AStudy of Abu Dhabi Securities Exchange.
TheAbu Dhabi securities exchange is said to have started as a result oflocal law No.3 of the year 2000.The securities exchange began itsoperations on the 15thof November of the same year. However, the research paper below dealswith the Abu Dhabi stock exchange while utilizing the concept ofefficient portfolio as per Markowitz’s principle. An efficientportfolio is one termed to provide high returns given an absolutevalue of risk. It is also known to provide minimum risk for theinvestor required rate of return. The concept is hence best inbalancing of assets and optimizing portfolio performance throughreducing individual asset risk. In the case of efficient portfolio,variance happens to be at a minimum among feasible portfolios(Markowitz 1952).
Inportfolio investments, investors usually worry about the assetsbalance so as to ensure proper returns for a given risk which may beassociated with the market. Return and risk are two terms that makeinvestors tense when it comes to managing their financial resources.The words seem to be highly related as assets known to have high riskprove to have a high rate of return. Hence, it is dependent on theinvestor’s decision to either take or avert the risk. A person cango to the extent of appreciating either of the two. The idea of riskaversion plays a significant role in categorizing investor’sbehavior together with the preferred assets for portfolio creation.
Theresearch paper aims at explaining different activities and situationswithin the stock market. It also explains the different companiesthat act as stakeholders of the stock exchange and the portions theyhold on the stock exchange arena. The paper also focuses on the issueof risk aversion, risk-free assets and risk-return values which areessential for an investors’decision-making process (Tobin 1958). Italso discusses a critical aspect of exchange markets that is therestricted and unrestricted portfolio in line with the variances andstandard deviations along other computations.
Theanalysis is from data collected during the recession period, which isknown for the aspect of economic instability. During theperiod, the market was in a position to account for a good number ofactivities within the year. However, that results in an opportunityto aversive investors prospects (Tobin 1958). The research paper alsoanalyzes the portfolio made up by nine companies discussed on thebasis of volume. The study takes into consideration both short termbuying and long term selling with respect to the interest of theinvestors. The paper clearly presents a step by step analysis ofdetermining the covariance, correlation, distribution and on top ofthat applying the utility function so as to determine the optimumrisky portfolio (ORP). As a result, the research is beneficial toinvestment professionals who might have an interest in investing inthe Abu Dhabi securities exchange.
TheAbu Dhabi securities market (ADSM) started in the year 2000after along unregulated trading in company stocks for decades. The first and task of the new institution was to Abu Dhabi’s large number ofprivate or individual owned companies. It was required to put thecompanies in check. That significantly led to many of the privatefirms understanding the importance of public listing (Jacob et al.2005). Hence, it eventually propelled the shifting of privatecompanies to public ownership.
Thesecond development phase of the stock exchange is known to havehappened during the mid-2000s. According to Markowitz, it is duringthat period that the government gave a mandate allowing for thelisting of all public companies. According to Michaud (2008),thethird face of the exchange market is known to have been enhanced in2008. That is when rebranding of ADSM to a new body known as ADX tookplace. The ADX logo acts as an outward sign of a more sophisticatedstrategy of deepening the market by introducing new products. A goodexample is the exchange traded funds (ETFs). As a result, there isthe addition of more foreign companies to the board.
Theresearch paper puts into consideration the location where the capitalmarket activities take place in Abu Dhabi. The events take place inline with the federal level regulatory framework of UAE. However, theADX alongside with the UAE holds a spot domestic market within anumber of exchanges. All the stock exchange bodies in UAE are underone body that has its headquarters in Abu Dhabi known as the EmiratesSecurities and Commodities Authority (SCA) (Markowitz 1952).
Goingdeeper into a market capitalization of UAE, the ADX is the largest.It is characterized by a market capitalization of about $ 79.5billion. Looking at the emerging prospects between UAEs to the twosignificant exchanges has proved to be a speculative matter for someyears. The public surrounding on the issue has in a way benefited interms of intensity following the wake of economic crises experiencedglobally (Michaud 2008). If the merger between the two primaryexchange bodies in UAE takes place, then there will be increasedefficiency and ability to attract more investors.
Theresearch analysis outcomes show that there are a good number ofeconomic sectors that are usually involved in the stock exchange ofthe country. In this analysis, there are nine economic sectors inwhich different companies listed fall. The sectors are banking, realestate, energy, telecommunication services, consumers’ staple,industrial services, insurance services, investment and financialservices and finally the industrial energy sector (Tobin 1958). Thesectors reflect the rising diversity of Abu Dhabi’s economy. TheADX goals are still in line since the challenging economic conditionsin the past years are yet to divert them. As of November 2012,research shows that ADX had 67 companies that are listed on theexchange market. The stock board also composes of nine open-endedfunds, five of them being run by the national bank of Abu Dhabi(NBDA) plus a single debt instrument known as NADA convertible notedated year 2006.
Interms of products that have a fixed income, the country’s exchangehas listed one or more bonds at any one time. Currently, the onlydebt instrument having been included in the stock market is the NBDA,subordinated convertible note products. Due to high levels ofliquidity experienced by the trade, a historical lack of sovereignissuances has recently given way to debt of the government (Schirripa&Tecotzky2000). The primary aim is to create a yield curve alongwhich corporate publications can undergo benchmarking. The ADXgeneral index is used primarily to carry out Abu Dhabi’sincreasingly sophisticated changes. For a stock to be in the stockindex, it must have been in exchange for at least the last five days.The market operates through 52 licensed brokers as at October 2012.
Followingthe global economic crises of 2008, all GCC markets have adapted abearish trend hence the continuous subdued trading levels. Theongoing Eurozone crises, unstable US economy, low levels of liquidityand the volatile political situation have all participated inpropagating a challenging economic situation. However, the periodperformance compares well to its regional peers. In 2010, theexchange market had a U-shaped performance(Schirripa &Tecotzky2000). It started the year with an upward index swing reaching a peakin March by having gained 6% slightly decline over the summer period.In 2011, ADX maintained a regional declining trend dropping index by11.7%.
Usingthe reverse declining image of the past years, the research revealsthat the height point for the general index came in June 19. That iswhen it reached 2775.4 points with its lowest decline being witnessedin December 21 having 2343.3 points (Jacob et al.2005). Measuring theperformance in terms of volume, the actual number of shares traded inthe ADX exchange reduced from 17.6 billion in 2010 to 15.9 billion inthe year 2011 which is a 9.6% decrease. To add to, that the aggregatetrading values show that a 24.9% decrease from $9.3 billion to $6.7billion.
Accordingto research analysis, the nine stock exchange sectors are all similarin that they show a decline. According to the projections, realestate sector has the highest drop off of about 54.25%. That is as aresult of two heavyweights in the sector who exhibited subduedperformance namely Sorouh real estate company and Aldar properties aswell. The investment industry portrays the second highest declinefrom real estate with a 33.8% decline. The downward trend rates theenergy sector as the third most declined industry with a 25.6%decline. Conversely, banking demonstrates a considerable robustnessin the year 2011(Jacob et al.2005). The robustness is as a result ofsustained profitability in the banking sector proving that the favorable position even with the existence of non-performing loans.The banking sector recorded a decline of 0.045 during the year 2011.
Volumesand values seem to be stable in the first half of the year 2012.Thus, an active mind is developed in the financial community puttinginto consideration that all exchanges and future growth remains firm.The analysis of outcomes of company reports shows an aggregate risein profits for the first quarter by 95% (Michaud 2008). Theimprovement is as a result of the high recovery in the real estatesector as well as a26.3% gain in the banking index over time.However, economic sectors like consumer staple, investment andfinancial services and the industrial sector have difficulty inprofit maximization due to current environmental challenges (Michaud2008). The profitability improvement by the ADX listed companies is anecessary flip in the market confidence.
Guidingrules and regulations
ADXis attributed to the regulatory system which allows rapid growth ofthe market and its establishment. It evolves as exchange prepares forwhat it is hoped to be another growth phase. The framework also givesADX the freedom of setting its growth agenda. According to the locallaws No. 3 of 2000, it defines ADX as an independent body withindependent finance and management structures (Schirripa &Tecotzky2000). It also ensures maximum supervisory and exercise of executivepower of its processes. The local laws also term the exchange asresponsible for ensuring the accuracy of transactions, soundness,promoting investment awareness and protecting of investors as well.
Inaddition, the ADX works in line with the SCA as the federal regulatorin governing the capital market according to the national law No.4 ofthe year 2000. The SCA in conjunction with the ADX has proven thatthey can formulate and implement new products and regulations. Apartfrom the local laws No.3 and No. 4 of year 2000, there exists anothertire of the rules. The tire is in the form of UAEs ministry ofeconomy that the SCA depends on it to address legislative matters bywhich the capital market is controlled.Reforming efforts of SCA to date are into reclassification fromfrontier market to secondary emerging market and an upgrade toemerging markets (Schirripa & Tecotzky2000).
Methodologyand data collection
Inthe stock exchange market, normalization of data is a must in orderto make prices comparable and increase the effectiveness. The mostused normalization technique is the min-max normalization. It bringsthe stock prices between zero and one for easy comparison. However,it is essential to make an analysis of risk and return factors thattend to associate with the company’s stock prices (Markowitz 1952).The correlation between diverse company’s share prices iscalculated using MS-Excel. As a result, the MS-Excel provides a nineby nine matrices showing interdependency of different stock companiesas in this case. The values range from -1 to 1. Negative onerepresents a complete reverse correlation while one represents a veryhigh positive correlation.
Thecomputation above is followed by formation of a covariance matrixdepicting variability and diversity of stock prices in all companies.The results from the co-variance matrix helps in assigningappropriate weight age among the different companies while definingtheir corresponding risk factor. The weight age acts as a primaryconcern making it easy to identify minimum variance portfolio (MVP),and the optimum risky portfolio (ORP) uses the Markowitz model.Considering the restricted and unrestricted category, they are bothdefined on thebasis of values that different weights are notprohibited to take. Given different values of return, it is possibleto achieve different values of weights and risks associated with thereturns (Markowitz 1952).
Thereturn value represents portfolio mean in the appendix along with therespective weights, while the risk value and company weight representportfolio standard deviation. On the other hand, risk and returnvalues are presented as percentages while company weights areabsolute values. Hence, effectiveness weight distribution isdetermined by the diversity of different company’s stock values. Itis hence taken care of with the help of cell formulae that aredefined using a matrix format for all firms present.
Therisk and return values in line with weight support the nine indetermining restricted and unrestricted efficient frontier. Thefrontiers will be determined using the cell formulae for differentreturn values expected by investors from their initial investment.The next step involves analyzing the standard deviation and the riskassociated with restricted and non- restricted portfolio. That goesin line with defining ORP and MVP using CAL (capital allocation line)values as in the formulae below (Tobin 1958).
CAL=E(up)- rf/ m where “m” is the standard deviation.
Nextstep in the methodology is to define the utility function. Thatincludes risk-free rates and the risk aversion rate, whichcharacterizes optimal risky portfolio using an explicit format. Riskaversion rate is approximated to be 6% due to high fluctuationconditions in Abu Dhabi and the entire Middle East. According toMarkowitz 1952, the base of the risk-free rate is generated fromAmerican depository offering. A risk-free rate ranges from 1% to 4%depending on the external situation.However, Abu Dhabi encountersintense effects hence making its free rate be1%. The process providesa return percentage in line with risk associated with it. Mostcrucial data that is essential for analysis purpose is the stockprices of the nine companies present in the Abu Dhabi stock market.The prices used are in the period between December 2008 and November2009 reason being, the time took into account the global recession,hence raising the need for portfolio optimization in order to sustainthe investors’ interest (Jacobs et al. 2005).
Resultsand data analysis.
Usingthe research analysis of the Abu Dhabi stock exchange, it isadvisable to invest in both restricted and unrestricted portfolio.The market bears the risk associated with oil governing nations. Itis clear that the value of MVP is the same as that of ORP for bothrestricted and unrestricted portfolio. For the restricted part, thefindings sum up to 15 and 23.7 for unrestricted part. Also, using 6%of risk aversion and v1% risk-free rate, the recommended percentageof risk-free assets is found to be 60%.Andas a result of that, 40% of risky assets in restricted portfolio(Michaud 2008). Hence, the return value has been calculated to 6.5%with a risk of 9%.
Inthe case of unrestricted collection, the outcome percentage is 30%and 70% respectively. That means if short selling is not allowed, aninvestor can freely invest in 70% optimal risk portfolio. That givesa return value of about 17% of the risk value of about 16%. Abu Dhabiportrays a definite indication considering other competitive marketsin the world. Thatmakes it promising to investors who invest in their stock market.
Limitationsof the research
Theresearch model however has some limitations that limit accuracytowards obtaining actual values in the stock market. According toJacobs et al. (2005),these limitations include number of companiesconsidered is only nine hence, the lower the number of components thelower the accuracy. Secondly, only a period of one year is consideredfor evaluating efficient portfolio for both restricted andunrestricted collection. Finally, the companies discussed are on thebasis of trading volume while it is also advisable to use priceearnings ratios.
Thepaper has used Markowitz model of efficient portfolio to determinethe amount of investment an investor needs to make in risk-free andrisky assets. The results have been computed in MS-Excel using solverto determine feasible rate of return. Hence looking at the analysisoutcomes, Abu Dhabi is saidto have a high restricted and unrestrictedportfolio.
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Jacobs,B., Levy, K., & Markowitz, H. (2005). Portfolio Optimization withFactors and Realistic Short Positions.OperationsResearch,586-599.
Michaud,R. (2008). Efficientasset management: A practical stock portfolio optimization and assetallocation(2nd ed.). New York: Oxford University Press.
Schirripa,F., & Tecotzky, N. (2000). An Optimal Frontier. TheJournal of Portfolio Management,29-40.