The Power of Religion: Islamic Investing in the Lab

Faith-based mutual funds have recently become a growing corner of the mutual fundindustry. Morality and ethics are thought to exert an influence on investors’ decisions in this segment, althoughtheir role in driving such investments is not clear as these funds are also attractive due to their distinct risk-returnprofile. If nonpecuniary motives are predominant, investors in such funds may be less sensitive to financialperformance, resulting in different patterns of fund flows relative to conventional funds. This paper fills the gap inthe literature, by providing an express linkage between religious preferences and investment in an Islamic fund.Using an incentivized lab experiment, the analysis compares the extent to which investors with religious preferences arelikely to accept inferior financial performance to pursue investments aligned with their religious preferences. Thefindings show that investment in an Islamic fund is driven by religious preferences and religiosity is strongly tied toinvestor loyalty in the Islamic fund, with investors more willing to accept reductions in returns and increases inrisk. The analysis fails to find that social preferences play a similar role in socially responsible funds. Whenpitted directly against each other, investors prefer religious investments over socially responsible investments,suggesting that they do not view the two as substitutes.