Ramadan fasting is one of the most celebrated religious rituals in the world. Ramadan is a positively perceived feast (in the same way as other feasts like Christmas, New Year, etc.); therefore, we can anticipate it should positively affect investor psychology.
Academic research confirms this speculation. Equity returns during Ramadan are almost nine times higher and less volatile than during the rest of the year. A simple market timing strategy could be therefore created by holding an equally weighted basket of ETFs, from countries with a large Muslim population during the month of Ramadan and staying in cash during the rest of the year. Due to its simplicity, this strategy could be easily incorporated into various portfolios.
Academic research postulates that the euphoria derived from Ramadan could influence investor behavior in Islamic markets. The upbeat mood during Ramadan leads to positive investor sentiment and has a positive valuation effect on equity markets in Islamic countries.
estimated per annum return for strategy, calculated as equity return during Ramadan month ( ~2.7% = (1 + 38.09%)^(1/12) – 1 ) plus cash return (4%) during rest of the year
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The investment universe consists of countries for which stock market index data are available and in which the proportion of the population professing Muslim faith exceeded 50%. Most of the countries could be easily tracked via index ETFs. The research paper we use as an example uses 14 Muslim countries.
Ramadan is the ninth month in the Islamic calendar, which is based on the motion of the moon. The Ramadan month could be calculated by using the information on the lunar phases and sunset times from the astronomical calendar or information about Ramadan dates from various public sources.
The trading strategy is simple. The investor holds an equally weighted portfolio of ETFs during the Ramadan month. He/she is otherwise invested in cash.
Partially - The selected strategy is a class of “Market Timing” strategies that try to rotate out of equities during the time of stress. Therefore the proposed strategy isn’t mainly used as an add-on to the portfolio to hedge equity risk directly. Still, it is more an overlay that can be used to manage the percentual representation of equities (or “equity-like assets”) in a portfolio. “Equity Market Timing” strategy can decrease the overall risk of equities in a portfolio, and it can improve the risk-adjusted returns. Moreover, as strategy’s goal is to hold the equity market only in positive times for equity market factor and be out of equities otherwise, therefore, this logic might be used to create an amended market timing strategy (using original rules), which is out of equities during positive times and holds bonds (or goes short equities) during bad times. This new amended strategy can be maybe used as a hedge/diversification to equity market risk factor during bear markets. However, performance/risk characteristics and overall correlation and quality of suggested amended strategy can be found out only by rigorous backtest and source academic research paper doesn’t give us any clues on how it will perform…
