Since the beginning of the year, Middle East and North Africa (Mena) markets have undergone a roller-coaster ride. The year started with uncertainty over the short term direction of oil prices and then Greece bail out concerns. Off late the markets have turned bearish on the back of slowdown in China and the likely impact of Iran deal on regional markets. As a result of these events, investors have turned more cautious as they prefer to wait on the sidelines to preserve cash and allocate fresh capital when the outlook brightens in the near future.
The array of events witnessed during the last eight months has led to increased volatility in the markets and a decline in real estate activity (both value and transactions) as both these asset classes accounts for majority of UAE portfolios. Although there is high volatility in the markets, which are challenging from an investor’s perspective, it presents an opportunity for portfolio and asset managers to diversify their portfolios into other asset classes such as commodities and private equity. This will enable them to realign their existing portfolios (equity and real estate) and reduce volatility to reflect the underlying pillars of the UAE economy (retail, hospitality, aviation, tourism etc). Additionally, investors should utilise this period to increase the cash allocation to create a buffer/pool that can be utilised to allocate fresh capital once the environment stabilises.
The crisis that started in 2008 led to a fallout in all the assets classes across the globe as investors were clueless about the nature and extent of the crisis. However, the situation started easing out in 2010 and since the beginning of 2012, the markets have witnessed a bullish period as most of the asset classes reported strong rally fuelled by the economic recovery from 2008 crisis. Hence, a long-term investor will review or take a closer look at the past six to nine months as a period of consolidation and re-evaluate the current portfolio to reflect current market conditions to built a dynamic portfolio.
Dynamic portfolio management is the best way to mitigate the risk that arises from changing market environments. Inflation, uncertainty, volatility and oil prices are all obstacles, however, these can be managed efficiently with active portfolio management strategies that are based on current market dynamics. A passive portfolio can potentially increase the risk especially if it is not aligned with the prevailing market conditions. Therefore, it is always advisable to have an active, knowledgeable and market based portfolio management to mitigate the risk and optimise the returns to outperform the market or index portfolios.
Given the current investment environment in the UAE, the optimal portfolio allocation would comprise of equities (40 per cent), alternative investments including real estate and private equity (40 per cent), bonds (10 per cent), commodities excluding oil (8-9 per cent) and cash (1-2 per cent). Additionally, it is also important to consider the duration of the investment and the stage of the investment cycle as it will provide a clear perspective for long term investments. For instance, a prolonged high inflation environment (e.g.) + 5 per cent every year for three to five years) can certainly become detrimental to the value of a portfolio but a short period of reasonable inflation (e.g.) +2-3 per cent every year for one to two years will have less impact on the portfolio, especially if the portfolio is constructed in an inflation friendly manner.
Another key consideration would be to focus on inflation-friendly sectors as investments in sectors, asset classes and companies that benefit from high prices can protect the portfolio against general inflation as the value of investments will outperform the level of inflation. For instance, increased exposure to companies in the consumer sectors such as retail or FMCG would be beneficial in a high inflationary environment.
Investors should also seek for dividends given that investment income is a natural hedge against inflation as it either augments capital gains or minimises capital losses. Investments and/or asset classes that have a strong history of dividend payouts will continue that trend even in an inflationary environment thereby allowing an investor an extra stream of investment income to offset the inflation impact.
Therefore, companies that are growing and committed to a strong dividend payout history make ideal candidates for such a portfolio strategy.
Although bonds as an asset class offer a viable option in stable market conditions but they tend to suffer the most in an inflationary environment as compared to commodities (ex oil), real estate and equities which often fare better. Therefore, reduced exposure to bonds would be advisable in the near future.
From the commodities perspective, buying gold would be advisable, especially if it viewed over a long term. Given commodities and gold have been very volatile recently especially in short-term windows, investors should buy gradually and on market weaknesses, thereby spreading and averaging down the cost.
In conclusion, dynamic portfolio management aims to complement existing asset allocation while making the portfolio more robust in an increasingly uncertain and volatile environment. Therefore, rather than focusing on market turbulence, investors should focus on developing and maintaining a sound investment plan. The ability to adapt to a changing environment will be the key to success and those who can see beyond short-term volatility by focusing on the principles of dynamic portfolio management will be rewarded for their patience and discipline.
— Shailesh Dash, Founder and CEO, Al Masah Capital Management Limited
