* Dubai, Abu Dhabi, Qatar have soared ahead of MSCI move
* But history shows stocks often underperform after upgrades
* Rich valuations increase the risk
* Data shows foreigners already cutting Dubai exposure
* Inflows into Abu Dhabi and Qatar continue, but are modest
By Olzhas Auyezov
DUBAI, May 28 (Reuters) - When index compiler MSCI upgrades the United Arab Emirates and Qatar to emerging market status at the end of this week, it will put those countries on the global investment map. But it may also end the bull runs in their stock markets.
The history of other markets upgraded by MSCI shows that many perform poorly in the 12 months after the actions take effect, because stocks have already shot up and become richly valued in anticipation of the upgrades.
A Reuters analysis of exchange data indicates foreign investors have already started to decrease their exposure to Dubai, the region’s top-performing bourse.
Nine companies from the UAE and 10 stocks from Qatar will become part of the MSCI emerging market index after the markets close on Thursday.
Since MSCI announced the move last June, Dubai’s main index has rocketed 112 percent, making Dubai one of the world’s best-performing markets, while Qatar has added 44 percent and Abu Dhabi has gained 43 percent.
Expectations that the upgrades will attract more foreign money have been a key reason for the bull runs, along with strong local economies, rising property prices and plans for heavy government spending on projects such as the 2020 Expo world fair in Dubai and the 2022 soccer World Cup in Qatar.
Indeed, Reuters calculations show foreign investors have poured a net total of about $2 billion into the UAE and Qatar stock markets so far this year. Much of that sum has come from “active” foreign funds which use MSCI benchmarks as rough guidelines and can position themselves before adjustments occur.
Another wave of inflows is likely to start on Thursday when “passive” funds, which follow the MSCI emerging market index closely, start buying too.
However, passive funds are smaller than active ones, so analysts estimate they may only add several hundred million dollars each to the UAE and Qatar - and some of that buying will be offset by selling on the part of funds tracking the MSCI frontier market index, which the UAE and Qatar are leaving.
Out of nine national stock markets upgraded by MSCI since 1997, six posted outright losses in the first month after the action while five underperformed the new index in which they had been included, according to a Reuters study.
On average, MSCI indexes for Portugal, Greece, Israel, Pakistan, Serbia, Lithuania, Sri Lanka, Egypt and Morocco posted a loss of 2.5 percent in the first month, a gain of 3.4 percent over six months and a loss of 4.0 percent over 12 months.
A year after upgrade, five out of nine country indexes were underperforming their MSCI benchmarks.
It is by no means certain that the UAE and Qatar will follow this pattern, but high valuations have increased the chances. The UAE and Qatar are now trading at about two times their trailing price-to-book ratios, a 40 percent premium to emerging markets in general, compared with a 50 percent discount a couple of years ago, Citi analyst Andrew Howell estimated.
Exchange data shows foreign investors are becoming more picky in Dubai. Non-Gulf investors reduced their holdings of stocks listed on the Dubai Financial Market by at least $200 million between March 16 and May 13.
Inflows appear to be continuing in the other two markets. Foreigners, including Gulf investors, increased their holdings in Abu Dhabi by roughly $200 million during the period and pumped about $500 million into Qatar.
But these amounts are modest compared to the size of the markets - Abu Dhabi has a capitalisation of about $135 billion and Qatar, $200 billion.
“I’d be inclined to tread cautiously starting next week,” Howell wrote in a research note last week. “The annals of emerging markets history are littered with the roadkill of markets that peaked right around the time that they were upgraded or added to a new index.” (Editing by Andrew Torchia)