Abstract

This study examines the extent to which imposing constraints on a portfolio diminishes its return. I look at the cost of observance of Islamic laws ( Sharia ), which restrict the composition of portfolios according to the activities of companies and their financial ratios. Cross-sectional regressions of monthly risk-adjusted S&P 500 stock returns on a variety of company characteristics reveal that individual mean returns are significantly related to industry membership but not to the various Islamic compliance criteria. This is further supported by spanning tests which suggest that an Islamic index can be considered a substitute for the overall Secular index. However, randomly selected Islamic-compliant portfolios of various sizes tend under-perform their risk-matched Secular counterparts in-sample. And while out-of-sample performance turns against Secular portfolios, this is attributable largely to investment in Financials by the latter.