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Tuesday, April 18, 2017

Questions on Nigerian Stock Exchange profitability

      Looking at the huge losses incurred by investors in Nigerian stock exchange (NSE) after the 2009 financial crisis, many professional investors were asking the important question of whether it was possible to make money by investing in the market. Since 2009 to date, the performance of the market has been moving up and down making the market one of the most volatile in the world. Beta as measure of investment volatility in the market has been high over the period, while profits paid (in form of dividend and capital appreciation) has not been high enough to compensate for the high risk. Considering the current unpredictability of Nigerian foreign exchange management system operated by CBN, how safe is it for a foreign investor to include Nigeria in his portfolio? Added to this is the fact that Buhari's government is yet to have a complete blueprint on ways to manage Nigerian economy in the face of dwindling revenue. According to conventional finance models, such as Capital Assets Pricing Model (CAPM) developed by Sharpe and others, and Arbitrage pricing theory (APT) developed by Stephen Ross, return to any investment is payment for non diversifiable risk. And, an investment is good only when it is able to earn an investor reasonable return with minimum risk. Taken the above into consideration, investment in the Nigerian stock exchange will look unattractive to investors. Of course, this is actually what has been happening over the years as the level of investments in the market keep falling.Though, the market has recovered some of its mojo, but it is yet to return to it pre-crisis level.

    Like other African stock exchanges, with the exception of South Africa's, Nigerian stock exchange is segmented from other major stock exchanges in the world. This has important implication, it means that Nigerian stock exchange is  good for inclusion in international investment portfolios created by various fund management companies and other global investors - since lack of integration means the market does not move together with the rest of the world markets. Hence, Nigerian stock exchange will be perfect for portfolio investment. But, on the other hand, lack of integration means absence of efficiency and underdevelopment of the market. Here the simple lack of efficiency will among other things means poor service provision, high cost of transactions and bureaucracy. Thus, foreign investors who decided to include the market (i.e. NSE) in their portfolio must be cautious and calculative. While segmentation of the market will provide opportunity for realizing non diversifiable risk as assumed by finance theory to be provided by any good portfolio. It is also argued,  under CAPM and APT models, that higher beta (due to volatility of the market) and high cost of transaction (due to lack of efficiency) will mean risk is high in the Nigerian stock exchange. In summary, looking at things from the portfolio diversification point of view, Nigeria stock exchange is good for investors looking to gain from investing in African stock markets. While from the perspective of efficiency and predictability of returns, Nigerian stock exchange look unattractive.