By Rufus Mwanyasi
In Summary
- Investors should add shares offering less volatility to their portfolios
As we get closer to the era of low lending rates and
the subsequent tick-up in loans and advances, large banks are likely to
be good bets for this market environment.
Investors with long term vision may be interested in reasonably large bank stocks while the economy is on sound footing. Rising interest rates will also help banks to boost their profits through its effect on net interest margins.
That notwithstanding, investing in bank stocks does
carry some specific risks. No matter how optimistic investors become
about these stocks, price risks in particular must be considered.
Several factors may drive prices down and could even hurt profitability by generating mostly unpredicted losses.
In this article, I intend to support investors at
their decision-making process who think of flowing some cash into large
bank stocks.
To do this, I will use a simple form of
value-at-risk analysis and try to figure out how risky each bank stock
is. Value-at-Risk, widely known as VaR, is one of the most widespread
tools for measuring and managing financial risk.
It is expressed in just one number which calculates
the maximum loss expected (or worst case scenario) on an investment,
over a given period and given a specified degree of confidence.
For instance, if a stock has one-day five per cent
VaR of Sh1 million, there is 0.05 probability that the stock will fall
in value by more than Sh1 million over a day period if there is no
trading.
It also means that you will not lose much more than
Sh50,000 over the given time horizon. The larger the VaR of an
individual stock, the higher the risk, and vice versa.
I believe that readers have already seen where this is going.
I made this analysis for the four largest bank stocks, namely KCB, StanChart, Barclays and Equity, to show which one is the least risky to invest in. I used monthly returns of the stocks over the last three years.
The results suggest that Equity and StanChart are
the less risky bets with a 95 per cent confidence interval while
volatility of KCB and Barclays stocks is relatively higher.
In other words, Equity and StanChart should be the top picks for risk sensitive investors.
In as much as all the stocks mentioned above have
their own specific headwinds and tailwinds, one thing is certain; all of
them will take advantage of the low interest rate and economic
recovery.
At this stage, investors should add the stocks
offering less volatility to their portfolios. This simple method could
be a helpful tool for those looking forward to see a pick-up in large
bank stocks.
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