Determining the Optimal Portfolio Size on the Nairobi Securities Exchange

Abstract

There is consensus that diversification results in risk reduction. However there is no consensus on the number of securities required for maximum risk diversification. Studies done on different capital markets have yielded differing results. This study aimed at determining the optimal portfolio size for investors on the Nairobi Securities Exchange in Kenya. The study used mean variance optimization model and secondary data consisting of monthly security returns over a five year period from January 2009 to December 2013. Forty three of the sixty listed firms had complete information on monthly security returns and were used in the study. Portfolios of different sizes were formed by random selection of securities and the portfolio risk was computed. The study found that portfolio risk reduced as the number of securities in the portfolio increased but beyond the optimal portfolio size the risk started rising again. The optimal portfolio size in the Nairobi Securities Exchange was found to lie between 18 and 22 securities.