EXAMINES THE RELATIONSHIP BETWEEN PORTFOLIO DIVERSIFICATION AND INVESTMENT RETURN IN NIGERIA
ABSTRACT
This study examines the relationship between portfolio diversification and investment return in Nigeria. It investigates the relationship between the Nigerian stock market and 5 developed stock markets (US, UK, Japan, Germany and France) in the context of the global financial crisis. The Vector Autoregressive (VAR) Granger causality test results show that the Nigerian stock market and all the developed stock markets are not linked in all the sub-sample periods except the Japanese stock market in the post-crisis period, thus implying that international portfolio diversification is possible in the Nigerian stock markets except Japanese investors in the post-crisis period. Under the full sample period, only the Japanese and German stock markets are not linked to the Nigerian stock market and this indicates international portfolio diversification is feasible for only Japanese and German investors in Nigeria. The Generalized Method of Moments (GMM) regression results indicate that only German and French stock markets have significant impact on the Nigerian stock market in the pre-crisis period, but none of the developed stock markets exert significant impact in the crisis period. In the post-crisis period, only the German stock market is significantly related to the Nigerian stock market. The regression estimates reveal that only the Japanese, German and French stock markets are significantly related to the Nigerian stock market over the full sample period.
TABLE OF CONTENTS
TITLE PAGE - - - - - - - ii
DECLARATION - - - - - - - iii
CERTIFICATION - - - - - - - iv
DEDICATION - - - - - - - v
ACKNOWLEDGEMENTS - - - - - - vi
CHAPTER ONE: INTRODUCTION
1.1 Background to the Study - - - - - 1
1.2 Statement of Problem - - - - - - 4
1.3 Objective of the Study - - - - - 4
1.4 Research Questions- - - - - - - 5
1.5 Statement of the Hypothesis - - - - 5
1.6 Significance of Study - - - - - - 6
1.7 Scope of the Study - - - - - - 6
1.8 Definition of Key Terms - - - - - 7
CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction - - - - - - 8
2.2 Conceptual Framework - - - - - - 8
2.3 Theoretical Framework - - - - - - 30
2.4 Empirical Review - - - - - - - 38
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Research Design - - - - - 45
3.2 Population of the Study - - - - - - 45
3.3 Sample Size - - - - - - - 45
3.4 Sampling Technique - - - - - - 46
3.5 Method of Data Collection - - - - - 46
3.6 Technique for Data Analysis - - - - - 46
3.7 Model Specification and Variable Definition - - - 46
3.8 Measurement of Variables - - - - - 48
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1 Description of the Sample - - - - - 35
4.2 Testing of Research Hypothesis - - - - 38
4.3 List of Research Findings - - - - - 40
CHAPTER FIVE: DISCUSSION, CONCLUSION AND RECOMMENDATIONS
5.1 Discussion - - - - - - - 41
5.2 Conclusion - - - - - - 42
5.3 Recommendation - - - - - - 42
5.4 Limitations and Suggestions for Further Studies - - 43
References - - - - - - - 44-47
CHAPTER ONE
INTRODUCTION
Background of the Study
One of the main features of the evolving global financial system is stock market linkages which have been facilitated by the liberalisation of stock markets in most countries of the world over the years. Stock market liberalisation created opportunity for investors to hold financial assets in domestic and foreign stock markets. This provides investors with the opportunity to exploit international portfolio diversification. International portfolio diversification is an investment strategy which allows an investor to reduce portfolio risk by holding domestic and foreign financial assets simultaneously.
Grubel (2021) identifies international portfolio diversification as a source of welfare gains from international economic relations. Most investors prefer international portfolio diversification to domestic portfolio diversification because investment returns in the domestic stock market are influenced by natural and artificial factors, business cycles and government policies whose effects are limited to the domestic stock market (Grubel & Fadnar, 2019). However, the benefits of international portfolio diversification is limited when stock markets are linked or share a common trend.
International investors prefer to hold a global portfolio containing assets of both developed and emerging stock markets. Harvey (2024) argues that emerging stock markets are weakly correlated with developed stock markets. Therefore, investing in assets traded in emerging and developed stocks markets simultaneously is a portfolio risk-reduction strategy. Studies such as Agyei-Ampomah (2011), Alagidede, Panagiotidis, and Zhang (2011), Kapingura, Mishi, and Khumalo (2014), and Mensah and Alagidede (2017) document that African stock markets are attractive investment grounds for international investors. The weak correlation between African and developed stock markets suggests that international investors would maximise international portfolio diversification benefits by including African stocks in a mean-variance portfolio (Alagidede, Panagiotidis, & Zhang, 2011). The world has become a global market as a result of increased financial integration among countries. This has allowed financial turmoil in one country to cause crisis in the financial market of another country.
Diversification refers to the practice of spreading investments across multiple asset classes to reduce the overall risk of a portfolio (Jain & Jain, 2021; Hestbaek & Joensen, 2020). The ultimate goal of diversification is to strike an optimal balance between risks and returns by investing in a variety of assets that are not highly correlated with each other (Estrada, 2020). Diversification
can help investors achieve their long-term investment goals by reducing the impact of market volatility on their returns (Estrada, 2020).
Portfolio diversification can involve investing in stocks, bonds, real estate, commodities, and other asset classes, as well as using other investment vehicles like mutual funds and exchange-traded funds (ETFs) (DiLallo, 2021). One of t
he key benefits of portfolio diversification is that it can help investors achieve higher returns with lower risk than investing in individual assets (Hestbaek & Joensen, 2020).
Portfolio diversification allows investors to absorb shocks during market down turns, leverage growth opportunities in different sectors, and provide stability during volatile times by balancing risks (Aristei & Lugo, 2020). The goal
of portfolio diversification is to achieve higher returns with lower risk than investing in individual assets (Jain & Jain, 2021). Market Portfolio Theory (MPT) suggests that investors can reduce portfolio risk by holding a diversified portfolio of assets that are not highly correlated with each other (Amenc, 2020). Additionally, diversification can also help investors to achieve their long-term investment goals by reducing the impact of market volatility on their returns (Jain & Jain, 2021). Diversification, according to Cernas (2011), is a portfolio management strategy involving the aggregation of diverse assets to reduce the overall portfolio risk. Daud et al. (2009) argued that firms with diversified portfolios have comparatively better financial performance.
Alagidede (2008) argues that African stock markets are segmented from developed stock markets and are likely to respond more to domestic rather than global information. However, the global financial crisis which metamorphosed from the US subprime mortgage crisis crippled the performance of stock markets across the world and was alluded as the reason for the 2008 stock market crash in Nigeria. Allen, Otchere, and Senbet (2011) identify the Nigerian stock market as one of the worst performing markets in sub-Saharan Africa in 2008.
Nigeria in the last few years had clamored for foreign portfolio investment in the country. This is believed to be a facilitator of economic growth and development, which leads to industrialization of the economy in the long run (Adeleke et al, 2004). Foreign portfolio investment means the purchase of shares in a foreign country where the investing party does not seek control over the investment. A portfolio investment typically takes the form of the purchase of equity (preference share) or government debt in a foreign stock market, or loans made to a foreign company. Obviously the purchase of bonds issued by a company, which gives no voting rights, or of government debt, and making loans to foreign company do not give control (Bosodersten et al, 1996).
Portfolio investment is a recent phenomenon in Nigeria. Up to the mid 1980’s, Nigeria did not record any figure on portfolio investment (inflow or outflow) in her balance of payment account. The nil return on the inflow column of the account is attributable to the absence of foreign portfolio investors in the Nigerian economy. This is largely because of the non-internalization of the country’s money and capital markets as well as the non-disclosure of information on the portfolio investments in foreign capital/money markets (Obadan, 2004). Following a careful review of the consequences of the Exchange Control Act of 1962 on the economy, after some thirty three years of its operation, Nigerian authorities came to the conclusion that the Act had not brought the economy any substantial benefits.
The Act was judged inimical to a market driven economy, new policy government had pursued since 1986, with the deregulation of the economy. While equity investment trickled into Nigeria as a result of the Exchange Control Act of 1962, Portfolio Investments dried up, because portfolio investments required an investment climate, which guarantees speedy “free entry” and “free exit” of investment funds into and out of a country in a flash. The investment climate in Nigeria engineered by the Exchange Control Act of 1962 did not guarantee the speedy mobility of funds across international borders. It took the authorities more than three decades to realize that protection of the economy in a world striving to dismantle economic frontiers had not paid off, and that the capital market being a major player in the mobilization of funds for investment has to be liberalized and modernized to enable it capture enough resources for the economy from within and from outside. The Exchange Control Act of 1962 was identified as a major constraint on the growth of the Nigerian capital market. Accordingly the Act was blown away with gale force in 2024, by the strong wind of deregulation, which swept across the Nigerian Macro-economic policy arena, from the beginning of the last quarter of 1986 (Onoh, 2002).
The deregulation of securities pricing by SEC in 1993; the abolition in 2024 of both the Exchange Control Act of 1962 and the Nigerian Enterprises Promotion Decree (NEPD) of 1989, demanded the reorganization of the Nigerian Stock Exchange to make it more dynamic and mobile in the provision of adequate liquidity of investment bring up the operation of the exchange to international standard and attract foreign portfolio investors. Accordingly, Federal Government of Nigeria in March 1996 set up a panel on the Nigerian Stock Exchange and , the panel’s term of reference include the reorganization of the Nigeria Stock Exchange to make it more dynamic, to recommend ways for modernizing the exchange to bring it up to international standard and to make other recommendations, which in the view of the panel, would strengthen the operation of the exchange, and position it to deal with the domestic and international capital market challenges to the coming millennium (Onoh, 2002).
Nigeria’s stock market index is the Nigerian stock exchange’s All-share Index (NSE-ASI, or simply ASI), and currently provides a composite picture of the financial health of 233 listed equities. Starting with an index value of 100 in 1984, with increased listings and financial activity, the index value saw changes from 12,137; 20,129; 23,845; 24,086; to 33,358 at the end of the years 2002-2006 respectively; with respective end of-year market capitalizations of N0.748 trillion, N1.32 trillion, N1.93 trillion, N2.90 trillion and N5.12 trillion. The ASI attained a value of 57,990 (and N10.180 trillion capitalization) at the end of year 2007, started the year 2008 at 58,580 (with a market capitalization of N10.284 trillion), and then went on to achieve its highest value ever of 66,371 on March 5, 2008 with a market capitalization of about N12.640 trillion.
However, ever since that high, the ASI has severally declined, exhibiting a secular bear posture since July 17, 2008 when, at ASI of 52,910, the Index fell below 20% of its all time high. It fell further, crossing below the 50,000 mark on August 8, 2008 and closing on October 22 at 42,207 (a 36.4% loss from the high within just seven months, and a year to date decline of 27.9%) (Mobolaji, 2008). Meanwhile CBN annual report on Foreign portfolio investment from 2000-2006 are 51,0791.1; 26,317.1; 24, 789.2; 23,555.5; 23,541.0; 375, 858.9; 117,218.9 respectively, imply fluctuation on Foreign portfolio investment in Nigeria (CBN Annual Report, 2006). The figures and dates above suggest an overlap of distress periods. Bearing in mind that there is virtually no cross-ownership of banks (investment or otherwise) between Nigeria and foreign countries, and there is hardly any vibrant domestic mortgage market for there to be sub-prime problems as found particularly in the UK and the USA. It is difficult to pronounce any direct impact. Nevertheless a factor on which this situation may have direct or indirect effect is:
Foreign portfolio investment withdrawals and withholding in order to service financial problems at home, as well as prospects of reduced foreign direct investment (FDI), are bound to affect investors’ confidence and the economic health of Nigeria. (Mobolaji, 2008). ·
There has also been competition among emerging markets to attract foreign portfolio investments, which has led to a situation in which in order to sustain inflows of portfolio investments, it has become increasingly important for developing countries to ensure attractive returns for portfolio investors. Often this means offering increasing operational flexibility (Parthapratim, 2006).
The global financial crisis had more adverse impact on the stock markets of South Africa, Egypt and Nigeria than other African stock markets (Senbet & Otchere, 2010). The liberalisation of the Nigerian stock market was facilitated by the introduction of the Nigerian Investment Promotion Commission Decree No. 16 of 2024 and Foreign Exchange (Monitoring and Miscellaneous Provisions) Decree No. 17 of 2024. The official liberalisation period of the Nigerian stock market was August 2024.1 The liberalisation facilitated the inflow of foreign portfolio investment in Nigerian stock market. Foreign portfolio equity inflow in Nigeria had a negative growth rate of -165.91% and -151.09% in 2008 and 2009 respectively (World Bank, 2016). This indicates that the global financial crisis made the Nigerian stock market become less attractive to international investors.
One of the greatest problems facing Nigerian economy today is inflation which is persistently a complex, economic and social problem of the economy. Inflation has become a leading topic of discussion in Nigerian families and other countries of the world. Government’s inability to provide a lasting solution to this aroused a universal conviction that inflation is inevitable and created pessimism that government has no power to bring rising price (inflation) trend to an end. Inflation is not only a serious problem but also has a disquieting effect on the economic life, political system and the society as a whole. A situation where the value of money continues to depreciate in terms of value, there is the tendency for rising prices for available goods and services generally and such situation is being referred to as inflation. Inflation can be defined as continuous rise in prices of goods and services. Inflation simply means too-much money chasing few goods. Inflation in the country has become a threat to the Nigerian economy particularly to investment and development.
Portfolio diversity, which includes stock, bond, and real estate investments, has been shown to improve financial outcomes for major organisations, but studies have shown conflicting effects. There is also a considerable gap in our understanding of the impact of portfolio diversity on the financial performance of large organisations in Kisumu County, Kenya, as most prior research has concentrated on large firms listed on stock exchanges. Addressing this gap, this study aimed to offer light on potential solutions for improving the financial outcomes of major firms in Nigeria by examining the connection between portfolio diversity and financial performance. Thus, the researchers in this study set out to determine if and how diversified portfolios affected the monetary outcomes of large companies in Nigeria.
1.2 STATEMENT OF THE PROBLEM
Since the attainment of independence of 1960, economic policies have been concerned basically with investment measures aimed at achieving portfolio diversification stability. There is almost a universal consensus that macroeconomic stability, indeed, the monetary policy framework adopted by Nigeria since 1993 has an overriding objective and that is the achievement of single digit diversification. Monetary and fiscal policies as well as wage freeze, price control, exchange rate and other measures have been employed from time to time to stem the tide of sustained increase in the general price level. In retrospect, it appears that in spite of these efforts; the achievement of portfolio diversification and investment return.
Inflation undermines the role of money as a store of value. It frustrates investments and growth. It also, hurts people who are retired and living on a fixed income.it is very difficult to determine how much to produce because business cannot predict the demand for their product at the higher prices they will have to charge in order to break-even. Empirical studies on diversification, investment and development confirm the long-term inverse relationship between diversification and investment. The negative relationship between diversification and investment has been attributed to the strong negative association between investment, capital accumulation and productivity diversification. Consequently, high inflation is said to be harmful to both investment and hence, real output.
Though most countries aim at keeping investment low, it has been volatile in Nigeria in-spite of the consistent effort of the central bank of Nigeria through its monetary policy that is geared towards achieving a single-digit inflation rate. For instance, within the last thirty years (1970 - 2000), investment rate has fluctuated widely. It assumed single-digit only in seven years and double in twenty-three years reaching a peak of 72.8% in 1994 from 57.2% in 1993.
1.3 OBJECTIVE OF THE STUDY
The specific objectives of this study are to:
1). Analyze the trend of investment and economic diversification in the country over the years.
2). Investigate the relationship between diversification and investment in Nigeria.
3) Examine the effect of investment on economic diversification in Nigeria.
1.4 RESEARCH QUESTIONS
This study would be guided by the following research questions:
1). What is the trend of investment in Nigeria?
2). How does investment impact on economic diversification in Nigeria?
3). What is the effect of investment on diversification in Nigeria?
1.5 RESEARCH HYPOTHESIS
The hypotheses to be tested in the course of this study are stated below:
Ho: Investment does not affect diversification in Nigeria.
H1: Investment affect diversification in Nigeria.
Hypothesis II
Ho: Diversification does not affect investment in Nigeria.
H1: Diversification affect investment in Nigeria.
Hypothesis III
Ho: There is no significant relationship between investment and diversification in Nigeria.
H1: There is no significant relationship between bond investment and the diversification Nigeria.
1.6 JUSTIFICATION OF THE STUDY
The justification of the study is that it intends to answer certain questions such as, what are the causes of low investment in Nigeria, and how can it be related to economic diversification. This answer will form the basis upon which suggestions will be made as to how investment can be increase to the highest level.
1.7 SCOPE OF THE STUDY
This study shall examines the relationship between portfolio diversification and investment return in Nigeria, covering the period between 1980 and 2023. Therefore, this study examines not only the effect of relationship between portfolio diversification and investment, it will also investigate its effect on other macroeconomic variables.
1.8 ORGANIZATION OF THE STUDY
This study shall be divided in five chapters.
I. Chapter one
Providing a background of the subject matter justifying the need for the study.
II. Chapter two
Present related literature concerning inflation, its causes and effects.
III. Chapter three
The research methodology
IV. Chapter four
Data presentation and analyses
V. Chapter five
Findings and recommendations based on the findings
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