A dose of reality for UAE markets as MSCI upgrade draws near

When it was announced last June by MSCI that UAE stocks would be upgraded to emerging markets status, excitement built about the prospect of many billions of dollars of foreign capital washing into local bourses.

With MSCI’s emerging market index tracked by an estimated US$1.5 trillion in international funds, it was hoped that at least a portion of that amount would find its way to the UAE.

To date, the inflows have been smaller than many investors had anticipated. Last month Abu Dhabi and Dubai experienced net inflows from foreigners of $155 million and $44m, respectively, according to data provided by EFG-Hermes, an Egyptian investment bank. It was the first time foreigners were net buyers this year.

“People assumed there would be a multibillion dollar inflow, and perhaps they’ve been scrutinising the upgrade a bit more closely to see the numbers are quite a bit smaller and the valuations were getting a bit out of hand,” said Simon Kitchen, a strategist at EFG-Hermes.

The last few days have suggested that investors have woken up to that realisation. Between May 13 and May 20, stocks on the Dubai Financial Market General Index lost 12.6 per cent during a sharp sell-off. It brought to end an almost unchecked run up in valuations since last summer spurred by anticipation of the listing, together with euphoria about Dubai's winning bid in November to host the 2020 World Expo and overall positivity about the economy.

The DFM benchmark gauge is still up 118.6 per cent over the past year, while the Abu Dhabi Securities Exchange General Index is 48.8 per cent higher.

Some investors had already been starting to question whether the momentum was sustainable. BlackRock Frontiers Investment Trust, a $297m fund run by the world’s largest asset manager, said that valuations of some UAE stocks were “unusually high.” It cautioned that certain share prices were increasing rapidly.

Part of the volatility in recent days can be attributed to investors profit taking after the recent run. But it is also down to foreign investors exiting positions in stocks reclassified from frontier to emerging. Abu Dhabi Commercial Bank, Aldar Properties, Arabtec, DP World, Dubai Financial Market, Dubai Islamic Bank, Emaar Properties, First Gulf Bank and National Bank of Abu Dhabi were the stocks to be added to the emerging markets index, it announced earlier this month. Foreigners sold Dh69m in Abu Dhabi and Dh110.8m in Dubai on Thursday, according to data provided by the exchanges.

The recent turbulence is expected to continue in the coming weeks as more shuffling of investment positions occurs ahead of June 1, when the listing takes effect. Much of that has been driven by passive investors – ETFs and tracked funds – realigning their portfolios. HSBC estimated the UAE would receive about $500m in passive inflows that directly track the index.

But more cash is likely to follow from active investors, who manage their funds directly and could take longer to add UAE stocks to their portfolio. A further $2.3 billion could emerge in active inflows, estimates the investment bank VTB Capital.

In the long run, the upgrade could also help to usher in a new era of transparency among companies as they strive to meet the higher corporate governance standards demanded by international investors. That would likely be a magnet for further investment flows.

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