MODERATING EFFECT OF FUND SIZE ON THE RELATIONSHIP BETWEEN PORTFOLIO DIVERSIFICATION AND EFFICIENCY OF MONEY MARKET FUNDS IN KENYA

Abstract

Recent increases in market volatility, economic uncertainty and geopolitical tensions, have magnified investment risks. Therefore, fund managers need to adopt successful investments strategies and efficient operations
so as to manage risks and protect investors’ interest. Portfolio diversification as an investment strategy would
facilitate the creation of an optimal portfolio resulting in fund efficiency. However, fund size influences resources availability, managerial compensation and operation costs which would affect a fund’s ability to create
well diversified portfolios and eventually a fund efficiency. Thus, the main objective of this study was to investigate the moderating effect of fund size on the relationship between portfolio diversification and fund efficiency. The study was anchored on modern portfolio theory, capital asset pricing theory, and economies of
scale principle. Secondary data was collected from 25 money market funds (MMFs) over the period 2018 to
2024 yielding 122 fund year observations. Descriptive statistics were used to summarize fund characteristics.
Inferential statistics and panel data regressions were utilized for testing of statistical hypotheses. A two-stage
analysis was adopted whereby in the first stage, efficiency scores were computed using Data Envelopment
Analysis and in the second stage, Generalized Method of Moment was used to determine the dynamic relationship among study variables. The findings revealed that, over the study period, MMFs were not 100% efficient.
Further, portfolio diversification had a significant positive effect on fund efficiency (β=0.520, p-value<0.05).
Fund size had a statistically significant moderating effect on the relationship between portfolio diversification
and efficiency (β=0.522, p-value<0.05). The results implied that small funds are better placed in creating well
diversified portfolios and achieving efficiency. The study recommends that fund managers should create welldiversified portfolios so as to maximize fund efficiency. Funds should operate at size whereby it is easy to
manage and allocate resources and to keep operations at a low cost in order to achieve efficiency.