Index funds and diversification in Saudi Arabia

The purpose of this paper is to investigate how best to diversify in Saudi Arabia's stock market.

The analysis proceeds as follows: first, repeated sampling with replacement from a sample of 62 actual companies' monthly stock returns from January 2001 to June 2006 is used to simulate the performance of various portfolio sizes; second, a modified Statman diversification model is used to evaluate the performance of index funds in Saudi Arabia and thus assess the size of a diversified portfolio.

This paper reaches two important findings: first, due to high index funds fees, investors are better off diversifying by purchasing stocks directly from the stock market; second, a portfolio containing five randomly chosen stocks is sufficient to achieve diversification.

This paper provides useful recommendations on how to achieve diversification. Additionally, it highlights the fact that index funds are too expensive to be useful in Saudi Arabia.