Effect of Investment Portfolio Diversification on Financial Performance of Pension Schemes in Kenya

Abstract

The financial performance of pension schemes is crucial for ensuring the sustainability and reliability of retirement benefits, particularly in Kenya, where these schemes play a significant role in securing the livelihoods of retirees. This study was motivated by the need to understand how investment portfolio diversification influences the financial performance of pension schemes, given the increasing complexity of investment decisions. Anchored on modern portfolio theory and supported by agency theory and the capital asset pricing model, the study sought to determine the effect of investment portfolio diversification on the financial performance of pension schemes in Kenya. A descriptive panel research design was employed, with data collected from 119 randomly selected pension schemes over a five-year period (2019–2023). Financial performance was measured by return on assets (ROA), while investment portfolio diversification was quantified using the Herfindahl-Hirschman Index (HHI). Control variables included fund liquidity, fund size, interest rate, and managerial efficiency. Secondary data from annual reports and Retirement Benefits Authority publications were analyzed using descriptive statistics, correlation analysis, and panel regression, with diagnostic tests ensuring the validity and reliability of the model. The regression model demonstrated a good fit, with an R-squared value of 0.5751, indicating that 57.51% of the variation in financial performance was explained by the independent and control variables. The results showed that investment portfolio diversification had a significant positive effect on financial performance (β = 0.42636, p = 0.009). Among the control variables, fund liquidity (β = 1.0699, p = 0.003), fund size (β = 0.341096, p = 0.004), and interest rate (β = 1.027967, p = 0.000) also significantly enhanced financial performance. However, managerial efficiency did not have a statistically significant effect (β = 0.77486, p = 0.670). These findings affirm the importance of strategic diversification and robust financial management practices in optimizing the performance of pension schemes. The study concludes that investment portfolio diversification, liquidity management, fund size, and interest rate optimization are critical drivers of financial performance in Kenyan pension schemes. It recommends that pension fund managers prioritize diversification across asset classes and maintain adequate liquidity to capitalize on investment opportunities. Smaller schemes should consider pooling resources to benefit from economies of scale, while policymakers are encouraged to develop regulations that promote diversification and stability in the pension sector. Fund managers should also leverage favourable interest rate environments to enhance returns. For further research, the study suggests extending the period of analysis to capture long-term trends and assessing the influence of macroeconomic factors and regulatory policies on pension schemes' performance. Additionally, qualitative research could explore the perspectives of fund managers and policymakers to uncover practical challenges and innovative strategies in investment decision-making.