Dynamic nexus between Sharia and ESG indices and ETFs in India

This study aims to uncover interdependencies between two distinctive but increasingly influential dimensions in contemporary finance, namely, Environmental, Social, and Governance (ESG) and Sharia guidelines. We examine the long-term association between ESG and Sharia indices, along with ESG and Sharia Exchange-Traded Funds (ETFs) for the Indian market. We do this by employing Cointegration, Vector Auto-regression (VAR), Granger causality and dynamic connectedness analyses. We found a lack of cointegration between both the ESG and Sharia indices and ETFs. Second, we observed bi-directional causality between the chosen ESG and Sharia index and ETF pairs. Subsequently, the level of dynamic connectedness was found to be consistently high. We find that ETFs are recipients of return spillovers from the indices. In terms of applicability of findings, traders can devise hedging strategies and short-term trading scenarios based on dynamic connectedness analysis. The lack of cointegration may be attributable to the difference in the underlying asset composition of ESG and Sharia indices and ETFs. This suggests that while Sharia-based instruments cannot be a substitute for ESG-based instruments, they can be seen as a complementary asset class. Finally, this complementarity can contribute to a greater understanding of how Islamic finance principles align or diverge from ESG considerations, providing valuable insights for investors, financial institutions, and policymakers. This study sheds light on the relationship between ESG and Sharia based financial instruments. By analysing data of ESG and Sharia based indices and ETFs from India, the research reveals that indices are transmitters and the ETFs are receivers of spillovers. The findings also show the dynamic nature of connectedness between instruments over time. Most importantly, both types of instruments can act as complementary asset classes for investors. Hence, these observations have significant ramifications for financial institutions who specialise in designing financial indices and investment instruments, such as ETFs.