Islamic legal methodologies and Shariah screening standards: Application in the Indonesian stock market

• Author: Habib Ahmed,Muhamad R. Rizaldy
• Date: 01 September 2019
• DOI: http://doi.org/10.1002/tie.22042
• Published date: 01 September 2019

RESEARCH ARTICLE

Islamic legal methodologies and Shariah screening standards:

Application in the Indonesian stock market

Muhamad R. Rizaldy

1

| Habib Ahmed

2

1

Islamic Economics, Business, and Finance,

Gunadarma University, Depok, Indonesia

2

Islamic Law and Finance, Durham University

Business School, Durham University,

Durham, UK

Correspondence

Muhamad R. Rizaldy, Islamic Economics,

Business, and Finance, Gunadarma University,

Jl. Margonda Raya 100, Depok, West Java

16424, Indonesia.

Email: rizaldy@staff.gunadarma.ac.id

This article provides a framework for applying the principles of Islamic legal methodology to

determine the optimal Shariah screening standards for Islamic equity markets. It is argued that

using maslahah mursalah (unrestricted benefit) is an appropriate method for identifying appropri-

ate financial standards and its principles stipulate that the benchmark that yields the best eco-

nomic returns to investors should be chosen. The methodological framework is applied to the

Indonesia equity market where the economic implications of the Islamic stock screening stan-

dards of the Indonesian Islamic Shariah Stock Index and four global indices are assessed. Portfo-

lios are constructed by applying Islamic stock screening standards for each of the indices by

using data on 377 stocks listed in the Indonesian stock market for 5 years. The performances

measured by the Sharpe ratio, Treynor index, and Jensen alpha reveal that the Dow Jones

Islamic Index screening criteria performs the best. Based on the method of maslahah mursalah,

the article recommends using the screening standard of this index in the Indonesian stock mar-

ket to maximize benefits to investors. While the approach used in this article is applied to

Islamic equity markets, the methodological framework can also be used for other similar cases in

Islamic finance.

KEYWORDS

Indonesian stock market, Islamic equity market, Islamic stock screening standard, maslahah

mursalah (unrestricted benefit), portfolio performance

1|INTRODUCTION

Since its inception in the 1970s, the Islamic financial industry has

grown rapidly to become a significant sector in many jurisdictions.

A key feature of Islamic finance is the use of Islamic law (Shariah)in

financial transactions. Shariah compliance of Islamic financial opera-

tions is ensured by introducing a Shariah governance framework that

includes a Shariah board constituting a group of Islamic jurists who

review and approve different products and transactions. Capital mar-

kets are considered an integral part of a modern financial system as

they provide opportunities for investors to invest in productive ven-

tures which contribute to economic growth (Enisan & Olufisayo,

2009; Hearn, Piesse, & Strange, 2011; Kassim, 2016; Narayan & Nara-

yan, 2013). The Islamic capital market, as a part of the larger Islamic

financial industry, is one of the innovations engineered by the Muslim

scholars to facilitate a harmonious connection between the modern

capitalistic world and Islamic traditions (Tripp, 2006). Though smaller

in size compared to the Islamic banking sector, the Islamic capital mar-

ket is growing in many jurisdictions and the number of Islamic inves-

tors globally is increasing (Akhtyamova, Panasyuk, & Azitov, 2015;

Derigs & Marzban, 2008). Pragmatically, the Islamic capital market

aims to draw on the trust and attention of potential Muslim investors

to increase their involvement so that their economic advantages can

be optimized.

Islam is seen as a comprehensive way of life by its followers, pro-

viding rules and guiding principles for different aspects of Muslim life

related to both spiritual and religious aspects and activities governing

worldly affairs including commercial transactions (Marzban & Asutay,

2012). Since many Muslim investors have objectives and preferences

for investing in Shariah compliant assets, conformity and consistency

with the Shariah principles becomes fundamentally important. This

would require eliminating the elements that are considered unlawful

in light of the Shariah from the asset universe when considering

Islamic portfolio optimization. For instance, since the prohibition of

DOI: 10.1002/tie.22042

Thunderbird Int. Bus. Rev. 2019;61:793–805. wileyonlinelibrary.com/journal/tie © 2019 Wiley Periodicals, Inc. 793