How Global Shocks Drive Investors to Oil-Rich Frontier Markets

Gulf Arab markets are notoriously secretive and closed to foreign investors, but one academic paper aims to unearth conclusions about the area's appeal.

(January 11, 2013) — During volatile economic climates, herding behavior among investors is a reality in oil-rich frontier stock markets of Abu Dubai, Dubai, Kuwait, Qatar and Saudi Arabia, a newly released academic paper shows.

The paper hones in on the markets of the Gulf Cooperation Council (GCC)– the political and economic union of the Arab states bordering the Persian Gulf.

“Diversification benefits in Gulf area markets for global investors are numerous,” co-author Riza Demirer, a professor at Southern Illinois University, tells aiCIO. He adds, however, that investors’ hands are often tied from harnessing these typically secretive and closed-off markets. “The Gulf area is trying to upgrade from frontier to emerging market status, and when that happens, they will be more often to foreign investors.”

He adds: “Gulf area market stocks will always benefit from high oil prices, and with oil prices continuing to be volatile, investors can harness opportunities in the region.”

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Thus, in anticipation of that, according to the research, global investors should be aware of the potential of the area.

As outlined by the paper, GCC frontier stock markets respond significantly to global market conditions in two distinct ways:

(1) global factors play a significant role in determining various economic cycles in these frontier markets as well as their transitions from one cycle to another

(2) shocks in global systematic risk factors significantly contribute to investor herding in these frontier markets.

“Higher levels of global risk indexes including the VIX and the FSI as well as positive changes in the US stock market performance and in the price of oil govern the transitions out of low into higher volatility states during which herding behavior is found to be present,” the paper asserts.

Additionally, the paper notes that these findings imply that equity investment, particularly in Dubai and Kuwait. Policy makers in these two markets should be cognizant of the findings, and thereby build safety circuits and hedging instruments to deal with volatility. “It will be a remiss if we do not point out that the volatility in Abu Dhabi is anti-persistent even in the low volatility environment. This speaks out for the different type of spending and economic growth policies pursued in this oil-rich emirate, which has the second largest sovereign wealth fund in the world. It is safe to say that the Abu Dhabi market is for the risk-averse and faint-hearted investors,” the authors write.

Read the full paper here.

(January 11, 2013) — Investors have plunged back into equities with flows reaching almost record levels in the first week of the year, showing renewed confidence in the global economy, market participants have said.

In the first full week of trading, US equity mutual funds saw massive inflows, according to data monitor Lipper.

A note from Lipper’s Director of Research Services Tom Roseen said: “Equity funds, including exchange-traded funds (ETFs), took in a whopping $18.3 billion for the week ended Wednesday, January 9, their fourth largest net inflows since Lipper began calculating weekly flows in January 1992.”

Roseen noted that on Friday, January 4, investors catapulted the S&P 500 index to its highest close since December 31, 2007, after the US Congress passed budget legislation that raised taxes on the wealthiest Americans and extended unemployment benefits-delaying the spending-cut fight until the debt debate occurs in a few weeks.

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More widely, so far this week the trend has continued, according to data monitor EPFR. It showed that $6.8 billion was moved into equity funds, widening the gap over flows into fixed income funds, which have stayed relatively stable.

Kevin Murphy, equities fund manager at Schroders, told aiCIO: “The significant flows into bonds since 2008 has pushed yields down to a level that many investors feel offer insufficient compensation for the risks of inflation. As such, investors are beginning to look to equities as they offer greater potential upside, whilst also offering inflation protection. With equities having suffered many years of outflows, the move at the beginning of this year is an encouraging start.”

A note from investment bank UBS showed that over the last couple of months investors in the US had begun reversing a trend of selling equities in favour of buying bond funds, with the largest outflows coming from high yield products.

Bank of America Merrill Lynch’s equity strategy team said over the past week, 17 of the top 20 ‘winners’ were country-based equity funds. These funds posted total returns of between 1.3% and 3.2%. The three bond ‘winners’ were Greek, Korean and Mexican government debt.