Chapter 36 · Portfolio Management
Correlation, rebalancing and NEPSE's concentration problem
Why counting holdings is not diversification, and what to do about an exchange dominated by one sector.
Correlation, not count
Diversification is about correlation, not count. Ten holdings that rise and fall together are one position held ten times, and the portfolio behaves accordingly when that one thing goes wrong.
Worked: two portfolios that look identical
| Portfolio A | Portfolio B | |
|---|---|---|
| Holdings | 8 | 8 |
| Sectors | 1 — commercial banks | 5 — banks, hydro, insurance, manufacturing, a listed fund |
| Largest position | 12.5% | 12.5% |
| Effective bets | About 1 | About 5 |
| If banking falls 25% | Portfolio falls 25% | Portfolio falls about 5% |
Both portfolios pass a naive check — eight holdings, none above 13%. Only one of them is diversified.
The problem specific to NEPSE
Banking and finance dominate the exchange by market capitalisation. A portfolio assembled from the largest, most liquid NEPSE shares will be concentrated in one sector by default, without any decision to concentrate having been made.
- Sub-index correlation within Nepali financials is high — they respond to the same interest-rate and liquidity conditions.
- Hydropower behaves differently, and is driven by monsoon, PPA terms and project completion rather than by rates.
- Check the share of your portfolio by sector, not by company. That number is the one that matters, and it is usually worse than people expect.
Rebalancing: two rules, pick one
| Rule | How it works | Trade-off |
|---|---|---|
| Calendar | Rebalance on fixed dates — say, twice a year | Simple; may trade when nothing has drifted |
| Threshold | Rebalance when a holding drifts past a set band, e.g. ±5 points | Trades only when needed; requires monitoring |
Worked: a target of 20% drifts to 27% after a strong run. On a Rs 10,00,000 portfolio that is Rs 2,70,000 against a Rs 2,00,000 target — Rs 70,000 to trim to restore the weight.
Position limits worth setting in advance
- 1A maximum for any single company.
- 2A maximum for any single sector — the one that actually binds on NEPSE.
- 3A minimum position size, below which a holding is not worth the charges or the attention.
- 4A cash level you are willing to hold when nothing meets your criteria.
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