This study explores the challenges of managing Shariah-compliant portfolios and the importance of addressing Shariah non-compliance (SNC) risk, particularly in the context of social media and reputational risk. Keywords: Portfolio Management, Shariah Compliant Investment, Shariah Non-Compliance Risk (SNC), Black-Litterman Portfolio Optimization Model, Gold Investment. The risk of Shariah non-compliance (SNC) is an important consideration in managing the Shariah Compliant Portfolio, as non-compliance can result in financial losses and damage the reputation of financial institutions (Omar & Rusni, 2019; Rusni, 2016; Lahsasna, 2014).
Shariah non-compliance risk refers to the risk that a financial institution or any other entity involved in Islamic finance may violate Shariah principles in its operations or transactions. Shariah non-compliance risk may arise from non-compliance with the Shariah rules and principles governing Islamic finance activities and may have significant consequences for the financial institution or entity involved. It is a fact that committing Shariah non-compliance can cause Shariah non-compliant income for the financial institution and thus affect the returns that are shared and delivered to the shareholders and investors.
In fact, the risk of non-compliance with Shariah will affect the reputation of the fund provider and manager, which reflects the perception of market participants. The study also finds that the relationship between gold and Islamic stocks is stronger during periods of financial crisis, suggesting that gold can serve as a safe haven in times of market turmoil.
Methodology
However, the study also finds that the relationship between gold and Islamic stocks is weaker and less significant during normal and bullish market conditions. This suggests that gold may not provide significant diversification benefits during normal or bullish market conditions. The study covers the period from January 2005 to December 2015 and focuses on the Islamic stock markets of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.
The results show that the relationship between gold and Islamic stocks varies in different market regimes. The study finds that gold acts as a hedge during bear market conditions, but does not provide significant diversification benefits during normal or bull market conditions. The confidence level is interpreted as a standard deviation around the expected return of the view.
The more certain an investor is about his view, the smaller the standard deviation and vice versa. Furthermore, there is a positive relationship between the level of trust and its impact on the portfolio. The risk aversion coefficient (λ) characterizes the expected return-risk profile and indicates the size of the expected return that the investor is willing to give up to derive a less volatile portfolio.
The expected return increases as the risk aversion coefficient increases, i.e., a higher λ implies a higher risk appetite of the investor. The Black-Litterman formula calculates new expected returns on portfolio assets based on investor views and market equilibrium. The formula balances the investor's views with the market equilibrium, taking into account the level of uncertainty in the investor's views and the investor's risk aversion.
The resulting portfolio is efficient and well diversified, and reflects both investor views and market equilibrium.
Data
2009) who presented the evidence of the potential for gold to act as a safe haven asset. After explaining the safe haven feature of gold, we also need to explain the volatile nature of gold. One can observe from Table 3 that the volatility of gold (3.68%) is significantly higher compared to the volatility of Sukuk (0.33%) which at first glance can be seen as a contradiction with its safe haven asset- characteristics.
This phenomenon was explained in Baur (2012) who studied the volatility of gold and showed that there is an inverted asymmetric response to positive and negative shocks, such that positive shocks increase volatility more than negative shocks. The author suggested that this effect is due to the safe haven property of gold as investors interpret positive gold price changes as an indication of future adverse conditions and uncertainty in other markets. According to his results, the inverted volatility feature of gold can lower the aggregate risk of a portfolio for specific correlation levels.
Gold is a safe haven, therefore it is traditionally seen as an asset/commodity that preserves the value of the portfolio during extreme times of the market, and therefore it was always a preference for investors with low risk appetite and the goal of preserving the value of the portfolio. This was also investigated by Bayram et al. 2018), who implemented the Black-Litterman model to construct a strategic portfolio (portfolio that maintains its value in times of financial turmoil) for central banks with optimal allocation to gold and suggested that benchmark portfolios should increase gold holdings to preserve the value of the reserves in unstable times. It is obvious that the weight of gold in the very conservative benchmark portfolio needs to be increased, and the question is what is the optimal weight.
The Black Litterman model is used to derive the optimal gold level for the very conservative posterior portfolio. The interviews were conducted through online media and experts were given introductory remarks on the purpose of the study and disclaimers for the status of the expert's opinion for ethical consideration. The first question was about the risk exposure of the given list of portfolios based on the Shari'ah Compliant Benchmark Portfolios and the second question was the level of their confidence.
According to the list of portfolios (as in Table 2), experts believe that gold is minimally exposed to SNC risk if it is physically traded on the spot. Experts believe that Sukuk is less exposed to SNC risk compared to other assets, including global equities, emerging market equities and real estate. When sukuk is innovated, compliance with Shariah aspects starts from the very beginning of the submitted proposal and prospectus.
Methodology
In the Black-Litterman model, there are some assumptions related to professional views: first, the number of better assets does not necessarily match the number of worse assets, and second, the model does not require investors to state views on all assets (Idzorek, 2007). The variance-covariance matrix shows the extent to which corresponding elements from two sets of ordered data move in the same direction, which is known as the linear relationship between two variables. A positive coefficient corresponds to co-movement of variables in the same direction, while negative coefficients are interpreted as movement of variables in different directions.
On the diagonal (highlighted) of the variance-covariance matrix we have the variance of the variables and on the off-diagonal diagonal we have the covariances between the variables which are symmetrical. The main point that distinguishes the Black-Litterman model from mean-variance optimization is that it makes it possible to incorporate a portfolio manager's specific expectations on future asset performance, while mean-variance optimization considers only the historical performance of the asset. . Recall that the Black-Litterman model takes into account the historical performance of the asset as well as the subjective views of the portfolio manager on the future performance of the assets under consideration.
In our model, views are related to SNC risk and not just expected returns. The new or later very conservative portfolio derived from the Black-Litterman model is composed as follows: 61% allocated to sukuk and 39% allocated to gold. Note that this study derives an optimal asset allocation for the very conservative portfolio targeting the group of investors with a very low risk appetite (λ = 1).
As mentioned in previous sections, allocation to gold is underrepresented in our benchmark very conservative portfolio. Furthermore, according to the Sharia interviewed for this research, gold has minimum exposure to SNC risk if traded physically on the spot. Meanwhile, Sukuk is another asset with low SNC risk, it has an exposure to the credit risk.
These views and gold's historical performance justify its increased weight of 32% in the new very conservative portfolio.
Conclusion
For example, in some countries, Islamic banking institutions with gold accounts and their transactions are supervised and regulated by the banking board and legal credential of the home country. The model took into account the historical performance of the assets as well as subjective perceptions of SNC risk. The findings of this study are in line with existing literature that emphasizes the importance of incorporating subjective views and future expectations into portfolio construction models, such as the Black-Litterman model.
The study also recognizes the strict Sharia requirements for gold and the need for an oversight and regulatory structure to ensure compliance. In conclusion, the Black-Litterman model incorporating subjective views on SNC risk led to a revised portfolio allocation with increased weight to gold and Sukuk. The results of this study contribute to the existing literature by demonstrating the application of the Black-Litterman model in a Shariah-compliant investment context and emphasizing the importance of considering specific risk factors in portfolio construction.
Proceedings of the 1st Universitas Kuningan International Conference on Social Science, Environment and Technology, UNiSET 2020, 12 December 2020, Kuningan, West Java, Indonesia. The Case for Malaysia, Turkey, KSA and Pakistan", International Journal of Islamic and Middle Eastern Finance and Management, Vol. The dynamic relationship between gold and silver futures markets based on Copula-AR-GJR-GARCH Model.
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