Equity risk premium for GCC stock markets
In finance, equity risk premium refers to the extra return generated by stocks over the risk-free asset. So, instead of investing in a stock market index (which is risky), an investor could alternatively invest in a risk-free asset such as the US 10-year Treasury bond (which is almost risk-free). But, in search of higher return, most investors prefer stock over bonds. So, if you’re an investor contemplating to invest in the stock markets of the GCC countries, it is useful to know the extent of the premium that you might get from these markets.
The figure below shows the average annual returns over the period 2004-2013 for each stock market in the GCC. For comparison, the average annual return of the US 10-year Treasury bond over this period was 3.505%. So, a premium for each market is obtained by subtracting 3.505% from the average returns of respective equity market (which are indicated by the blue bar lines in the figure below).
The numbers speak for themselves. Over the 2004-2013 period, the equity risk premium was highest in Dubai followed by Qatar and Oman; while Bahrain was the worst market performer in the region. But, there is a catch: Dubai’s top performance was the result of a spectacular rally in 2013 during which the Dubai Financial Market index gained over 100% (thanks to a booming real estate sector). So, if we exclude 2013 from the analysis, over the 2004-2012 period, the highest equity risk premium was generated by Qatar (4.70%) followed by Oman (4.67%), Dubai (1.74%), Saudi Arabia (1.11%), Abu Dhabi (0.85%), Kuwait (-1.26%), and Bahrain (-6.15%). What a difference 2013 alone made!
There is yet another surprise, though this is mostly relevant for domestic investors. The above returns are nominal figures which made no allowance for inflation. In the past decade, some of the GCC countries, especially Qatar and the UAE experienced double-digit inflation in some years. So, if we adjust for inflation, the equity risk premium (in realterms) would be even lower, if not negative. This suggests that GCC stock markets are not a good destination for long-term investors. One can certainly generate money from short-term volatility in these market, but institutional investors such as pension funds should proceed with caution.
You can read the background paper here. Enjoy.