Is there a cost for adopting faith-based investment styles?

Religious considerations in making investment decisions, or considerations based on social beliefs, have now become a class of investments in their own right. This chapter addresses the issue of the possibility of extra costs for investors in these niche classes of screened assets. The first objective is to assess whether there is idiosyncratic risk in portfolios of such screened assets and, if there is, whether these portfolios are capable of diversifying their unsystematic risk. The second objective is to evaluate the risk-adjusted performance of screened portfolios. The sample used for analysis in this chapter includes three type of portfolios, namely shariah-compliant, socially responsible investments (SRIs), and market (proxy) portfolios in the United States. The portfolios are formulated based upon the constituent lists of different Dow Jones Indices to add credibility to stock selection. The SRI portfolio recorded the lowest average unsystematic risk, followed by the shariah portfolio. Analysis of the risk-adjusted return revealed that the SRI portfolio had a superior performance compared to the other two portfolios during the sample period. However, there was not much difference in performance among the sample portfolios during the sub-sample periods. It was found that the SRI portfolio had highest systematic risk, followed by the shariah portfolio. The returns for the SRI portfolio were predominantly generated by small stock premiums. All the portfolios manifested value bias and no momentum effect. The results indicate that both negative and positive screenings result in an increase of systematic risk. As SRI portfolios exercise both types of screenings, they record the highest level of systematic risk.