A Gulf Emerging Portfolio: And Why Not?


A Study on including Kuwait, Saudi, and UAE for Portfolio Enhancement Kuwait Financial Center (Markaz), has recently published a report on the benefits of inclusion of GCC stock markets with global emerging markets. The most sought after scenario for portfolio managers is to reduce risk and increase returns. This is possible by creating a Gulf Emerging Market Portfolio. The stock price returns from 2002 – 2007 indicates that a combination of the six GCC markets with the twenty five emerging markets (total 31 markets) reduces the risk and increases the return. There are several important reasons as to why GCC markets should find a place in the emerging market portfolio: • GCC markets have exhibited solid risk-adjusted returns, much better than all other emerging markets. • GCC stock market valuations look very attractive at current levels relative to emerging markets. • GCC stock markets enjoy low/negative correlation with emerging markets. This will increase portfolio efficiency. • All the GCC economies enjoy excellent current account surplus. This combined with low valuations makes the proposition doubly interesting. Presently, GCC stock markets are not included in the MSCI Emerging Market Index primarily because they are mostly closed to foreign investor through direct participation. However, all the GCC stock markets are accessible through mutual funds. To create a portfolio mix to produce the efficient returns, the entire set of 31 markets have been broken down into three different segments – large markets (9), medium markets (10) and the small markets (12). The classification is based on the market capitalizations. Market capitalization above USD 300 Bn is termed as large and markets with market capitalization above USD 100 Bn but less than USD 300 Bn have been termed as Medium sized. The rest have been classified as small markets. In this classification, Saudi Arabia is the only market in the GCC, which forms part of the large market segment. Kuwait and UAE form a part of the Medium market segment. Oman, Qatar and Bahrain form a part of the small market segments. The division of markets into various segments and the resultant risk - return profiles have showcased that within the GCC region combining Kuwait, UAE and Saudi Arabia will provide a better favorable risk-return tradeoff. Portfolio Performance Summary (Jan 2002-March 2007) Annualized Return Risk (SD Annualized) Excl GCC Incl GCC Excl GCC Incl GCC All markets 27% 28% 20% 17% Large Markets 26% 27% 19% 17% Mid Markets 25% 27% 17% 15% Small Markets 42% 40% 15% 14% Source: Markaz Analysis Contrary to the belief that Emerging markets are over heated, studies show that the increase in emerging market is brought about by increase in earnings. Similarly, GCC stock markets look attractive given the steep correction witnessed during year 2006. Earnings growth continues to be robust in key sectors such as banking, industrials, etc. GCC economies have also entered a new era of oil prices that will usher much higher economic growth than what was witnessed during the last few decades. This will propel investments across the sectors providing immense opportunities to investors. However both the emerging markets and GCC stock markets face many risks including lack of liquidity, lack of research, geo political risks and corporate governance. Standards set by developed markets in all of these will be very difficult to exceed by emerging markets at least in the near-term. We should also not forget the fact that equity markets across the world have benefited from high levels of liquidity aided by low interest rates. Higher interest rates could take away this liquidity benefit Hence, the case for portfolio diversification. Due to risks presented, stock picking may be a hazardous game. Rather we would advise “fund-picking” i.e., selecting the best performing local fund managers that have strong understanding and feel of the markets. ### About Markaz Kuwait Financial Centre 'Markaz', with total assets under management of over KD1.20 billion as of December 31, 2006, was established in 1974 has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997; and was recently awarded a BBB+ corporate rating by Capital Intelligence Ltd.