Managing GCC Volatility

Kuwait Financial Centre “Markaz” R E S E A R C H

Managing GCC Volatility Strategies & Tactics

“In many instances, volatility will be a friend rather than an enemy. Success in equity investing must depend on an appetite for volatility.” - Peter Bernstein Is volatility good or bad? Depends on how you manage it. This question is very relevant for GCC stock markets that is abound in volatility. Investor sentiment and sophistication plays a major role in shaping volatility structure. That is why emerging markets in general exhibit higher volatility than developed markets. Higher volatility will make investors demand higher risk premium. GCC stock markets exhibit very high levels of volatility (implying increased riskiness) compared to other emerging and developed stock markets. This may taper off, but certainly not immediately. Volatility is here to stay. Hence, from a portfolio management perspective the following questions merit attention:

• How to define volatility? • How to measure it? & • How to manage it?

This paper attempts to answer the above. Managing GCC Volatility Managing volatility would mean making asset allocation/stock selection decisions taking volatility patterns into consideration. While there may be many strategies that can be tailored based on volatility, we would like to discuss four potential options within the GCC context: Four strategies are suggested for managing volatility.

1. Relative Vol Strategy 2. Contrarian Strategy 3. Technical Strategy & 4. Options-based Strategy

February 2007 Research Highlights: Devising risk-based portfolio strategy to benefit from the high-risk environment of GCC stock markets.

M.R. Raghu CFA, FRM Head of Research +965 224 8280 [email protected] Kuwait Financial Centre “Markaz” P.O.Box 23444, Safat 13095, Kuwait Tel: +965 224 8000 Fax: +965 242 5828 www.markaz.com

R E S E A R C H February 2007

Kuwait Financial Centre “Markaz” 2

1. Relative Vol Strategy

Like stock prices, even volatility goes through wave-like patterns alternating between high volatility and low volatility. The assumption behind this strategy is that periods of high volatility will be succeeded by falling share prices and vice-versa. Accordingly two pairs of assets/stocks that are less correlated to each other can be formed as a portfolio whose allocation between them will depend on the relative volatility. Based on this reasoning, the asset allocation rules can be established as follows:

• Start the portfolio allocation on an equal basis • Monitor the relative volatility of the assets • Underweight assets whose volatility is increasing and overweight

assets whose volatility is decreasing

The most important assumption in this strategy is that increasing volatility will reduce prospective returns. Let us examine this through the following charts examining Saudi Arabia and Dubai:

Relationship Between Return and RiskSaudi Arabia 2006

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Clearly, periods of increasing volatility has been marked by falling share prices and vice-versa (look at the shaded ovals).

Relationship Between Return and RiskDubai 2006

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Relative volatility strategy assumes that periods of high volatility will be succeeded by falling share prices and vice-versa.



Another important element impinging the strategy is the correlation. From a portfolio management perspective, it makes sense to pair two assets/stocks that are negatively correlated in order to achieve diversification benefits and reduce the portfolio risk. We present below the correlation of GCC markets to other markets during the year 2006. Saudi Arabia Kuwait Dubai AbuDhabi Qatar Oman Bahrain S&P 500 Nasdaq BRIC Sensex EM Nikkei 225Saudi Arabia 1.00 0.16 0.25 0.28 0.01 0.04 0.08 (0.16) (0.07) (0.07) (0.10) 0.02 0.08Kuwait 1.00 0.27 0.26 0.20 0.18 0.33 (0.03) (0.05) 0.07 0.02 0.08 0.04Dubai 1.00 0.53 0.12 0.07 0.15 (0.00) 0.03 0.02 0.03 0.07 0.01AbuDhabi 1.00 0.20 0.05 0.28 0.04 (0.04) 0.03 0.00 0.05 0.00Qatar 1.00 0.19 0.15 0.01 (0.04) 0.03 0.08 0.02 0.08Oman 1.00 0.21 0.13 0.12 0.07 0.05 0.05 0.02Bahrain 1.00 0.02 0.04 0.01 0.02 (0.00) 0.04S&P 500 1.00 0.93 0.43 0.12 0.37 0.11Nasdaq 1.00 0.41 0.12 0.36 0.14BRIC 1.00 0.65 0.94 0.45Sensex 1.00 0.64 0.40EM 1.00 0.56Nikkei 225 1.00Source: Markaz Database

GCC Market Correlation

Much against the popular belief that GCC markets are strongly correlated, we can notice that during year 2006 correlation dropped across the board. The highest correlated market in the GCC was Dubai and AbuDhabi at 0.53. However, if these markets are viewed as one (UAE), then the next highest correlation among GCC countries is between Kuwait and Bahrain (0.33). Saudi Arabia moved in the opposite market to many developed and emerging markets providing good asset allocation opportunity. When benchmarked with 12 other markets (including 5 GCC markets), Saudi Arabia enjoyed negative correlation with four markets. The highest of these is S&P 500 where the correlation was -0.16. The other markets with which it enjoyed negative or near zero correlation were: NASDAQ, India (Sensex), BRIC, Emerging Market, Qatar, & Oman. In general, US markets enjoyed negative correlation with many GCC markets during the year 2006. Highest Correlation Lowest CorrelationSaudi Arabia AbuDhabi(0.28) S&P500(-0.16)Kuwait Bahrain(0.33) Nasdaq (-0.05)Dubai AbuDhabi(0.53) S&P500(0)AbuDhabi Bahrain(0.28) Nasdaq (-0.04)Qatar Kuwait & AbuDhabi (0.2) Nasdaq (-0.04)Oman Bahrain (0.21) Nikke 225(0.02)Bahrain Kuwait (0.33) EM(0.00) Almost all GCC countries (except Bahrain) found least correlated with US markets (S&P 500 and NASDAQ). Hence, from a portfolio strategy it would be wise to combine GCC markets with US markets or emerging markets. Case Study 1: Two Asset Portfolio In order to demonstrate this strategy, let us consider a case study of a portfolio between Saudi Arabia and S&P 500. The initial allocation between the assets will be 50:50. Further changes to asset allocation between the two will depend on the relative volatility. In other words, reduction in volatility will increase the allocation and vice-versa. For instance, the rolling standard deviation (30 days) for Saudi Arabia ranges from a low of 0.41% to 1.82% during the period of study (year 2006). Since this is a two asset portfolio, we can have a simple asset allocation rule that will inverse the relative weights of risk of Saudi and S&P 500. In other words, if relative share of Saudi Arabia risk is 58%, its allocation in the portfolio will be 42%.

It makes sense to pair two assets that are least correlated. Much against the popular belief that GCC markets are strongly correlated, we can notice that correlation dropped across the board during 2006.



DateSaudi S&P500 Saudi S&P500 Saudi S&P500

28-Jan-06 0.99% 0.70% 58% 42% 42% 58%27-Feb-06 0.63% 0.59% 51% 49% 49% 51%7-Apr-06 2.08% 0.50% 81% 19% 19% 81%15-May-06 0.87% 0.73% 54% 46% 46% 54%14-Jun-06 0.62% 0.96% 39% 61% 61% 39%13-Sep-06 0.41% 0.43% 49% 51% 51% 49%28-Nov-06 1.11% 0.53% 68% 32% 32% 68%14-Dec-06 1.82% 0.50% 78% 22% 22% 78%

Rolling SD Relative Share Asset A llocation

Such an asset allocation based on risk progression will look graphically like this:

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Such a portfolio allocation strategy will result in the following pattern of portfolio performance:

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As per the framework, allocation will increase when risk falls and vice-versa.



100 dollars of investment at the beginning of the year as per the strategy would have produced the following outcome during the year 2006:

Saudi Only S&P 500 only Relative Vol PortfolioInitial Investment 100 100 100Year end value 48.25 113.62 85.77

Saudi & S&P 500

While the relative vol strategy performance is lower than S&P 500, it is considerably higher than a stand alone Saudi exposure. Similar pairing is quite possible for other GCC markets based on correlation. Some of the possible combinations and their results are presented below:

Kuwait Only Nasdaq only Relative Vol PortfolioInitial Investment 100 100 100Year end value 87.96 109.99 100.89

Dubai Only BRIC only Relative Vol PortfolioInitial Investment 100 100 100Year end value 55.35 156.36 105.50

AbuDhabi Only Sensex only Relative Vol PortfolioInitial Investment 100 100 100Year end value 57.36 146.70 102.09

Qatar Only EM only Relative Vol PortfolioInitial Investment 100 100 100Year end value 62.31 132.17 98.66

Kuwait & Nasdaq

Dubai & BRIC

A buDhabi & Sensex

Qatar & EM

In each of the above scenarios, we can see that a stand alone GCC exposure is inferior to the relative vol portfolio outcome. However, these combinations are conjured up post-facto i.e., with prior knowledge of outcomes of these markets. However, based on long-term correlation behavior it is possible to bring together two least correlated asset classes together and determine asset allocation based on volatility behavior. Case Study 2: Multi Asset Portfolios It is also possible to combine more than two asset classes, which will involve algorithms. We present below such a case where some of the volatile GCC markets are combined with developed and emerging markets for portfolio construction. Asset allocation among the markets will be dependent on its relative share of risk in the portfolio. In other words, assets that exhibit increasing risk will see reduced allocation and vice-versa.

GCC Markets Other Markets Saudi Arabia S&P 500 (US)

Dubai BRIC Abu Dhabi Emerging Market

Kuwait Nikkei 225 (Japan)

The outcome of relative vol strategy is better in a falling market than otherwise. Combination of GCC markets with other global markets provide superior outcome.



Initial value Ending ValueSaudi Arabia 1 0.48Kuwait 1 0.88Dubai 1 0.55Abudhabi 1 0.57S&P 500 1 1.14BRIC 1 1.56EM 1 1.32Nikkei225 1 1.07Rel vol Port 1 1.07

Such a portfolio would result in the following asset allocation pattern:

Asset Allocation-Multi Asset

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The performance of such a portfolio would be as follows:

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S&P 500 Nasdaq BRIC Sensex EM Nikkei 225 Rel Vol Port

Relative vol strategy can be employed for more than two assets as well. The multi-asset strategy outperforms GCC markets, but underperforms other markets.



2. Contrarian Strategy The golden rules as per this strategy are:

• Buy when market falls & • Sell when market rises

As the name implies, a trader has to move in the opposite direction of market trend in order to succeed (daunting indeed!). The operational basis of this theory is described as “constant-mix”. Initially, the trader establishes a fixed “equity: cash” ratio and rebalances the portfolio at periodical intervals to revert to this constant mix. For e.g. if the equity:cash ratio of 75:25 and the trader decides to rebalance at the end of every day, he will have buy on days when market falls in order to bring the share back to 75. The success of this strategy will depend to a great extent on the extent of volatility. The higher the volatility, the better will be the success. However, this strategy is proven to under perform in a bull market while it is expected to outperform in a bear market. The effectiveness of this strategy can be explained by the following illustration:

Initial Investment 1,000,000 Equity:Cash Ratio 75:25 TotalDay 1 Equity 750,000 Cash 250,000 1,000,000Equity Return -3% 0%Day end balance 727,500 250,000 977,500Rebalanced figure* 733,125 244,375 977,500Action Buy 5,625Day 2Equity Return 2% 0%Day end balance 747,788 244,375 992,163Rebalanced figure 744,122 248,041 992,163Action Sell (3,666)Day 3Equity Return -4% 0%Day end balance 714,357 248,041 962,398Rebalanced figure 721,798 240,599 962,398Action Buy 7,441Day 4Equity Return 1% 0%Day end balance 729,016 240,599 969,616Rebalanced figure 727,212 242,404 969,616Action Sell (1,804)Day 5Equity Return -2% 0%Day end balance 712,667 242,404 955,071Rebalanced figure 716,304 238,768 955,071Action Buy 3,636

End of Week Balance 955,071Direct Exposure Balance 940,136Profit 14,936Weekly return 1.49%Annualized Return 116%* Computed as 75% of 977,500

Illustration

Contrarian strategy moves against the market. The success of the contrarian strategy will depend on the extent of volatility



The above illustration considers a hypothetical situation where markets gyrate between positive and negative returns. A “do-nothing” strategy, in this case, would have seen the wealth drop from 1000,000 to 940,136. Employing contrarian strategy would have seen wealth drop from 1,000,000 to 955,071. Hence, the difference between the respective wealth levels would constitute the profit for the strategy. We should note that the strategy depends to a great extent on the levels of volatility. Case Study: Saudi Electricity Company Having explained this through an illustration, we can now take a stock specific situation to test its efficacy. Let us consider Saudi Electricity co, one of the most volatile stocks in GCC. The result of the strategy for 2005 and 2006 is presented below:

Saudi Electricity CoPerformance 2005

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Saudi Electricity CoPerformance 2006

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Saudi Electricity annualized volatility more than doubled from 36% to 77% between year 2005 and 2006. The contrarian strategy performed on par during year 2005 while it outperformed during year 2006. Application of this

Back testing on Saudi Electricity Company yields positive results.



strategy to other highly volatile stocks in GCC markets provided the following results:

Company CountryInitial

Investment RiskStrategy Exposure

Direct Exposure

Upside Loss Risk

Strategy Exposure

Direct Exposure

Downside Protection

Saudi Electricity KSA 100 36% 107 109 2% 77% 66 45 49%

AlRajhi Bank KSA 100 35% 184 271 47% 66% 69 50 39%Sabic KSA 100 45% 173 239 38% 57% 61 42 48%

National Bank of Abudhabi UAE 100 56% 195 287 47% 54% 62 42 46%Emaar Properties UAE 100 60% 217 339 56% 53% 68 50 36%Agility Kuwait 100 36% 133 157 18% 40% 81 68 19%

Industries Qatar Qatar 100 51% 178 248 39% 36% 74 59 25%

20062005

Contrarian Strategy

While results were heartening for Saudi Electricity, other stocks behaved differently. In most of the cases, the upside loss was significant. However, the downside protection was also significant making the strategy an important one during down market cycle. 3. Technical Strategy (Bollinger Bands) While there are many technical strategies, the one that depends on volatility is Bollinger Bands. Thanks to John Bollinger, this technique using moving averages with two bands (upper and lower) allows users to compare volatility and relative price levels over a period of time. The indicator consists of three bands designed to encompass the majority of a security's price action.

1. A simple moving average in the middle (SMA)

2. An upper band (SMA plus 2 standard deviations)

3. A lower band (SMA minus 2 standard deviations)

In short the rules can be summarized as follows:

• The bands expand when volatility increases and contracts when volatility decreases.

• It is advisable to take trading actions when bands are wide as it is difficult to get confirmation of trend in a contracting band.

• When stock price hits the upper band, it represents overbought position (indicating a sell) and vice-versa.

• If the price deflects off the lower band and crosses above the 20-day average (which is the middle line), then we can initiate a buy after confirmations.

• Similarly, if the price deflects off the higher band and crosses below the 20-day moving average (middle line), then we can initiate a sell after confirmations.

• In a bull market, prices usually fluctuate between the upper band and the middle band. In that scenario, a crossing below the 20-day moving average warns of a trend reversal to the downside.

• The length of the moving average and number of deviations can be adjusted through trial and error to suit individual preferences and specific characteristics of a security.

• If prices appear to penetrate the outer bands too often, then a longer moving average may be required. If prices rarely touch the outer bands, then a shorter moving average may be required.

Among technical strategies, Bollinger bands explicitly considers volatility as a parameter for spotting trends. If the price deflects off the higher band and crosses below the 20-day moving average (middle line), then we can initiate a buy after confirmations.



Case Study: Saudi Arabia

Points Trading Action

Rationale

1 Sell The price line pierced the top band and came back to cross the 20-D moving average. While piercing the top band is an indication of overbought condition (warranting a sell), a sell is not actually initiated until it crosses over the 20-Day moving average on the downside.

2 Buy After piercing the 20-Day moving average on the downside, the price keeps below the middle line (moving average). However, after hitting the lower band the price crosses over the middle line on the upside. This triggers a buy provided the band is wide enough.

3 Sell But it soon hits the upper band, reverts back to pierce the middle line again initiating a sell.

4 Buy After crossing the lower band, the price line went very near to the middle line, but fell back. (awaiting confirmation). However, very soon it went back to cross over the middle line triggering a buy.

5 Sell After hitting the upper band, price pierced into the middle line triggering a sell.

6 Buy After touching the lower band, the price pierced the middle line to indicate a buy. But watch out that the width of the band is narrowing indicating that volatility is slowing. Hence, further actions will have to be validated strongly for confirmation.

7 Sell After hitting the upper band, the price line broke the middle line triggering a sell. However, further actions will have to wait till the band width increases

8 Not Clear

The price line pierced the lower band. From here if it pierces the middle line and the band width increases, we might see a buy signal emerging

Refer Appendix for a detailed explanation on Bollinger Bands and similar analysis on other GCC markets.

Case study on application of Bollinger bands on Saudi market yields good results.



4. Options Based Strategy

Given the abundance of volatility in the GCC stock markets, derivatives strategies can be profitability employed to take advantage of this. The basic idea would be to write call and put options on stocks. There are many reasons as to why this can be pursued profitably.

• Presence of volatility would be an important reason for being an options writer. Options written on stocks with high volatility tends to command higher premium than otherwise. Hence, it is a win-win situation where the holder of the options can expect to make money as well as the writer of the options. In the first instance, the presences of higher volatility will increase the probability of the options hitting “in-the-money” position. Due to this reason, the writer of the option can charge a higher premium as he is exposed to probability of higher loss.

• The “free-float” for many large and mid cap stocks is relatively low compared to other emerging markets. This is due to high strategic holdings by government and families. The strategic holding (non-free float) tends to be dormant and not traded in the stock markets. Ability to write options on this will enable the owners of the non-free float shares to make money through option premiums.

• Ability to write call and put options will give rise to further sophisticated strategies like straddle. Long straddle involves going long (i.e. buying) both a call option and a put option on some stock at the same strike price with same expiration. Straddles are typically employed when an investor thinks the market is highly volatile, but does not know in which direction it is going to move. For example, if Agility is set to release its quarterly financial results in two weeks. A trader believes that the release of these results will cause a large movement in the price of Agility, but does not know whether the results will be positive or negative, and so does not know in which direction the price will move. The trader can enter into a long straddle, where a profit will be realized no matter which way the price of Agility stock moves, so long as the magnitude of the movement is sufficiently large in either direction.

However, in the GCC context, the concept of using derivatives to trade volatility is still at an infancy stage. Only Kuwait market has call options written on stocks traded in Kuwait stock exchange. Absence of derivatives in other parts of GCC renders this ineffective at the moment.

Options based strategies can be profitably employed when volatility is high.



Measuring Volatility (GCC Markets) Very simply defined, volatility is nothing but variability of returns around its mean. The more the variability, the more the risk. Equity markets are inherently volatile than say bond markets. Hence, to compensate this function, the expected return on equity is also higher. Investors demand additional returns to compensate the additional risk through what is now called as risk premium. Though there are many statistical measures to record and understand volatility, the following are widely used and followed:

• Standard Deviation • Range of Returns & • Threshold Returns

a. Standard Deviation

Risk (Standard Deviation)

49%

38%

24% 27

%

17%

12%

10%

10% 14

%

15% 18

%

20% 26

%

24%

35%

29% 31%

12% 15%

11%

10% 13% 15%

12%

13% 17

%

0%

10%

20%

30%

40%

50%

60%

Saud

i Ara

bia

Dub

ai

ADSM

Qat

ar

Kuw

ait

Om

an

Bahr

ain

S&P

500

Nas

daq

BRIC

Emer

ging

Mkt

Nik

kei 2

25

Sens

ex (

Indi

a)

2006 2005

Measured on the most used scale of standard deviation (daily standard deviation annualized), we can see that during year 2006, international stock markets witnessed increased levels of risk with emerging markets reporting marked increase compared to developed markets. Among emerging markets, India witnessed a sharp increase in the standard deviation from 17% in year 2005 to 26% in year 2006. Among developed markets, Japan experienced the maximum increase in standard deviation from 13% to 20%. S&P 500 exhibited lowest risk at around 10%. GCC countries experienced relatively very high risk compared to other international indices. Among GCC, Saudi Arabia, Dubai, Abu Dhabi and Qatar exhibited high levels of risk while Kuwait, Oman and Bahrain has been at levels comparable to other international markets. The increase in risk for Saudi Arabia has been remarkable from 24% to 49% literally doubling.

Volatility refers to variability of returns. Expected return on equity is higher than bonds due to higher volatility. International stock markets witnessed increased volatility during 2006. GCC countries experienced very high volatility compared to other international indices.



b. Range of Returns

Range of Returns (2006)

-15.00% -10.00% -5.00% 0.00% 5.00% 10.00% 15.00%

Saudi Arabia

Dubai

ADSM

Qatar

Kuwait

Oman

Bahrain

S&P 500

Nasdaq

BRIC

Emerging M kt

Nikkei 225

Sensex (India)

Highest Daily Return Lowest Daily Return

Another powerful tool to measure risk would be range of returns. In simple terms, it looks at the highest and lowest one day return during the year. The higher the range, the higher the risk. As can be inspected in the graph, Saudi Arabia again tops the chart with the highest positive and negative one-day return among stock markets. This was closely followed by Dubai and Abu Dhabi. The lowest was S&P 500. While emerging market range of return was in check, India exhibited high risk on this measure. It should be noted that range of returns statistics can be sometimes flawed in markets that have circuit breakers (also called fluctuation limit or limit down or limit up).


-10.00% -5.00% 0.00% 5.00% 10.00%

Saudi Ar abia

ADSM

Kuwait

Bahr ain

S&P 500

BRIC

Nikkei 225


Saudi Arabia has the highest variation between high and low, followed by Dubai and AbuDhabi.



c. Threshold Returns

Total Trading

Days +/-2% +/-3% +/-4% +/-5%

Saudi Arabia 247 97 65 46 22Dubai 281 86 42 19 10ADSM 280 34 14 8 3Qatar 249 62 30 5 2Kuwait 242 18 7 1 1Oman 247 4 2 0 0Bahrain 246 4 1 0 0

S&P 500 251 2 0 0 0Nasdaq 251 11 0 0 0BRIC 260 10 2 0 0Emerging Mkt 260 20 6 3 0Nikkei 225 248 24 5 1 0Sensex (India) 250 44 20 7 3

Total Trading

Days +/-2% +/-3% +/-4% +/-5%

Saudi Arabia 250 40 20 10 1Dubai 299 80 37 18 7ADSM 293 51 21 12 8Qatar 254 77 36 12 1Kuwait 248 6 2 0 0Oman 252 13 0 0 0Bahrain 249 8 1 0 0

S&P 500 252 0 0 0 0Nasdaq 252 2 0 0 0BRIC 260 10 2 0 0Emerging Mkt 260 3 0 0 0Nikkei 225 245 6 1 0 0Sensex (India) 251 14 3 0 0Source: Markaz Analysis

2006Daily Returns greater or less than (Days)

2005Daily Returns greater or less than (Days)

This examines stock price returns greater than or less than a certain threshold (limit). It typically answers a question like this: among the total number of trading days, on how many days did the stock market showed change of more than 2%? The higher the number, the higher the risk and vice versa. In the table above, we present this statistics for threshold limit of +/-2%, +/-3%, +/-4% and +/-5%. GCC markets exhibit very high levels of volatility as we peruse the results. +/-2%: Saudi Arabia reported changes of more than +/-2% on 97 days out of 247 trading days during year 2006. This is roughly 40% of trading days. Dubai was not far behind with 86 days, followed by Qatar at 62 days. Compare this with say S&P 500 that reported only 2 days out of 251 trading days (0.8% of the days). Among emerging markets, the highest was from India where out of 250 trading days, 44 days reported changes of in excess of +/- 2%. Kuwait, Oman and Bahrain again exhibited trends comparable to other developed markets.

Threshold returns considers movement beyond certain pre-defined limits Saudi Arabia reported price change of more than +/-2% on 97 out of 247 trading days during year 2006.



+/- 3%: Similarly in the 3% category, Dubai topped the list with 37 days followed by Qatar at 36 days. Saudi Arabia and Abu Dhabi reported 20 and 21 days. When benchmarked with other stock markets, these represent very abnormal levels. For e.g., in the whole of 2006, NASDAQ did not report a single day of change exceeding 3%! +/-4%: Dubai reported 18 days, followed by Abu Dhabi and Qatar at 12 days each respectively. Saudi Arabia reported 10 days of change above 4%. All other markets had no days of change of this magnitude. +/- 5%: This probably represents the maximum spectrum. Abu Dhabi reported 8 days of such movements, followed by Dubai at 7 while Saudi Arabia and Qatar each had one day of such extreme movements. No other market reported such movements. Measuring Volatility (GCC Companies) a. Standard Deviation

Risk (Standard Deviation)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Sabic

Al-Ra

jhi B

ank

STC

SAMBA SE

C

Etisa

lat

Emaa

r Pro

pNBA

DDIB

NBK MTC KFHAg

ility

Gulf B

ank

Indu

stries

Qata

rQNB

Q-Tel

Raya

n Ban

kCB

Q

Oman T

eleco

m

Bank

Mus

cat

NBO

OIB

Rays

ut C

emen

tAU

B

AlBara

ka B

ank

Inve

stcor

pGFH

Batel

co

2006 2005

Saudi Arabia: The top 4 volatile stocks of GCC came from Saudi Arabia during the year 2006. Saudi Electricity topped the volatility chart for year 2006 among GCC heavy weights with a standard deviation of 77% followed by Al-Rajhi Bank at 66% and Sabic at 57%. UAE: National Bank of Abu Dhabi (54%) and Emaar (53%) also exhibited above-normal volatility. Kuwait: Agility (earlier known as PWC) reflected highest volatility (40%) among Kuwaiti companies. Qatar: Commercial Bank of Qatar (40%) topped the chart followed by Rayan Bank (38%). However, Rayan Bank traded only for the part of the year being a newly listed stock. Oman: Raysut cement (28%) topped the list. National Bank of Oman (17%) enjoyed the lowest volatility among all GCC heavyweights. Bahrain: Among the top heavyweights in Bahrain, companies like Investcorp and Batelco suffered very low levels of liquidity. For e.g., Investcorp traded only 15 days while Batelco traded on 19 days. Gulf Finance House (41%) topped the vol chart for Qatar, Oman and Bahrain respectively.

Dubai topped the list of price change of more than +/-3% at 37 days followed by Qatar at 36 days. The top 4 most volatile stocks of GCC came from Saudi Arabia National Bank of AbuDhabi and Emaar exhibited above-normal volatility



b. Range of Returns


-35% -25% -15% -5% 5% 15% 25% 35%

SabicAl-Rajhi Bank

STCSAMBA

SEC

EtisalatEmaar Prop

NBADDIB

NBKMTCKFH

AgilityGulf Bank

Industries QatarQNB

Q-TelRayan Bank

CBQ

Oman TelecomBank Muscat

NBOOIB

Raysut Cement

AUBAlBaraka Bank

InvestcorpGFH

Batelco


Saudi and UAE companies exhibited high range of returns than other markets. Dubai Islamic Bank (DIB) topped the highest one day return (14.2%) followed by Emaar Properties (14%). On the negative side, Saudi Electricity experienced the largest one day loss (15.2%) followed by Al-Rajhi Bank (14%). Among actively traded stock, Oman International Bank represented a very tight range with highest return at 3.55% and lowest return at -5.26%.

Range of Returns plots the single-day highest and lowest return. Saudi Arabia and UAE companies exhibited high range of returns



c. Threshold Returns

Total Trading Days +/-2% +/-3% +/-4% +/-5%Sabic 247 113 80 62 31Al-Rajhi Bank 247 120 87 74 52STC 247 94 66 52 29SAMBA 247 61 35 26 15SEC 247 141 113 97 64

Etisalat 279 65 39 24 12Emaar Prop 280 129 84 57 31NBAD 258 132 91 61 38DIB 280 100 61 33 22

NBK 242 29 14 6 1MTC 242 59 25 1 0KFH 242 28 11 6 1Agility 242 104 64 31 14Gulf Bank 231 40 17 8 5

Industries Qatar 247 88 48 27 9QNB 243 85 47 29 6Q-Tel 248 83 59 23 9Rayan Bank 133 57 41 29 11CBQ 247 91 52 33 16

Oman Telecom 247 30 13 9 8Bank Muscat 247 34 12 6 3NBO 222 21 4 1 1OIB 242 37 15 9 7Raysut Cement 245 42 22 15 8

AUB 214 35 18 8 7AlBaraka Bank 76 13 6 4 4Investcorp 15 0 0 0 0GFH 202 64 46 28 18Batelco 19 6 6 5 2Source: Markaz Analysis

Daily Returns Greater or less than (Days)2006

+/-2%: On 30% of the days, GCC heavyweights reported single day change of more than +/-2%. Seven companies reported movement of more than +/-2% on over 100 days during the year 2006. These were: SEC (141), NBAD (132), Emaar (129), AlRajhi Bank (120), Sabic (113), Agility (104), and DIB (100). +/-3%: SEC traded on 113 days at more than +/-3% during 2006. This was followed by NBAD (91), AlRajhi Bank (87) & Emaar (84). +/-4%: SEC more than +/- 4% on 97 out of 247 trading days, followed by AlRajhi Bank at 74. +/-5%: SEC reported 64 days of change more than +/- 5% followed by Al-Rajhi at 52. In general, Saudi companies exhibited unusually high levels of volatility followed by Qatari companies.

On 30% of the days, GCC heavyweights reported single day change of more than +/-2%. Industries Qatar traded on 90 days at more than +/-3% during 2006. UAE companies exhibited high levels of volatility across the spectrum of analysis followed by Qatari companies.



CONCLUSION GCC markets display considerable volatility in price movements. Left to itself, this volatility simply means taking more risk and may not offer commensurate rewards. However, if we can employ strategies that require presence of volatility, it might be a profitable idea. This paper presented some such ideas that solely depend on volatility. However, the following caveats should be noted:

• The strategies and tactics will suit only short-term investors and traders and will not apply to long-term investments. Long-term investments should always be carried out using fundamental analysis, where the price paid to buy a stock should be in relation to its intrinsic value.

• The workings used to demonstrate the effectiveness of the strategies do not consider transaction costs. Strategies that involves rapid buying and selling can be severely constrained by high transaction costs.



Appendix 1: RISK STATISTICS

Total Trading Days Return Risk

Highest Daily Return

Lowest Daily Return +/-2% +/-3% +/-4% +/-5%

Saudi Arabia 247 -53% 49.46% 9.54% -11.69% 97 65 46 22Dubai 281 -47% 38.40% 9.73% -11.45% 86 42 19 10ADSM 280 -43% 24.40% 6.55% -5.69% 34 14 8 3Qatar 249 -36% 26.99% 5.45% -6.08% 62 30 5 2Kuw ait 242 -12% 16.88% 5.18% -3.67% 18 7 1 1Oman 247 14% 12.17% 3.23% -3.06% 4 2 0 0Bahrain 246 1% 9.98% 3.68% -2.15% 4 1 0 0

S&P 500 251 12% 10.02% 2.16% -1.83% 2 0 0 0Nasdaq 251 8% 14.16% 2.96% -2.35% 11 0 0 0BRIC 260 56% 15.42% 3.00% -3.44% 10 2 0 0Emerging Mkt 260 32% 18.07% 3.33% -4.64% 20 6 3 0Nikkei 225 248 5% 19.73% 3.58% -4.14% 24 5 1 0Sensex (India) 250 47% 25.68% 6.89% -6.76% 44 20 7 3

Total Trading Days Return Risk

Highest Daily Return

Lowest Daily Return +/-2% +/-3% +/-4% +/-5%

Saudi Arabia 250 105% 24.12% 5.10% -4.51% 40 20 10 1Dubai 299 195% 35.24% 9.04% -7.91% 80 37 18 7ADSM 293 69% 28.68% 6.79% -6.37% 51 21 12 8Qatar 254 70% 30.89% 5.99% -4.65% 77 36 12 1Kuw ait 248 79% 12.49% 3.95% -2.22% 6 2 0 0Oman 252 46% 15.09% 3.99% -2.75% 13 0 0 0Bahrain 249 24% 11.48% 3.12% -2.29% 8 1 0 0

S&P 500 252 3% 10.28% 1.97% -1.67% 0 0 0 0Nasdaq 252 1% 12.51% 2.54% -2.06% 2 0 0 0BRIC 260 44% 15.42% 3.00% -3.44% 10 2 0 0Emerging Mkt 260 34% 11.96% 1.94% -2.38% 3 0 0 0Nikkei 225 245 40% 13.38% 2.49% -3.80% 6 1 0 0Sensex (India) 251 42% 17.10% 3.12% -3.39% 14 3 0 0

Source: Markaz Analysis

Returns Greater or less than (Days)

Returns Greater or less than (Days)

2006

2005



Total Trading Days Performance

Std Dev (Annual) Highest Lowest +/-2% +/-3% +/-4% +/-5%

Sabic 247 -58.39% 56.65% 10.00% -12.79% 113 80 62 31Al-Rajhi Bank 247 -46.59% 66.20% 10.02% -14.04% 120 87 74 52STC 247 -40.55% 54.52% 13.72% -12.86% 94 66 52 29SAMBA 247 -28.33% 38.38% 9.97% -9.58% 61 35 26 15SEC 247 -55.33% 77.05% 11.27% -15.29% 141 113 97 64

Etisalat 279 -24.60% 36.67% 9.59% -8.88% 65 39 24 12Emaar Prop 280 -47.07% 53.34% 14.02% -10.51% 129 84 57 31NBAD 258 -54.55% 54.45% 10.37% -8.41% 132 91 61 38DIB 280 -48.04% 47.89% 14.22% -11.72% 100 61 33 22

NBK 242 12.37% 22.49% 5.43% -4.04% 29 14 6 1MTC 242 8.50% 25.28% 4.03% -3.82% 59 25 1 0KFH 242 2.83% 22.72% 5.05% -4.81% 28 11 6 1Agility 242 -33.33% 39.80% 7.14% -6.67% 104 64 31 14Gulf Bank 231 40.98% 27.75% 8.33% -7.69% 40 17 8 5

Industries Qatar 247 -43.87% 36.07% 6.18% -7.63% 88 48 27 9QNB 243 -20.09% 36.55% 7.32% -5.78% 85 47 29 6Q-Tel 248 -5.10% 36.64% 9.21% -5.16% 83 59 23 9Rayan Bank 133 9.41% 37.75% 12.50% -8.52% 57 41 29 11CBQ 247 -36.07% 40.37% 9.67% -7.30% 91 52 33 16

Oman Telecom 247 -26.41% 24.82% 8.39% -7.14% 30 13 9 8Bank Muscat 247 41.90% 23.75% 7.83% -4.62% 34 12 6 3NBO 222 24.98% 17.42% 3.55% -5.26% 21 4 1 1OIB 242 -10.42% 25.88% 6.94% -7.98% 37 15 9 7Raysut Cement 245 27.82% 28.19% 6.72% -7.76% 42 22 15 8

AUB 214 31.11% 29.47% 10.20% -8.33% 35 18 8 7AlBaraka Bank 76 -2.92% 16.54% 6.55% -5.00% 13 6 4 4Investcorp 15 0.42% 1.89% 1.16% -0.85% 0 0 0 0GFH 202 -19.32% 41.36% 10.00% -9.87% 64 46 28 18Batelco 19 2.95% 13.33% 6.67% -4.69% 6 6 5 2Source: Markaz Analysis

Daily Change Greater or less than2006

Total Trading Days Performance

Std Dev (Annual) Highest Lowest +/-2% +/-3% +/-4% +/-5%

Sabic 250 143% 44.96% 10.34% -10.00% 89 51 32 19Al-Rajhi Bank 250 171% 34.68% 12.81% -4.38% 47 28 17 10STC 249 47% 46.84% 10.00% -6.70% 53 23 11 7SAMBA 250 83% 23.85% 7.33% -3.83% 35 16 8 4SEC 250 9% 36.44% 8.87% -7.25% 61 35 20 14

Etisalat 299 37% 48.22% 10.24% -8.31% 80 51 43 26Emaar Prop 298 272% 59.85% 15.43% -13.87% 138 88 57 36NBAD 282 185.34% 56% 10.03% -10.82% 126 80 63 43DIB 296 214% 60.64% 17.02% -13.79% 90 62 42 29

NBK 250 73% 30.24% 9.62% -8.93% 45 29 13 6MTC 250 82% 27.38% 4.96% -4.73% 68 21 5 0KFH 250 80% 30.15% 7.94% -5.97% 55 28 14 6Agility 248 62% 35.60% 4.79% -4.10% 132 49 8 0Gulf Bank 245 30% 36.26% 9.09% -10.00% 51 42 20 12

Industries Qatar 252 145% 50.97% 9.70% -7.42% 125 90 65 18QNB 251 82% 43.71% 13.82% -11.58% 91 62 42 12Q-Tel 252 2% 42.13% 16.85% -14.75% 86 48 28 11CBQ 250 76% 46.01% 9.19% -6.23% 107 81 55 16

Oman Telecom 105 -29% 23.96% 6.21% -8.22% 25 12 9 8Bank Muscat 248 62% 30.31% 9.93% -6.20% 51 25 14 8NBO 244 88% 34.85% 18.82% -4.92% 57 26 16 6OIB 250 31% 26.65% 6.51% -8.09% 45 14 8 6Raysut Cement 220 127% 31.57% 9.87% -9.09% 37 18 15 12

AUB 228 15% 29.03% 10.53% -10.23% 44 15 12 9Investcorp 28 57.33% 42% 28.29% -10.00% 15 15 15 11GFH 204 121.15% 44% 16.91% -10.05% 67 45 26 19Batelco 36 0.99% 13% 5.63% -8.54% 9 2 2 2Source: Markaz Analysis

2005Daily Change Greater or less than



Appendix 2: Bollinger Bands Explained Bollinger Bands are a technical trading tool created by John Bollinger in the early 1980s. They arose from the need for adaptive trading bands and the observation that volatility was dynamic, not static as was widely believed at the time. The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition prices are high at the upper band and low at the lower band. This definition can aid in rigorous pattern recognition and is useful in comparing price action to the action of indicators to arrive at systematic trading decisions. Bollinger Bands consist of a set of three curves drawn in relation to securities prices. The middle band is a measure of the intermediate-term trend, usually a simple moving average, that serves as the base for the upper and lower bands. The interval between the upper and lower bands and the middle band is determined by volatility, typically the standard deviation of the same data that were used for the average. The default parameters, 20 periods and two standard deviations, may be adjusted to suit your purposes: Middle Bollinger Band = 20-period simple moving average Upper Bollinger Band = Middle Bollinger Band + 2 * 20-period standard deviation Lower Bollinger Band = Middle Bollinger Band - 2 * 20-period standard deviation Two important tools are derived from the Bollinger Bands: Bandwidth, a relative measure of the width of the bands, and %b, a measure of where the last price is in relation to the bands. Bandwidth = (Upper Bollinger Band - Lower Bollinger Band) / Middle Bollinger Band %b = (Last - Lower Bollinger Band) / (Upper Bollinger Band - Lower Bollinger Band) Bandwidth is most often used to quantify The Squeeze, a volatility-based trading opportunity. %b is used to clarify trading patterns and as an input for trading systems. Source: http://www.bollingerbands.com/



Appendix 3: Bollinger Bands -GCC Markets







Appendix 4: GLOSSARY OF IMPORTANT TERMS BRIC: Stands for Brazil, Russia, India and China Correlation: A relationship between two variables. Circuit Breakers: The highest and lowest prices that a stock is permitted to reach in a given trading session. Once reached, no trading occurs on that stock until the following session. also called price limit or daily trading limit. Emerging Markets: A financial market of a developing country, usually a small market with a short operating history. GCC: Gulf Co-operation Council countries comprising Saudi Arabia, UAE, Kuwait, Qatar, Oman & Bahrain. Moving Average: A technical analysis term meaning the average price of a security over a specified time period (the most common being 20, 30, 50, 100 and 200 days), used in order to spot pricing trends by flattening out large fluctuations. This is perhaps the most commonly used variable in technical analysis. Moving average data is used to create charts that show whether a stock's price is trending up or down. They can be used to track daily, weekly, or monthly patterns. Each new day's (or week's or month's) numbers are added to the average and the oldest numbers are dropped; thus, the average "moves" over time. In general, the shorter the time frame used, the more volatile the prices will appear, so, for example, 20 day moving average lines tend to move up and down more than 200 day moving average lines. Options: The right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, , at a specified price (the strike price) during a specified period of time. Portfolio: A collection of investments all owned by the same individual or organization. These investments often include stocks, which are investments in individual businesses; bonds, which are investments in debt that are designed to earn interest; and mutual funds, which are essentially pools of money from many investors that are invested by professionals or according to indices. Range: The high and low transaction prices of a given security or commodity during a given period. Also called trading range. Relative Volatility: The standard deviation of an investment's or portfolio's return divided by the standard deviation of another portfolio. Relative volatility is used to compare the risk levels of different portfolios. Risk: The quantifiable likelihood of loss or less-than-expected returns.

Standard Deviation: The standard deviation of a series is a measure of the extent to which observations in the series differ from the arithmetic mean of the series. The standard deviation of a series of asset returns is the measure of the volatility, or risk, of the asset.

Technical Analysis: A method of evaluating securities by relying on the assumption that market data, such as charts of price, volume, and open interest, can help predict future (usually short-term) market trends. Unlike fundamental analysis, the intrinsic value of the security is not considered. Technical analysts believe that they can accurately predict the future price of a stock by looking at its historical prices and other trading variables. Technical analysis assumes that market psychology influences trading in a way that enables predicting when a stock will rise or fall. For that reason, many technical analysts are also market timers, who believe that technical analysis can be applied just as easily to the market as a whole as to an individual stock. Underweight: Having too little of, relative to other things. In the case of a portfolio, containing too little exposure to a given company, sector or country. opposite of overweighed. Volatility: The relative rate at which the price of a security moves up and down. Volatility is found by calculating the annualized standard deviation of daily change in price. If the price of a stock moves up and down rapidly over short time periods, it has high volatility. If the price almost never changes, it has low volatility. Source: www.investorwords.com



Markaz Latest Published Research

1. GCC Equity Funds: The Asset Allocation Challenge (September 2006)

Synopsis: The report examines issues behind asset allocation for GCC equity funds. It was observed that funds have increased cash levels of their portfolios due to negative performance of GCC stock markets. The study points out that fund managers have overweight Kuwait and underweight Saudi Arabia. Compared to their market share, allocation to Qatar, Bahrain and Oman was observed to be high. Nearly 10 funds were observed to allocate highest to their home country, implying “home bias”. National Bank of Kuwait (Kuwait), Emaar Properties (UAE) and MTC(Kuwait) were the most popular stocks among fund managers. The report concludes that current overweight to Kuwait and underweight to Saudi Arabia looks justified given the historical performance and current valuation. Relative to the overall market, blue chips appear expensive in many markets. Future out performance can come through stock selection among mid-cap and small-cap segment. However, geographical allocation will remain the key challenge.

2. GCC Leverage Risk: How real it is? (November 2006) Synopsis: The report examines the risks behind increased exposure of GCC financial system to stock market. The report observes that while bank lending has increased proportional to economic growth, the share of personal/consumer loans has gone up significantly leading to the risk perception. While the increase has been significant, they are not alarming when benchmarked with other leading emerging markets. The report considers four key variables: Size, Asset Intermediation, Cross border activity and Capital market representation. The report also analyses the linkage between bank credit growth and interest rate margin. According to the report, UAE appears vulnerable to leverage risk given the high bank credit share to the economy and the extent of personal loan exposure. Vulnerability assessment for Kuwait, Qatar, Bahrain & Saudi Arabia was ranked medium while that of Oman assessed low. The report also observes that GCC banks have risk-averse portfolios backed by more than adequate capital adequacy ratios. Stress tests conducted by central banks points to adequate resilience.

3. GCC for fundamentalists: A top-down framework (December 2006) Synopsis: The report establishes a framework involving fundamental variables likely to affect GCC stock markets for the year 2007. The report examined nine important variables like economic factors, valuation attraction, economic liquidity, investor sentiment, etc and assigned scores based on each factor in order to assess the relative attraction of each GCC market. On a scale of 1-5, Oman top scored at 2.93, followed by Bahrain (2.85) and Kuwait (2.84). Saudi Arabia scored 2.66 while UAE was at the bottom with a score of only 2.18. Accordingly, the report suggests overweight to Kuwait, Oman and Bahrain, neutral weight to Saudi Arabia and underweight to UAE. Among GCC sectors, the report assigns positive ratings to banking, telecom, and services sectors; neutral rating to industrial sector and negative rating to real estate sector. To obtain a copy, contact: Kuwait Financial Centre “Markaz” - Client Relations & Marketing Department Tel: +965 224 8000 Ext. 1804 Fax: +965 2414499 Postal Address: P.O. Box 23444, Safat, 13095, State of Kuwait Email: [email protected]



Disclaimer This report has been prepared and issued by Kuwait Financial Centre S.A.K (Markaz), which is regulated by the Central Bank of Kuwait. The report is intended to be circulated for general information only and should not to be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction. The information and statistical data herein have been obtained from sources we believe to be reliable but in no way are warranted by us as to its accuracy or completeness. Opinions, estimates and projections in this report constitute the current judgment of the author as of the date of this report. They do not necessarily reflect the opinion of Markaz and are subject to change without notice. Markaz has no obligation to update, modify or amend this report or to otherwise notify a reader thereof in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate, or if research on the subject company is withdrawn. This report does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. Kuwait Financial Centre S.A.K (Markaz) does and seeks to do business, including investment banking deals, with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.

Date post:	09-Mar-2016
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Managing GCC Volatility

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