Effect of Shariah Compliance on Stock Performance at the Nairobi Securities Exchange

Abstract

The study set out to establish the effect of Shari’ah compliance on stock returns in the NSE. The objective was achieved through comparison of the risk adjusted and excess returns (Jensen’s alpha), returns per unit of volatility (Sharpe & Treynor ratios) between the NSE 20 index and a constructed Shari’ah index based on the Morgan Stanley Capital International (MSCI) global Shari’ah screening criterion. The Shari’ah index generated higher and statistically significant excess returns and mean risk adjusted returns. The index also recorded superior Sharpe and Treynor ratios. The Sharpe ratio difference was statistically significant while the Treynor ratio difference was insignificant. The volatility as measured by beta was of statistical irrelevance though both indices underperformed the market. The study found the Shari’ah index to outperform the conventional counterpart as far as generation of excess returns and mean risk adjusted return and returns per unit of total volatility (Sharpe ratio). The study recommends formation of a Shari’ah board, construction of a Shari’ah index, creation of an Islamic capital market, Public sensitization, education and timely dissemination of Shari’ah related information to investors. The recommendations were aimed at faster growth and regulation of the nascent industry. Further studies should be done using other Shari’ah screening methods in the greater East Africa region and the results compared with those of this study. It would be worthwhile to do another study contrasting a Shari’ah index with that of FTSE NSE 15 and FTSE NSE 25 with an objective of ascertaining whether the same conclusions would be drawn. In order to draw more robust and representative conclusions the study proposes a further study on the same subject but covering a longer period since the inception of the NSE 20 index.