Warrick and Yaksick (2004)
Warrick, Alexander and Rudy Yaksick. "Developing a Global Islamic Index Fund with Minimum Tracking Error to a Broad Market Index." Mystic, Connecticut: Eastern Finance Association Annual Meeting. April 2004.
This strong and complex paper analyzes the Dow Jones Islamic Market Titans 100, a global Islamic market index, comparing it with the Dow Jones World Index for the 1996-2002 time period. The Islamic index underperformed during this time period, with an annualized return of -0.32% vs. +2.32% for the unscreened index.
The authors conduct a holdings-based attribution for the last 27 months of the study (2001-2003 1Q) using the the Northfield Global Equity Risk factor model (see www.northinfo.com for a full discussion of this model). During this subperiod the Islamic Market Titans outperformed the Dow Jones World Index by 30 bps / month, despite negative returns impact (-17 bps / month) from model factors (size, dividend yield, oil prices, etc.). Stock-specific returns totally offset the negative factor impact.
The authors then attempt to optimize the Islamic product to the Dow Jones World Index using the risk model in a standard mean-variance optimization, and backtested it over the full 1996-2002 time period. This optimized portfolio beat the benchmark by 9 bps / month, again with strong stock-specific returns offsetting negative factor returns. The observed tracking error, however, was slightly below 4%, which the authors note "would be considered too high for an enhanced index fund.
This was one of the first strong papers on Islamic investing.