Geopolitical concerns and perceived liquidity risk are among the issues that have kept investors from embracing Middle East stocks and ETFs in recent years. A prime example of a market hampered by those issues is Egypt.
The Market Vectors Egypt ETF (NYSE:EGPT), the lone ETF devoted exclusively to North Africa's largest economy, has had its share of struggles at the hands of negative news flow. However, that does not mean the entire Middle East investment thesis is damaged. Actually, the opposite is true.
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"The Middle East markets may be associated with higher levels of risk as a result of the seemingly constant conflict-oriented headlines coming out of the region (i.e., from Israel, Syria, Iran, Iraq, Egypt, to name just a few of the dicey spots)," said WisdomTree Research Director in a new research note. "Yet at least the market moves this year illustrate that not all news is bad. Many of the Middle East economies are growing as they develop significant infrastructure spending with their oil wealth in an effort to diversify their economies."
Indeed, some Middle East markets, many of which are classified by index providers as frontier markets, are found among the world's high fliers in 2013. Through Thursday, the Dubai Financial Market General Index (DFMGI) was up 48 percent this year while the Abu Dhabi Securities General Market Index (ADSMI) was higher by nearly 39 percent.
Predictably, gains like that often prompt questions about whether Middle East ETFs have any value left to offer.
"With the strong gains already experienced in 2013, it is natural to ask if there is any value left in this region," said Schwartz in the note. "The Middle East has not participated as much as other emerging market countries in the gains off the lows of early 2009."
However, select Middle East ETFs have been under-the-radar leaders this year. For example, the WisdomTree Middle East Dividend Fund (NASDAQ:GULF), which features a decent 30-day SEC yield of 3.1 percent, has surged 19.3 percent year-to-date. The Market Vectors Gulf States ETF (NYSE:MES) is up nearly 16 percent. Still, there are differences between investing in Qatar and the United Arab Emirates compared to investing in Brazil and China.
"Exposure to these Middle East countries thus represents a different type of emerging market allocation. Whereas China has the potential to catch up with the developed world on a per capita income basis, the largest Middle East countries already have larger income levels. The investment case is really about how these countries diversify their oil wealth into their economies and create opportunities throughout the broader region for countries such as Egypt, which are not as endowed with oil wealth and high GDP numbers," said Schwartz.
There is at least one potential near-term catalyst that jolt GULF, MES and rival ETFs. On June 11, index provider MSCI (NYSE:MSCI) releases its annual market reclassification and and Qatar and United Arab Emirates could be promoted to emerging markets status.
Should that move occur, it could possibly alter risk perceptions because frontier markets are often regarded as riskier and more volatile than their emerging peers. In turn, that would benefit GULF, which allocates almost 65 percent of its combined weight to UAE and Qatar. MES is no slouch on the Qatar/UAE front, either, with a combined 56 percent weight to those countries. UAE and Qatar combine for over 47 percent of the PowerShares MENA Frontier Countries Portfolio's (NASDAQ:PMNA).
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