The Effect of Portfolio Diversification on the Financial Performance of Provident Funds in Kenya

Abstract

Studies on portfolio diversification and asset allocation have generally focused on the financial performance of pension funds as opposed to provident funds. Provident funds are impeded by the requirement to make payments of the benefits to exiting members as a lumpsum, as opposed to pension funds which make a part payment as a lumpsum and the rest as annuities. These lumpsum payments can create liquidity challenges for the fund especially with a large number of exiting members. This study sought to fill the research gap by evaluating the effect of portfolio diversification on the provident funds. Thirty-three provident funds were sampled from the pool of provident funds in Kenya and using secondary data from RBA, their diversification of investments in various assets considered. To measure financial performance, this study looked at the return on investments. The study adopted a fixed effects model where return on investment was the dependent variable, and the independent variables consisted of the various assets: cash and demand deposits, fixed and time deposits, government securities, quoted shares, unquoted shares, and immovable property. The study found that there is significant correlation between the independent variables and the dependent variable with quoted shares having the strongest correlation. Further, cash and demand deposits have the highest impact on the financial performance of provident funds in line with the nature of provident funds. The model adopted explained 9% of the financial performance of the provident funds and further studies need to be carried out to assess other factors that affect the financial performance of provident funds