International Journal of Trade, Economics and Finance, Vol. 3, No.

6, December 2012

Diversification in Portfolio Risk Management:

The Case of the UAE Financial Market
Ikhlaas Gurrib and Saad Alshahrani

 would simultaneously underperform. Consequently, the risk

Abstract—The paper looks at the existence of portfolio risk involved in such a portfolio would remain high. The goal of
management for the UAE Financial Market. The research portfolio formation is to diversify and minimize the risk
methodology centers on applying Modern Portfolio Theory, involved. Thus, the securities that have minimum correlation
with particular emphasis on the Markowitz Efficient Frontier,
Minimum Variance Analysis, and Portfolio Optimization. The
with each other should be included in a portfolio, so as to
data is essentially based on the top performing sectors of the generate the maximum portfolio return while minimizing the
UAE economy, and twenty key companies are chosen from each risk [2].
sector to test for diversification. Key findings suggest that the This study would conduct a portfolio management analysis
risk of the portfolio is lower than the weighted risk of the twenty of a portfolio formed by 20 publicly listed companies in the
individual stocks, i.e. efficient diversification can be achieved. United Arab Emirates. The analysis would attempt to
demonstrate if efficient diversification can be accomplished
Index Terms—Efficient diversification, portfolio
optimization, UAE financial market. by exercising the Markowitz model. We would attempt to
find out the most favorable investment allocations in a
portfolio. To encompass the characteristic of the whole UAE
I. INTRODUCTION market as a whole, the twenty stocks chosen for this
assignment were selected from five different industries,
The objective of investors and, particularly, portfolio
ranging from banking, telecommunication, insurance, real
managers is to attain the optimal trade off amid risk of a
estate and transportation. The main objective of this study is
portfolio of investment and the return expected from it. In the
to find out if it is possible to build an efficient frontier using
portfolios built from a set number of assets or financial
UAE based securities. The Dubai Financial Market (DFM) is
securities, the risk and return characteristics would change
one of the most prominent stock exchanges in UAE and had
with the composition of the portfolio. The portfolio that is
around sixty companies listed to it.
expected to generate the maximum return at a particular level
of risk, or alternatively stated, the portfolio of securities that
would minimize the rise for a particular level of return, is
II. DATA
termed as an optimal portfolio. A collection of such optimal
portfolios form a curve in the risk-return graph and is known For the portfolio formation and creation of the efficient
as the efficient frontier [1]. frontier, twenty companies, whose stocks trade in the Dubai
It is generally accepted in finance literature that the Financial Market, were chosen. With the intension of
systematic risk involved in any stock cannot be mitigated and forming an optimal diversified portfolio, the stocks were
hence a portfolio cannot be diversified completely. However, selected from five diverse industries, to be precise, Banking,
the Markowitz model proposes that it is feasible to lessen the Real Estate & Construction, Transportation,
extent of risk under diversifiable risk. Any individual who Telecommunication and Insurance [3]. The names of the
wants to make investments in financial securities has to twenty companies selected for the portfolio formation have
choose securities from a huge array of financial assets. The been clustered below with regards to their respective
choice of securities to be included in a portfolio should rely industries:
on the risk and return attributes of the individual securities. It A. Real Estate & Construction
should be noted that the risk and return attribute of a portfolio 1) Arabtec Holding PJSC (ARTC)
of securities is different from the risk return attribute of the 2) Emaar Properties PJSC (EMAAR)
assets used in forming the portfolio. Moreover, the 3) Union Properties PJSC (UPP)
correlation of one security with the other is also a very 4) Deyaar Development PJSC (DEYAAR)
important factor, while considering which securities should 5) Drake & Scull International P.J.S.C (DSI)
be included in a portfolio. If all the securities included in a
B. Transportation
portfolio are positively correlated to each other’s price
movements and hence move in the same direction, then, 1) Air Arabia PJSC (AIRARABIA)
2) Gulf Navigation Holding PJSC (GULFNAV)
when the market faces financial depression, all the securities 3) ARAMEX PJSC (ARMX)
C. Bank
Manuscript received October 19, 2012; revised November 20, 2012.
I. Gurrib is with the Canadian University of Dubai, Sheikh Zayed Road, 1) AJMAN BANK PJSC (AJMANBANK)
PO Box 117781, Dubai, United Arab Emirates (e-mail: [email protected]). 2) AL SALAM BANK SUDAN (ALSALAMSUDAN)
S. Alshahrani is with the International Monetary Fund (IMF), Fiscal 3) TAMWEEL PJSC (TAMWEEL)
Affairs Department, 700 19th St, Washington, DC 20431, USA. 4) Dubai Islamic Bank (DIB)
(e-mail:[email protected]).

DOI: 10.7763/IJTEF.2012.V3.243 445

 International Journal of Trade, Economics and Finance, Vol. 3, No. 6, December 2012

5) Al Salam Bank –Bahrain (SALAM_BAH) 2011 to August 2012 were gathered. The mean value of the
6) Gulf Finance House B.S.C (GFH) stock prices, their variances and the rate of return produced
D. Insurance by the twenty stocks when held for one year (explicitly, Sept
1) Dubai Islamic Insurance and Reinsurance Co. (AMAN) 2011 to Aug 2012) were calculated, using the collected share
2) Islamic Arab Insurance Company (SALAMA) price movements from the official website of the Dubai
3) Takaful House (DARTAKAFUL) Financial Market. Table I shows the mean stock prices, share
4) Takaful Emarat (PSC) (TAKAFUL-EM) price variance and returns if stocks were hold for one year. It
E. Telecommunication can be observed from the above table, that the shares of
Arabtec Holding produced the highest return (approximately
1) Hits Telecom Holding K.S.C. (HITSTELEC)
2) Emirate Integrated Telecommunications Company PJSC (DU) 103%), if they were bought and held for a period of one year.
Additionally, it can be observed that the variance of its share
Subsequent to choosing the 20 companies for the portfolio price, usually used as a proxy of risk, was one of the highest
formation and diversification, the daily closing prices of the among the chosen companies.
companies’ stocks for the period starting from September

TABLE I: MEAN STOCK PRICES, SHARE PRICE VARIANCE, AND RETURNS IF STOCKS WERE HELD FOR 1 YEAR.
Companies Mean Stock Share Price Returns if stocks
Price Variance would have been
held for one year

1 (GULFNAV) Gulf Navigation Holding 0.26 0.2560% -13.79%

2 (DEYAAR) Deyaar Development 0.3 0.4820% 28.57%

3 (UPP) Union Properties 0.36 0.4280% 2.63%

4 (SALAM_BAH) Al Salam Bank – 0.43 0.2240% -12.50%

Bahrain

5 (GFH) Gulf Finance House 0.59 1.7130% 8.51%

6 (TAKAFUL-EM) Takaful Emarat 0.61 0.3470% -1.59%
7 (DARTAKAFUL) Takaful House 0.62 0.4300% -1.67%

8 (AIRARABIA) Air Arabia 0.63 0.2260% 6.45%

9 (SALAMA) Islamic Arab Insurance 0.66 0.9690% -1.43%
Company

10 (AMAN) Dubai Islamic Insurance and 0.74 5.3540% 51.67%

Reinsurance Co.

11 (AJMANBANK) AJMAN BANK 0.81 0.0650% -1.23%

12 (DSI) Drake & Scull International 0.86 0.6900% 1.16%
13 (TAMWEEL) TAMWEEL 0.96 7.2670% 51.25%
14 (HITSTELEC) Hits Telecom Holding 0.97 8.1750% 53.33%
15 (ALSALAMSUDAN) AL SALAM 1.62 3.0280% -5.59%
BANK SUDAN

16 (ARMX) ARAMEX 1.8 0.2150% -1.67%

17 (DIB) Dubai Islamic Bank 1.98 1.0344% -3.47%
18 (ARTC) Arabtec Holding 2.36 61.0480% 102.92%
19 (EMAAR) Emaar Properties 2.89 7.7720% 16.14%
20 (DU) Emirate Integrated 3.04 2.5850% 12.17%
Telecommunications Company

different kinds of investment, on average, will give higher

III. METHODOLOGY returns as well as posture a lower risk compared to any other
individual investment that is found within the portfolio. The
A. Portfolio Management
purpose of diversification is to nullify the unsystematic risk
The technique of reducing the risk by investing in different events within a portfolio. Consequently, the positive
types of assets is referred as diversification. In other words, performance of some investments will rule out the not so
diversification is a process of risk management that takes into positive or negative performance of the other investments.
account a broad selection of investments within a portfolio. The benefits from the process of diversification can only be
Portfolio diversification is crucial in the process of portfolio accrued if the securities within the portfolio are perfectly
risk management because it enables the investors to uncorrelated [4].
considerably reduce their portfolio risk without There are generally, two styles of diversification, one
compromising their portfolio return. A portfolio that is vertical diversification and the other horizontal
diversified will have less risk in comparison to the weighted diversification. In case of horizontal diversification, an
average risk of the constituent assets when the values of the investor invests his capital in different types of a particular
assets do not fluctuate in a perfect synchrony. The rationale asset group. This mode of diversification is commonly
that guides this technique argues that a portfolio consisting of observed in case of shares, where investors invest in shares of

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 International Journal of Trade, Economics and Finance, Vol. 3, No. 6, December 2012

companies across industries and regions so as to reduce the equation for covariance is as follows:
sector-specific perils. On the other hand, in vertical
diversification, an investor invests his money among Cov  ri , rj   ij i j   ij
different categories of assets such as stocks, bonds, cash,
property and derivatives among others. These asset where ij is the correlation coefficient. It should be noted
categories are anticipated to behave unlike each other and
that an elevated covariance between the returns of two stocks
produce dissimilar returns with respect to the changes in the
indicates that a raise in the return of one stock would result in
economic scenario. Thus, the negative or not so good
a simultaneous raise in the return of the other [8]. On the
performances of certain assets are compensated by the
other hand, zero or low covariance signifies that the returns of
superior performance of other asset groups.
the involved stocks are comparatively independent of each
In the year 1952, Harry Markowitz, deemed as the father of
other, while a negative covariance implies that a raise in one
Modern Portfolio Theory, developed a framework for the
stock’s return would match a corresponding decline in
systematic selection of assets in a portfolio on the basis of the
another stock’s return. For an efficient diversification of risk
principles of risk and return. He was the foremost individual
in a portfolio, it is necessary that securities whose returns
to point out that the interrelationship between the returns of
have negative or very low covariance to each other be
the constituent assets should be taken into consideration in
included in the portfolio, as supported in [9].
the computation of portfolio risk. This is because the
consideration of the interrelationships assists in the reduction B. Minimum Variance Portfolio
of the portfolio risk to the least possible level for a specified The computation of the minimum variance portfolio and
level of portfolio return [5]. The concept of portfolio the efficient frontier require the study of the historical share
diversification is based on the fact that the cumulative risk of price movements of the 20 considered companies, in order to
a portfolio is less than the summation of the risks of the calculate their standard deviations and their returns. The
individual assets included in the portfolio. The risk of a monthly returns of the 20 companies over a period of one
portfolio is an exclusive attribute and not just the summation year were used to compute the correlation and the covariance
of individual asset risks [6]. For instance, a particular matrixes for the selected stocks. This is accomplished with
security has high risk if held individually but a reduced the help of the Data Analysis tool of Microsoft Excel ©. The
amount of risk when comprised in a portfolio [7]. Markowitz snapshots of the two matrixes are shown in Table II. The
model of portfolio diversification is based on two covariance matrix so obtained was then converted to a
approaches, first, minimizing the risk for a given level of weighted covariance matrix in order to include the weights of
expected return, or second, maximizing the expected return the respective stocks in the portfolio. The variance of the
for any given level of risk. The risk or variance of a portfolio portfolio was the summation of the weighted values of the
of stocks is equivalent to the weighted average covariance of covariance matrix. Since, the assignment involved 20 stocks;
the individual stock returns. The variance of a portfolio can the manual computation of the minimum variance portfolio
be represented by the following equation: was not possible. The computation of the minimum variance
portfolio required the use of Solver Function; where in the
Var  rp    p2   wi w j Cov  ri , rj 
n n

standard deviation of the portfolio was set as target to be

i 1 j 1
minimized, by changing the respective weights of the 20
where wi and wj are the respective weights of two pair of stocks. However, there were two constraints that were used,
stocks in the portfolio and ri and rj, their respective returns. first, the sum of the weights of all the securities would add up
The covariance between the returns of two pair of stocks is to 100% or 1, and second, the individual weights of each of
equal to the product of the correlation coefficient between the the stocks would be greater or equal to zero as supported in
stock returns and the corresponding standard deviations. The [9].

TABLE II. CORRELATION AND COVARIANCE MATRIX AMONG THE 20 STOCKS

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The minimum variance portfolio so obtained involved a Telecommunications Company (46.59%).

standard deviation of 2.68% and the expected return of this
portfolio was 3.31%. This portfolio was composed of
investments in three securities, namely, Dubai Islamic Bank IV. OPTIMAL PORTFOLIOS
(6.15%), ARAMEX (47.26%) and Emirate Integrated

TABLE III. OPTIMAL PORTFOLIO WEIGHTS, STANDARD DEVIATION AND EXPECTED RETURN OF PORTFOLIO
Dubai ARAMEX Emirate Integrated Hits Telecom Variance of Standard Expected return
Islamic (ARMX) Telecommunications Company Holding Portfolio Deviation of of Portfolio
Bank (DU) HitsTele) Portfolio
(DIB)

6.11% 47.22% 46.68% 0.00% 0.000719324 2.68% 3.32%

6.00% 47.24% 46.75% 0.00% 0.000719332 2.68% 3.33%

5.76% 47.22% 47.01% 0.00% 0.000719359 2.68% 3.36%

5.85% 47.03% 47.11% 0.01% 0.000719376 2.68% 3.37%

5.73% 47.09% 47.17% 0.01% 0.000719395 2.68% 3.38%

4.99% 47.30% 47.57% 0.14% 0.000719743 2.68% 3.55%

2.90% 48.20% 48.38% 0.52% 0.000721088 2.69% 4.00%

1.97% 48.60% 48.74% 0.69% 0.000721868 2.69% 4.20%

0.58% 49.20% 49.28% 0.95% 0.000723247 2.69% 4.50%

0.00% 48.17% 50.41% 1.42% 0.000727579 2.70% 5.00%

0.00% 44.76% 52.85% 2.39% 0.000753785 2.75% 6.00%

0.00% 41.36% 55.28% 3.36% 0.00080382 2.84% 7.00%

0.00% 39.69% 55.99% 3.93% 0.000871248 2.95% 8.00%

0.00% 38.10% 56.62% 4.48% 0.000948411 3.08% 9.00%

0.00% 36.96% 56.68% 4.99% 0.001035205 3.22% 10.00%

Following the formation of the minimal variance portfolio, their risk level constant. On the contrary, portfolios above
the standard deviation of the portfolio was continuously the curve would be sought for but it is not possible to build
increased minimally, in order to obtain a collection of such portfolios, as supported in [11]. It is generally
portfolios that have the maximum return for a specific level acceptable in Modern Portfolio Theory that a line originating
of risk. The optimal portfolios that were used to build the from the risk free rate on the Y axis and touching the risk
efficient frontier using UAE securities comprise of the return curve is the Capital Asset Allocation Line. Assuming
weights as per shown in Table III. The expected return and the risk free rate to be 3% (based on the Emirates Interbank
the standard deviation of the optimal portfolios were plotted Lending rate), the line originating from it touches the
along the Y axis and the X axis respectively, to obtain the risk efficient frontier at the point (2.7%, 5%). This is the risk
return plane, where the curve represents the efficient frontier. return value of the tangential portfolio or the optimal risky
Portfolios that lie along the curve are optimal, because they portfolio. This portfolio comprises of 48.17% investment in
provide maximum return at a specific level of risk or they Aramex, 50.41% investment in Emirate Integrated
have the least possible risk for a particular level of return Telecommunications Company and 1.42% investment in Hits
[10]. Portfolios lying below the curve are not optimal in Telecom Holding.
nature, as their returns can be maximized in spite of keeping

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V. CONCLUSIVE REMARKS [6] T. Poddig and A. Unger, “On the Robustness Of Risk-Based
Asset Allocation,” Financial Markets and Portfolio
It is a known fact that diversification of portfolio assists in Management, vol. 26, no. 3, pp. 369-401, September 2012.
the reduction of the associated risk involved in it. [7] W. Lee, “Risk-Based Asset Allocation: A New Answer to An
Nevertheless, it is worth mentioning that it is not possible to Old Question?” Journal of Portfolio Management, vol. 37, no.
get rid of risk entirely by means of diversification. Even if 4, pp. 11-28, 2011.
the numbers of constituent securities in a particular portfolio [8] W. Lee, “Risk On/Risk Off,” Journal of Portfolio
are increased indefinitely, there would be certain level of risk Management, vol. 38, no. 3, pp. 28-39, 2012.
[9] E. Girard and E. Ferreira, “A N-Assets Efficient Frontier
associated with that portfolio. Nonetheless, the Guideline for Investments Courses,” Journal of College
diversification benefits in terms of reduced associated risk Teaching & Learning, vol. 2, no. 1, 2005.
rapidly decreases with the inclusion of more securities in the [10] W. F. Sharpe, “The Sharpe Ratio,” Journal of Portfolio
portfolio. This is evident standard deviation stabilizes out Management, vol. 21, no. 1, pp. 49–58, Fall 1994.
eventually. This suggests there is a definite risk level that is [11] W. F. Sharpe, “Adjusting For Risk In Portfolio Performance
intrinsic in the investment of securities and this least level of Measurement,” Journal of Portfolio Management, vol. 1, no. 2,
pp. 29-34, 1975.
risk cannot be eradicated even by increasing the number of
securities in an investment portfolio indefinitely. This was
clearly observed from the portfolio management analysis of
the 20 stocks trading in the UAE markets. The study revealed Gurrib I. is currently the MBA Finance Program
that the use of 20 stocks could minimize the risk involved, Coordinator at the Canadian University of Dubai,
however the risk or variance could not be made nil. Even the which is ranked no. 1 in Dubai for its MBA program.
He is a holder of a Ph.D. (Economics and Finance)
minimum variance portfolio developed from the 20 selected
from Curtin University, Australia, together with a
stocks had a standard deviation of 2.68%. Future avenues of MPA (Master of Professional Accounting) and MFin
research could be taken to assess the implications of different (Master of Finance) from Victoria State University,
risk profiles of different investors, and what combination of Australia. He held various academic positions in Australia, Saudi Arabia
risky and risk free assets would be optimal for them. and UAE. He was also a finance manager at Westpac Bank, the 2nd largest
bank in Australia.

REFERENCES
[1] R. A. Strong, Portfolio Construction, Management, and
Protection, UK: Cengage Learning, 2008. Alshahrani S. is currently an Economist, with the
[2] F. K. Reilly and K. C. Brown, Investment Analysis and Portfolio Fiscal Affairs Department of the International
Management, United States: Cengage Learning, 2011. Monetary Fund (IMF) and is based in Washington,
[3] Dubai Financial Markets. (December 2012). Listed Securities. U.S. He previously held position at the Central Bank
[Online] Available: of Saudi Arabia (SAMA). He held some academic
http://www.dfm.ae/pages/default.aspx?c=1010 positions in USA & GCC universities. He holds a
[4] R. A. Ferri, All About Asset Allocation: The Easy Way to Get Ph.D. (Economics) from Washington State
Started, USA: McGrawHill, 2005, pp. 25-135. University (USA) and 2 graduate degrees in applied economics and
[5] C. P. Jones, Investments: Analysis and Management, USA: statistics.
John Wiley and Sons, 2009, pp. 75-221.

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