMt  0.782*** (8.65) 0.954*** (14.74) 1.161*** (19.69) 1.133*** (18.41) 1.019*** (10.88) 0.895*** (10.67) 0.703*** (8.46) 1.018*** (29.90)
RFt
ai 0.00753* (2.62) 0.0003 (0.23) 0.00220 (1.03) 0.00332* (2.00) 0.0008 (0.31) 0.0007 (0.35) 0.00660* (2.56) 0.00127 (1.33)
N 78 78 78 78 78 78 78 78
Adj. R2 0.521 0.830 0.776 0.842 0.650 0.706 0.531 0.946
This table shows the coefficient values and t-statistics from the results of testing the performance of the CAPM model portfolio.
*Significant at the 5% level.
**significant at the 1% level.

Appendix B. Estimation Result Based on Fama-French Three-Factor Model (3FF)

ISSI SRI ISRI Conven
E-W VeW E-W VeW E-W VeW E-W VeW
RMt  0.924*** (9.82) 0.927*** (12.09) 1.047*** (12.38) 1.050*** (15.66) 0.905*** (9.43) 0.841*** (9.66) 0.859*** (11.36) 0.978*** (24.56)
RFt
SMBt 0.416*** (3.90) 0.0547 (0.92) 0.198 (1.92) 0.236** (2.98) 0.116 (1.19) 0.156* (2.07) 0.445*** (5.27) 0.0993* (2.42)
HMLt 0.217*** (4.42) 0.00661 (0.17) 0.0836 (1.97) 0.113* (2.54) 0.241*** (3.91) 0.0800 (1.44) 0.216*** (5.96) 0.0245 (1.14)
ai 0.00269 (1.23) 0.00015 (0.09) 0.00228 (1.05) 0.00594*** (4.46) 0.00311 (1.10) 0.00104 (0.47) 0.00162 (0.98) 0.00210* (2.11)
N 78 78 78 78 78 78 78 78
Adj. R2 0,721 0827 0,784 0886 0,699 0729 0,805 0953
This table shows the coefficient values and t-statistics from the results of testing the performance of the Fama-French three-factor model portfolio.
*Significant at the 5% level.
**significant at the 1% level.

efficiency: A comparative analysis of islamic and conventional stock

markets. Physica A: Statistical Mechanics and its Applications, 503,
139e153. https://doi.org/10.1016/j.physa.2018.02.169
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