The effects of diversification on portfolio risk atthe Nairobi securities exchange

Abstract

Portfolio diversification is the practice of spreading one‟s money among many different investments. Portfolio risk is the chance that combination of assets or units within individual group of investment fail to meet financial objectives. In theory, portfolio risk can be eliminated by successful diversification (Ahuja, 2011). This study seeks to find out the effects of diversification on portfolio risk at the NSE. Its specific objectives include to find out the number of securities that makes a diversified portfolio and to find out the effect of number of assets in a portfolio on portfolio risk. A security (Safaricom Ltd) was randomly chosen and its variance calculated. Next, this security was combined with another security (also randomly selected) to form an equally weighted portfolio of securities. Step by step more securities were randomly added to the portfolio until all 62 securities were included. The data was obtained from the NSE daily closing prices for the past three years. The findings show that it can be concluded that a portfolio of equally weighted 7 securities can diversify away significant amount of risk for the investors than large number of security whose returns is mixed.