Time to balance your portfolio

Theory and experience suggest that a more diversified portfolio should offer a better trade-off between risk and return. But amidst the zooming real estate valuations, Gulf investors seem once again forgetting this golden rule. Property has been the dominant asset class in most Gulf portfolios during the past few years. High returns in the range of 30 to 70 per cent per year partly explain this phenomenon. But analysts and wealth managers are increasingly worried that the huge flow of liquidity into these assets could lead to high concentrations of real estate in portfolios and unrealistic valuations that could backfire on regional investors.

Like what happened in the regional stock markets two years ago, the real estate sector valuations could be heading too high. While the price-earnings (P/E) ratio serves as both absolute and comparative indicator in the case of stock market valuations, in the case of real estate there isn't any such measure that can tell if the prices are too high.

Rising oil prices, along with a desire to invest closer to home, have spurred investment growth in the region, resulting in huge money inflow into real estate. A shortage of real estate supply and a low interest rate environment is feeding the vicious cycle of liquidity-fed asset price increases.

Wealth managers are calling for caution. "Given the high real estate returns, it is extremely difficult to convince investors to look elsewhere or at other asset classes, but it is imperative that portfolios are adequately diversified," says Gerard Aquilina, managing director, private wealth, Barclays Wealth.

Analysts believe that Gulf investors who traditionally favoured US Treasuries and Western stocks are blinded by the high real estate returns and are ignoring huge diversification opportunities that are available within the region.

Mark Mobius, executive chairman of Templeton Asset Management, said on a recent visit to the region that valuations of Gulf stocks looked attractive compared with other emerging markets. Analysts in general believe that valuations aren't stretched while the company fundamentals appear very strong, although inflation remains a medium-term threat. Market data supports this assessment. Stock market performance has varied widely across the GCC in the year to date. Oman has returned the best performance at 27 per cent, closely followed by Qatar at 25 per cent, Kuwait 19 per cent, and Abu Dhabi nine per cent. Others have been less impressive, with Saudi Arabia the weakest at minus 15 per cent, followed by Dubai at minus 10 per cent, and Bahrain at four per cent.

Currently GCC markets are trading at a median P/E of 16, giving ample scope for appreciation. This presents an opportunity for investors to dilute their real estate holdings, preferably with those stocks that have low correlation to the sector.

Risks and returns are directly correlated. But there is a catch that all risks need not always translate into high returns. In the context of the Gulf, diversification for better trade-off between risk and return appears as good in practice as it is in theory.