Value-at-risk study of 4 large Kenyan bank stock returns

The Central Bank of Kenya building in Nairobi. The bank is seeking to compel the blacklisted bond trader to refund Sh31.2 million in stolen bond proceeds. FILE 

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.