Global risk exposures and industry diversification with Shariah-compliant equity sectors

• Islamic equity sectors exhibit positive risk exposures with respect to global market shocks.
• Islamic Consumer Services, Oil & Gas and Technology exhibit negative risk exposure.
• The risk exposure is during crash periods, implying possible safe haven benefits.
• Portfolios supplemented with positions in Islamic sectors improve risk-adjusted returns.
• Financials, Healthcare, Telecom, and Utilities are significant in diversification strategies.

This paper examines the risk exposures of ten major Islamic sector indexes with respect to shocks in global conventional markets. Utilizing a dynamic three-regime, three-factor risk spillover model, we generally observe positive risk exposures of Islamic equity sectors with respect to developed market shocks. Consumer Services, Oil & Gas and Technology, however, are found to exhibit negative risk exposures during crash periods, implying possible safe haven benefits for global investors. Both in- and out-of-sample results suggest that the portfolios supplemented with positions in Islamic equity sectors yield much improved risk adjusted returns, implying significant international diversification benefits. Financials, Healthcare, Telecommunication, and Utilities particularly stand out with relatively higher weights allocated in the optimal portfolios, implying the significance of these Islamic sectors in global diversification strategies.