London: Despite their recent upgrade to the more mainstream emerging market league, United Arab Emirates and Qatar are considered risky enough by many investors that they still treat them like frontier markets.
Erratic price moves, difficulties of accessing the market, and deep political risks, alongside strong growth, are common characteristics of frontier markets, which are less developed emerging markets, and the two Middle Eastern countries still tick those boxes for many.
UAE and Qatar stock markets rallied sharply over the past year in anticipation of the upgrade to emerging market status by index compiler MSCI, with the expectation that more risk-averse investors would buy in.
But since the upgrade took place at the end of May, the markets have fallen sharply.
Problems at Dubai-listed construction firm Arabtec fuelled the market rout. The spiky price action reminded investors why these markets had so recently been categorised as frontier.
"The stocks should not have moved up so much, they should not have dropped so much — we have sat on the sidelines and watched," said Andrew Brudenell, frontier fund manager at HSBC Global Asset Management.
"This is sometimes how frontier markets behave."
HSBC Global Asset Management categorises UAE and Qatar as "crossover" markets within its frontier fund, alongside some existing emerging markets where there may be issues about how easily foreign investors can enter, such as Peru and Egypt.
A frontier classification within investors' portfolios is not necessarily a bad thing.
Frontier stocks have consistently outstripped the more mature emerging markets, jumping 19 per cent this year compared with a six per cent gain in emerging markets. Their higher growth makes them an appealing investment, and a lower starting base in economic development gives them more upside room.
But frontier markets also tend to have more limited market access, often leading to greater volatility, and greater political risk — geopolitical risk can make western investors cautious about the whole Middle East region.
"We do not believe there is much of a difference between UAE and Qatar and the rest of the Mena region," said Slim Feriani, executive chairman at Advance Emerging Capital. "They are all 'growth' markets — investible and interesting markets."
MSCI announced its plan to upgrade UAE and Qatar just over a year ago, driving a furious rally in these markets.
The MSCI UAE index jumped by 100 per cent, though it has since fallen by as much as 20 per cent.
Non-Arab foreign investors make up a relatively small proportion of these markets — an estimated 15 per cent of the total UAE market capitalisation, for example.
They have remained loyal to the UAE, though stock exchange data shows outflows in the past month from Qatar.
EPFR data shows $30 million in inflows to UAE equity funds last month, their largest monthly inflow this year. Lipper data shows inflows of $114 million into Gulf equity funds over the first five months of 2014.
Favoured stocks include First Gulf Bank and Emaar Properties, though some investors are once more getting worried about a property bubble, as Dubai saw in 2008.
"Concerns about the property market being overheated may well be valid," said Asha Mehta, lead portfolio manager for frontier equity strategy at Acadian Asset Management.
"We are advocating a diversified approach to the UAE market; the market is bigger than just property."
Mehta said she would continue to hold, but not add to, UAE and Qatar in her frontier strategy after the countries also get an upgrade in S&P indexes later this year.
Oliver Bell, fund manager for Middle East and Africa at T Rowe Price, says he has a seven per cent overweight position in the UAE, though this is down from 12 percent in May.
But for frontier and emerging market investors, valuations are starting to look high, despite the recent correction. Investors point to valuations of 16 times earnings for the MSCI Dubai index, compared with 12 times for the emerging index.