Islamic Capital Markets: Theory and Practice

Chapter 14

Portfolio Performance and Value-at-Risk

The purpose of this chapter is to analyze the tools for measuring and assessing the performance of investment funds. Both investors and fund managers are interested in the performance of investment funds. The chapter describes the methodologies for evaluating performance, which essentially include risk-adjusted measures such as the Treynor index, the Sharpe index, the Jensen index, and Fama’s selectivity index. The chapter presents performance attribution models that explain the factors contributing to the performance of the fund such as timing, asset selection, sectors, and manager skills.

Investment funds are subject to significant risk. The chapter addresses the value-at-risk (VaR) of a portfolio, defined as a loss that a portfolio can sustain in a worst-case scenario. The chapter discusses methods for calculating VaR; it also discusses stress testing and back testing. Value-at-risk (VaR) is a risk measure used to assess worst-case scenarios for a portfolio. It is an estimate of how much the value of a portfolio could fall due to unanticipated changes in market prices or rates. In fact, stock markets have been characterized by crashes. They often exhibit severe volatility. Sukuks also are exposed to market risk. A jump in yields will cause a drop in value of sukuks. Exchange rates could vary drastically and cause a loss in a portfolio’s foreign assets. A stock and sukuks portfolio is therefore likely to suffer bad losses on ...