The effect of portfolio optimization on the returns of listed companies at the Nairobi securities exchange

Abstract

Portfolio optimization is the practice of determining the ‘best’ allocation of assets within a portfolio in order to maximize returns at a given level of risk. The study aimed at establishing the effect of portfolio optimization on returns of listed companies at the Nairobi Securities Exchange. Markowitz’ mean-variance optimization model was used to analyze the risk and returns of the portfolios. Secondary data of consistently trading companies’ stocks at the NSE during the period July 2008 to June 2013 were used to compute risk and returns thereafter construction of portfolios.Risk was based on beta of the stocks. The risks and returns of the constructed portfolio was compared to the benchmark portfolios, GMVP and naïve (1/N) portfolio, to check significance of the differences between the returns and risk of portfoliosby conducting T-tests. The study was descriptive in nature. Monthly stock prices risk and returns were computed. Single Index model was used to select stocks to the optimal portfolio with 2 out of the 45 stocks in the sample selected to the portfolio. The study found significant difference between return, risk and risk adjusted returns of optimal portfolio and the GMVP and naïve (1/N) portfolio thus portfolio optimization leads to better absolute and risk adjusted returns. The results are consistent with research findings in the literature review. Investors are recommended to optimize their portfolios to maximize the returns of their portfolio and the regulatory authorities such as the Capital Markets Authority and Insurance Regulatory Authority put in place policies that encourage portfolio optimization.