Are GCC fund managers following the correct strategy?

Byline: Developed markets to decide on international portfolio diversification.

There seems to be an increasing consensus among international investors and in the financial press that international portfolios should be primarily diversified across sectors and not across countries.

Observations like these have been guaranteed a hearing in developed markets as some considered differences between their index returns to be increasingly driven by differences in their sector composition.

Does the dominant influence of sectors extend its realm to the GCC equity markets?

The well trodden path of the evolution of corporations between venture capital to stock market listing and beyond was successfully replicated across the region. At present, the growth of the GCC capital markets coupled with (most recently) geographic and product diversity of companies operating within it had asset managers seeking further exposure to home-grown entities and the mix of assets with the best-case scenario.

What matters most for the GCC portfolio, countries or sectors? Is Emaar primarily a Dubai stock or a real estate stock? Which surpasses which in GCC portfolio allocations, country or sector characteristics? And, how does the optimal diversification strategy vary over time? These questions were brought to bear on the region in a report issued by Arqaam Research last September.

The research was realised from the viewpoint of equity managers. For these, overall evidence suggested that it was more important to get the country composition of the portfolio right than the sector composition, or top-down "country" managers would have seen their portfolios perform better than "thematic" or sector-focused investors.

While these are predominantly country-focused (or sector-agnostic), it still makes sense for managers to continue to think along country lines. While the influence of sector spreads seemed to increase over time, such evidence was marginal at best.

The findings would also imply that GCC markets, as an asset class, largely consist of assets located in relatively isolated markets despite progress made towards integration.

At this point, it's mostly speculation whether the importance of country allocations would be made more vulnerable in the GCC with the introduction of the monetary union, the dismantling of barriers to foreign ownership, or decline in home bias in the portfolio holdings of GCC investors.

It is the belief though, if developed markets are any measure, that increased capital market integration and the level of openness would go hand in hand with sector dominance asserting itself in the end.

Finally, given the variable nature of top-down diversification opportunities, investors who use mainly country allocation or mainly sector allocation may find their GCC opportunities restricted from time to time, while those who work across country and sector borders in stock selection may be better positioned at reaping the region's diversification benefits.

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- The writer is senior economist at Arqaam capital, Dubai.

[c] Al Nisr Publishing LLC 2009. All rights reserved.

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