The Nairobi Stock Exchange (NSE)- the case for a buy-and-hold strategy for equity investors


A list of stocks from both the Nairobi Stock				122
Exchange MIMS (large caps and mid-caps) and the
AIMS (small caps) that had either outperformed or				19%
underperformed the benchmark index (the NSE-20) in
all three periods was drawn up. The results revealed
that stocks that either outperformed or				Housing Finance Ltd.
underperformed the NSE-20 were diverse across
size, sector and investment style.				38

The research also went on to derive fundamental				-39%
data- PE ratios as well as book-to-market values -BV
MV ratios[1] for the list of stocks that had either				50
underperformed or outperformed the benchmark
index for all three periods. These revealed that a				-59%
value strategy that would have picked stocks on the
basis of high BV/MV ratios and low PE ratios would
have been unable to outperform the benchmark				Nation Media Group Ltd.
index. These findings were in line with anecdotal
evidence on value investing where superior returns of				32
value stocks are normalised when adjusted for risk.
The case is even stronger when agency costs of				-55%
delegated investment management are considered.
(Chan and Lakonishok, 2004).				32

Additionally, on the basis of the evidence gathered, a				-52%
momentum strategy[2] involving picking stocks on
the basis of high PE ratios would also have been
unable to outperform the benchmark index during the				Olympia Capital Holdings Ltd.
periods under consideration.
				35
To outperform the benchmark index, the fund
manager or private investor would have had to				-39%
select stocks across sector and size (involving time
and research and hence considerable cost) as well as
constantly vary his investment style in order to pick
winners.
				TPS (Serena) Ltd.
Data presentation
Table 1: Stock performance over three different				35
annualised periods
				-25%
Sector reclassification
% change (21/10/07 - 20/10/08)
% change (1/2/08 - 31/1/09)
% change (11/6/09 - 10/6/10)
STOCK				INDEX




MIMS

				NSE All-share index

				-22%
Agriculture
				-23%

				40%
				NSE-20 index
Kakuzi Ltd.
Agriculture				-27%
-15
-21				-32%
194
Commercial and Services				44%


				Source: Bloomberg, 2010; myStocks!, 2010
				*Only PE ratios above 30 are shown
Car & General Ltd.				Figures in bold represent the performances of stocks
Automobile				that outperformed the NSE-20 in the respective
-10				periods.
-20
48				Of the stocks that outperformed the benchmark
Nation Media Group Ltd. *				index in all three periods, only Bamburi Cement Ltd.,
Media				Equity Bank Ltd. and TPS (Serena) Ltd. showed PE
-55				ratios of above 20 but only in two of the three
-52				periods (see Table 2). Despite showing very high PE
9				ratios in periods I and II[3], Housing Finance Ltd. and
TPS (Serena) Ltd.				Nation Media Group Ltd. underperformed the NSE-20
Leisure & Hotels				index in all three periods.
-25
-18				Crown Berger Kenya Ltd. and Olympia Capital
65				Holdings Ltd. also showed high PE ratios in period I
Finance and Investment				but underperformed the benchmark index in all three
				periods. Despite low PE ratios averaging 4, 2 and 5
				respectively in the three periods, Car & General
				Ltd., Kakuzi Ltd. and Kapchorua Tea Company Ltd.
				outperformed the benchmark index in all three
CFC Stanbic Bank Ltd.				periods (see Table 1). Thus a momentum strategy
Banks				involving picking 'glamour' stocks with high PE ratios
-43				would have been unable to outperform the NSE-20
-53				index in the three periods covered.
16
Housing Finance Ltd.				From the observed data, a strategy to outperform a
Financials				buy-and-hold strategy (based on the NSE-20 index)
-39				would have had to select stocks across sector and
-59				size[4]. Also such a strategy would have had to,
29				ex-ante, discriminate between eventual strong and
Standard Chartered Bank Ltd. *				weak companies. In picking strong companies a
				strategy to outperform the benchmark index would
-12				have had to discriminate between companies within
-20				sector especially in the Banks, Financials and
59				Agriculture sectors where some outperformed the
Equity Bank Ltd. *				benchmark index while others under-performed it[5].
Banks				And even among the strong companies[6] not all
54				were able to outperform the benchmark index.
19
66				Analysis and Interpretation
Olympia Capital Holdings Ltd				Risk-return premia
Financials				Value investors seek to benefit by purchasing
-39				undervalued stocks and selling these once the prices
-33				move towards their intrinsic values. Momentum
-4				investors, for their part, expect recent stock price
Industrial and Allied				trends to continue and favour growth stocks- those
				which exhibit continued price increases whether or
				not the increases are justified by firm fundamentals.

				The inability of the value investor to outperform the
Athi River Mining Ltd. *				benchmark index stems from the fact that value
Building & Construction				stocks when adjusted for risk reveal at best average
10				returns. Beta values for small caps like Kapchorua Tea
-7				may be exceedingly high meaning that their real
56				return measured by the Treynor ratio (see below) is
Bamburi Cement Ltd. *				low or average.
Building & Construction
-4				Thus to get a true picture of the real return of
-21				stocks included in a value-seeking actively managed
67				portfolio, the risk associated with the individual stock
E.A. Cables Ltd. *				must be taken into account especially with regard to
Industrials				the small cap stocks which carry considerable risk. An
-32				additional risk premia for these particular stocks
-41				would have to be added.
-8
Crown Berger (K) Ltd.				However, on occasion, the actions of investors who
Industrials				collectively respond to price movements in a similar
-38				manner (or adopt a similar investment style) may still
-46				lead to pricing bubbles or excessive underpricing,
21				pricing anomalies that may lead to abnormal returns
KenGen Ltd. *				for the value investor, even after adjusting for risk.
Utilities				(Morrin et al.; 2002)
-37
-44				Mean reversion
21
				The ability of momentum stocks to outperform the
				benchmark index is confined by negative serial
				correlation of returns for holding periods of between
				three and five years. Mean reversion has the ability
				to return stock values to their mean or intrinsic
STOCK				values over time thereby halting correlative price
				movements in a particular direction[7]. Thus past
				winners become future losers and past losers
				become future winners.

AIMS				Furthermore, active investors make their purchases
				or sales well into a rally or decline thereby missing the
				opportunity to maximise their return by buying cheap
				before the market peaks[8] or minimising total loss
				by selling the stock or making portfolio reallocations
Express Ltd.**				before the market troughs. (Chan et al., 1996)
Transport
-39				When bubbles develop they correct overtime
-49				thereby limiting the gains of a momentum investor.
-4				However, bubbles usually overcorrect so that the
Kapchorua Tea Co. Ltd.**				market is selling well below fair value thereby
Agriculture				presenting value investors with a buying opportunity.
-17				However, mean reversion and the actions of
-24				arbitrageurs halt excessive movements to the
112				downside thereby limiting the benefits to the value
				investor.

				Equity portfolio diversification
				Diversification has the potential to reduce volatility
				without sacrificing risk-adjusted returns. Thus where
INDEX				increased returns can only be achieved by increasing
				the level of risk undertaken, a diversified portfolio (as
				exemplified in a wide-ranging benchmark index like
				the NSE-20) provides increased or at least similar
				returns without increasing the level of risk
NSE All-share index				undertaken. However these allocations across
				different equities should be selective taking into
-22				consideration strong fundamentals and technical
-23				analysis.
40				Critically, portfolio diversification should not be seen
NSE-20 index				solely from the view-point of numbers (number of
				stocks held or percentage of holdings in the top 10)
-27				but rather from the view-point of combining assets
-32				that have very little correlation with one another[9].
44				In that way, when one area is suffering e.g. Banks or
				Industrials another might hold up a little better e.g.
				Building & Construction[10]. However, cyclical
				stocks may be seen to all suffer at the same time
				and hence a fund that owns many non-correlated
				stocks might still be volatile where it makes big
Source: Bloomberg, 2010; myStocks!, 2010; NSE, 2010				sector, style or market-cap bets.
				Herd mentality
*Large cap stocks and constituents of the NSE-20				Following a spate of good or bad news investor
index				irrationality leads to an overreaction either to the
** Small cap stocks				upside or downside respectively. This is accentuated
Figures in bold italic represent the performances of				by a herd-like mentality which influences stock
stocks that outperformed the NSE-20 index in the				valuations beyond their fundamental or intrinsic values
respective periods.				thereby creating an ideal buying or selling opportunity.
				Both value and momentum investors see this as a
In all three periods the following stocks outperformed				window of opportunity to trade and outperform the
the benchmark index- the NSE-20 index				benchmark index.
Athi River Mining Ltd.* (Building &
Construction)Bamburi Cement Ltd.* (Building &				However, for both value and momentum investors,
Construction)Car & General Ltd.				the question is that of timing. When is it time to buy
(Automobiles)Equity Bank Ltd.* (Banks)Kakuzi				oversold stocks or sell overrated stocks? For value
Ltd.(Agriculture)Kapchorua Tea Co. Ltd.**				investors, the question is what valuations represent
(Agriculture)Standard Chartered Bank Ltd.*				the best buying opportunity[11]. In the case of
(Banks)TPS (Serena) Ltd. (Leisure & Hotels)				momentum investors the pitfall of chasing 'hot'
				stocks is that these may have reached peak values
In all three periods the following stocks				making it difficult for performance-chasing investors
underperformed the benchmark index- the NSE-20				to gain much if at all. Poor timing can thus have
index.				unintended consequences.
CFC Stanbic Bank Ltd. (Banks)Crown Berger (K) Ltd.
(Industrials)E.A Cables Ltd.* (Industrials)Express				Behavioural risk
Kenya Ltd.** (Transport)Housing Finance Ltd.				Apart from the transaction costs of an actively
(Financials)KenGen Ltd.* (Utilities)Nation Media Group				managed portfolio, there is also behavioural risk which
Ltd.* (Media)Olympia Capital Holdings Ltd. (Financials)				may lead to badly timed decisions. Market
* Large cap companies				corrections, in particular, are unpredictable in timing,
** Small cap companies				duration and even magnitude and hence any attempt
				to benefit from such corrections requires precise
Table 2: Key Fundamentals for selected 'value' and				timing and a bit of luck. Returns of an actively
'momentum' stocks				managed portfolio must reflect this behavioural
STOCK				(timing) risk.
Period I
Period II				Momentum investors may enter into investments
Period III				that showed good returns but any subsequent
				volatility may lead to disastrous results. Thus active
Shareprice				portfolio management may prove high-risk due to the
NAV/share				tendency to time purchase or sale points wrongly.
PE ratio				Additionally, momentum investors' greater confidence
Shareprice				levels (based on their reliance on past performance)
NAV/share				may make them more susceptible to 'knowledge
PE ratio				miscalibration'- the mismatch between decision
Share				confidence and decision accuracy. (Morrin et al., 2002)
Price
NAV/ share				Selling only when there are big deviations in the
PE ratio				portfolio mix versus targets[12]or selling part of the
Athi River Mining Ltd.*				investment (rather than the entire stock(s) at once)
86.5				may mitigate the risk of poor timing. The secret lies
15				in avoiding the instinct of thinking there is this only
17				one critical event or opportunity since this may cause
91				one to make a bad decision. Alternatively a
18				buy-and-hold strategy may be sought to minimise this
18				behavioural or timing risk.
82.5
21				Lack of timely information and analyst attention
16				Large blue-chip companies receive a lot of investor
Bamburi Cement Ltd.*				and analyst scrutiny making it near impossible for
196				price anomalies to develop. This is especially so in
38				rapid information dissemination/assimilation
22				environments[13].
190
42				Conversely and especially in frontier markets like the
22				NSE, small-cap firms rarely produce timely reports[14]
120				of their accounts and receive few analyst forecasts
46				or recommendations. As a result the identification of
14				value here is only achieved at great cost involving
Car & General Ltd.				research and investigative work. This makes the
50				process of identifying value small caps to outperform
40				the benchmark index a difficult proposition.[15].
5
50				Volatility of small caps, however, may still offer great
40				opportunities for those willing to take the time to
5				carefully study both the technical and fundamental
33				aspects of stock and market movements. Technical
51				analysis, in particular, is important in determining
3				ranges or trends in volatile markets.
CFC Stanbic Bank Ltd.
131				Illiquidity
36				Illiquidity leads to large bid-ask spreads. Illiquidity in
27				emerging markets is particularly caused by few
120				trading days, shorter trading hours and relatively low
30				volumes traded and relatively few company
24				listings[16]. Furthermore, institutional investors who
61				dominate frontier emerging markets like the NSE
70				adopt buy-and-hold strategies of usually the large cap
12				stocks. (Adjasi & Biekpe, 2006; Prather-Kinsey,
Crown Berger (K) Ltd.				2006)
44.75
32				These factors combine to induce a forced
37				buy-and-hold investment behaviour on investors as
41.5				they are unable to attain their desired sell prices. Such
35				a buy-and-hold investment behaviour is typified by
13				holding a benchmark index like the NSE-20 index
24.75
35				Alpha and beta values
21				An active management strategy only makes sense if
E.A Cables Ltd.*				it can outperform a passive management strategy
41.25				after adjusting for risk. For an actively managed fund
				to outperform a passively managed fund e.g. an
21				index fund that tracks a benchmark index over time,
42				its alpha must be less than that of a passively
22				managed portfolio. This also means that the value
23				added (positive returns achieved or losses minimised)
22.75				by an actively managed portfolio must exceed that
7				added by a passively managed portfolio on a
12				risk-adjusted basis as well as a cost basis.
Equity Bank Ltd.*				(Timmerman and Granger, 2004)
121
24				Composite portfolio performance measures like the
113				Sharpe ratio and the Treynor ratio measure the level
131				of risk-adjusted portfolio returns relative to those of
41				a benchmark portfolio. Thus:
122
14				Sharpe ratio (S) = (Return portfolio – Return
53				risk free) / αportfolio
13
Express Kenya Ltd.**				Other factors held constant the selection of a
23				portfolio based on the benchmark index will reduce
11				the alpha denominator[17] (αportfolio) thereby
11				increasing the Sharpe ratio.
22.25				and
13
11				Treynor ratio (T) = (Returnportfolio - Returnriskfree)
9				/ βportfolio)
12
4				A portfolio built around the benchmark index (usually
Housing Finance Ltd.				large stocks that are more representative of the
30.25				market) will show low volatility of returns and hence
12				a low beta. Following on the equation above and
38				assuming other factors are held constant, a low
39.75				portfolio beta (βportfolio) will lead to a higher
13				Treynor ratio. To achieve a similar Treynor ratio as
50				the benchmark tracker fund, a riskier portfolio (for
16.1				example one that includes more high-risk small caps
16				as in a value strategy) must yield a higher return.
20
Kakuzi Ltd.				Transaction and other costs
33				Active portfolio management aims to earn a
52				risk-adjusted portfolio return that exceeds that on a
3				passively managed portfolio. The possibility of
28				achieving this only comes at the expense of
62				substantial transaction costs (including stamp duty),
2				management and commission fees[18], additional
26				risk-taking involving small cap stocks (and hence an
74				added risk premium) as well as the added costs of
2				studying both the technical and fundamental aspects
Kapchorua Tea Co. Ltd.**				of particular stock and market movements. This
90				reduces the likelihood of an active management
182				strategy outperforming a buy-and-hold strategy both
5				in the short and long term. (Damodaran, 2002)
90
183				Following Barber and Odean (2000), investors who
5				traded frequently earn a lesser annualised return than
65				inactive investors mostly due to broker fees.
179				Furthermore, regular reallocations under active
4				management (involving regular purchases of securities
KenGen Ltd.*				each of which incurs stamp duty) adds further to
27.75				overall costs. The converse is true of a passive
29				buy-and-hold strategy.
13
25				Tax benefits
29				From a tax position a buy-and-hold strategy has
11				better tax implications since unrealised capital gains
14				are not taxed and the tax point is usually a one-off
29				payment every so many years as the investor
6				liquidates his assets. An active strategy, due to its
Nation Media Group Ltd.*				higher rates of liquidation, has tax payable at every
290				profit-taking event.
49
32				Caveats
289				However, in arriving at the best investment strategy
52				consideration has to be made of the investment time
32				horizon of any group of investors. Someone investing
129				for the short-term (up to five years) should generally
30				stay away from equities (or other equity-linked
14				securities) as they run the risk of getting back less
Olympia Capital Holdings Ltd.				than they invest. For longer time horizons (five-year
17.95				periods and beyond), equities do provide higher
20				potential returns.
35
13.55				Fundamental analysis is a broad concept and is not
				confined to merely accessing value (discount stocks)
27				through book-to-market valuations or accessing
8.9				growth potential by merely deriving PE ratios. Other
17				factors that would need consideration include, but are
17				not restricted to:leverage ratioscash generation and
Standard Chartered Bank Ltd.*				stabilitydividend policy (increases in dividends or share
191				buybacks)other financial guidance indicatorsfirm costs
31				(financial)capexinterest ratesdepreciation and
17				amortisationcomparable salestax liability/ rategoing
201				concern issuesimpending debt maturity
33				cost-cutting measures (operational) contingency
18				planning effective management long-established
135				business market share (growth)good internal controls
35				environment adherence to corporate governance
12				guidelinesrelevance of business model in a
TPS (Serena) Ltd.				fast-changing environment (competition, globalisation,
74.5				etc)broader market (macro-economic)
39				indicatorsgeneral trend of benchmark indicesgeneral
35				trend of exportsconsumer confidence
58.5				numbersbusiness confidence numbersunemployment
35				figuresindustry/ sector analysis (trend- growth or
28				decline or volatility)company risk profilemarket
38.25				riskliquidity riskcredit risk exchange rate riskinterest
35				rate riskoperational risk (internal to the
18				business)compliance risktax issuesenvironmental
				issuesoperational issues (e.g. health & safety
Source: myStocks!, 2010; NSE, 2010				regulations, food & health standards)company
* Large cap stocks				law (director eligibility, financial statement disclosures,
** Small cap stocks				listing rules)
Athi River Mining Ltd.: Stocks that outperformed the
NSE-20 in all three annualised periods				Limitations
CFC Stanbic Bank Ltd.: Stocks that underperformed				The study considered investment periods of upto a
the NSE-20 in all three annualised periods				year ignoring returns that could be earned over
				longer term horizons. In view of research evidence
				(Basu, 1977) that risk-adjusted returns on
				undervalued small caps outperform those of their
				larger counterparts in the long-term, a different set
				of results would have been seen had longer
Table 3: Performance of selected 'value' stocks*				investment periods been considered.
STOCK
Period I				In conducting a fundamental analysis of the quoted
(BV/MV)				companies, only two factors were considered- the
Performance				book-to-market values and PE ratios. This narrow
				purview ignored other equally relevant variables like
Period II				dividend yield which is key in measuring the return
(BV/MV)				over time and in determining the direction of investor
Performance				allocations. Wider market (macro-economic) factors
Period III				especially the impact of the 2008 financial crisis were
(BM/MV)				also ignored. This latter may well have been a
Performance				destabilising factor that influenced returns in a
Car & General Ltd.				particular direction.

				'Out-of-sample' testing may have also reduced the
				robustness of the study in that different results
				would have become apparent had a different era
				been considered. In particular, the severe market
1.5				volatility following the 2008 financial crisis represented
				abnormal circumstances which may not hold true in
48%				the typical investment environment.
CFC Stanbic Bank
				Critically, the lack of more up-to-date reporting in
				interim and/or quarterly reports may partly explain
				the divergence between book values (NPV per
				share) and market values (market price per share)
				seen.
1.1
				Conclusions
16%				Despite the apparent limitations of this research on
Crown Berger (K) Ltd.				the case for a buy-and-hold strategy on the NSE, the
				report uncovered the difficulties of adopting an
				active management strategy to achieve superior
				returns on a typical illiquid frontier market. Although
				price anomalies exist in these markets, the cost of
				taking advantage of these anomalies outways the
1.4				derived benefit.

21%				Investing in a benchmark index (tracker fund) of
Equity Bank Ltd.				mostly large-cap stocks of long-established
				businesses with strong sales and cash positions brings
				with it steady but not significantly high returns.
				Investing in a portfolio of individually selected stocks
				– some of which carry significant risk requires
				great skill and cost to pick out winners that will bring
3.8				about an above-average return[19]. This is especially
				so in the equity space where risk levels are higher
66%				than with other asset classes like fixed income
Express Kenya Ltd.				securities and cash.

				However, it's not all bad news for those wishing to
				pursue a more involving active management strategy
				as great buying opportunities and significant returns
				can be achieved for those ready to apply
1.3				considerable technical and fundamental analysis as well
				as having a portion of luck. Research has established
-4%				that under-valued small cap stocks outperform the
Housing Finance				wider market in the long-term even when adjusted
				for risk. It may well be the management of agency
				costs that tips the scale in favour of an active
				management strategy.

				In the final analysis, however, this study has shown
1				that for an active management strategy to
				outperform the benchmark index- the NSE-20 it
29%				would have to select a diversified portfolio across
Kakuzi Ltd.				size, sector and involve a multi-faceted investment
				style. This would however come at considerable cost
1.6				in time, investigative work and risk analysis[20] for
				the fund manager. For the retail investor, the
-15%				transaction (agency) costs of an active management
				strategy add to the unattractiveness of such a
2.2				strategy. Both sets of investors would benefit
				greatly by simply adopting a buy-and-hold strategy
-21%				based on a benchmark index like the NSE-20 index.

2.8

194%
Kapchorua Tea Co. Ltd.

2.0

-17%

2.0

-24%

2.8

112%
KenGen

1.1				[1] The BM/MV ratio helps establish whether a
				particular stock is under- or overvalued.
-37%				[2] The argument here is that well-performing stocks
				will continue to perform well into the future since
1.2				they represent firms with positive long-term
				forecasts of sales, strong resultant cash flows and
-44%				non-financial information. Thus analysts continue to
				recommend such firms exhibiting strong recent
2.1				performance. In addition, in inefficient frontier
				markets like the NSE short-run positive serial
21%				correlations tend to induce the spiral of price
Olympia Capital Holdings Lt.				movements in a particular direction. (Morrin et al.,
				2002)
1.1				[3] The PE ratio for Housing Finance Ltd. was as high
				as 50 in period II
-39%				[4] Kakuzi Ltd. - a large cap stock and Kapchorua
				Tea Ltd. - a small cap both outperformed the NSE-20
				index in all three periods. From Table 1 stocks that
				outperformed the NSE-20 index in all three periods
1.9				were diversified across sector.
				[5] While Equity Bank Ltd. and Standard Chartered
-4%				Bank Ltd. outperformed the NSE-20 index in all three
INDEX				periods, CFC Stanbic Bank Ltd., Housing Finance Ltd.
				and Olympia Capital Holdings Ltd. underperformed the
				same index in all three periods.
				[6] Despite improving year-on-year top-line and
				bottom-line figures during the three periods and
				having significant market shares, KenGen and Nation
				Media Group Ltd. underperformed the NSE-20 index in
NSE All-share index				all three periods.
				[7] Such moments are akin to a market peak or
-22%				market trough
				[8] In an over-rated market correct timing can prove
-23%				very rewarding if after investing in 'multiples' stocks
				the investor pulls out of the market before the
40%				prices head south
NSE-20 index				[9] It is quite apparent from looking at the NSE-20
				index that this is a wide-encompassing index involving
-27%				a cross-section of stocks across different sectors.
				[10] In the three periods studied while Banks and
-32%				Industrials showed mixed and poor returns
				respectively, returns by Building & Construction
44%				were pretty impressive (see Table 1).
				[11] Buying stocks before the market has bottomed
Source: Bloomberg, 2010; myStocks!, 2010; The				may reduce potential gains.
Financial Times Ltd., 2010				[12] Long-term strategic asset allocations or matching
* Only book-to-market values equal to or above 1				asset allocations to a pre-determined investment time
are shown.				horizon.
Figures in bold represent the performances of value				[13] These are also environments of high share
stocks that outperformed the NSE-20 in the				volume transactions and high analyst activity and
respective periods.				participating firms are high share-turnover firms.
				[14] Annual reports may be hard to come by and
Although CFC Stanbic Bank Ltd., Crown Berger (K)				accounting treatments and disclosures may not
Ltd., Express Kenya Ltd., Housing Finance Ltd.,				conform to international standards.
KenGen and Olympia Capital Holdings Ltd. showed				[15] While Kapchorua Tea Co. Ltd. outperformed the
positive BV/MV ratios in at least one period they all				NSE-20 index during all three periods, Express Kenya
underperformed the NSE-20 index in all three periods.				Ltd. and Williamson Tea Kenya Ltd. underperformed
A value strategy in these periods would have been				the index in at least two of the three periods. All
unable to outperform the benchmark index. Only				these stocks are small cap stocks.
Kakuzi Ltd. and Kapchorua Tea Company Ltd.				[16] For example, on 30th July 2010 the volumes of
showed positive BV/MV for the three periods and				listed shares on the NYSE and LSE stood at
were able to outperform the NSE-20 in all of them.				4,046,227,000 and 1,137,071,711 respectively while
Both these firms are in the Agriculture sector.				those on the Nairobi Stock Exchange stood at a
				mere 23,076,900. While there are 3000 listings on the
Rea Vipingo Ltd. and Sasini Tea & Coffee Ltd.				LSE, only 55 companies are listed on the Nairobi
(both large caps) are also in the Agriculture sector				Stock Exchange.
but both underperformed the NSE-20 index in at least				[17] Alpha is the difference between a portfolio's
two of the three periods. Both firms trade in tea as				expected risk-adjusted returns and its actual returns.
Kakuzi Ltd. and Kapchorua Tea. This supports the				It is the value that a portfolio manager adds, above
posit that a successful trading strategy would have				and beyond a relevant index's risk/reward profile. A
had to select stocks across size as well as				portfolio that tracks the benchmark index like the
discriminate between strong and weak companies				NSE-20 comprises stocks that are most
within sector.				representative of the market since they are the
				largest companies by market capitalisation. Hence
Table 4: Performance of selected 'momentum'				their beta values (volatility) are close to 1. Due to
stocks*				their low volatility there is little divergence between
STOCK				their risk-adjusted returns and expected returns
Period I				leading to a low alpha.
(PE ratio)				[18] Management fees increase with regard to an
Performance				actively managed portfolio as opposed to a passively
Period II				managed one.
(PE ratio)				[19] Where the NSE All-share index was used as the
Performance				benchmark index rather than the NSE-20 index, none
Period III				of the small caps was able to outperform the NSE
(PE ratio)				All-share index in all three periods. Kapchorua Tea in
Performance				particular dropped out of the list of stocks that
Crown Berger Kenya Ltd.				outperformed the benchmark index in all three
				periods. This suggests that small cap stocks on
37				average underperformed the large and mid-caps in
				the three periods further supporting the premise that
-38%				small caps carry considerable risk and their returns fall
				below average when adjusted for risk.
				[20] Small caps in particular carry considerable risk. In
				addition to poor reporting most of these operate in
				the Agriculture sector which is dogged by volatility in
Equity Bank Ltd.				weather, world demand and prices for tea, coffee
				and other cash crops as well as a volatile
113				exchange-rate regime all contributing to a risky
				environment for stock evaluation.
54%

VentureInc.

The Nairobi Stock Exchange (NSE)- the case for a buy-and-hold strategy for equity investors