Equity Portfolio Construction for NEPSE

First published 23 Aug 2026 · Last verified 29 Aug 2026

Every hydropower project in Nepal starts the same way: dam a river, spread the flow across many turbines, and if one turbine jams for maintenance, the others keep the lights on in Kathmandu. That is the entire logic of diversification in one sentence. But now picture a hydropower plant where all the turbines share one intake gate. If silt clogs that gate, every turbine stops at once — no matter how many turbines you built. This is the trap that catches many new NEPSE investors. They buy fifteen different stocks, feel diversified, and then watch all fifteen fall on the same day, because all fifteen shared one intake gate: exposure to Nepal Rastra Bank's interest rate policy, or to Kathmandu's tourist season, or to the same monsoon that fills every hydropower reservoir at once. Chapter 59 taught you how much of your total wealth should sit in NEPSE equities versus government securities, fixed deposits, mutual funds, gold, and real estate. This chapter assumes that decision is already made. You have decided, say, that NPR 15 lakh of your household savings will live in NEPSE-listed shares. The question now is: which shares, how many, and in what proportions — so that this NPR 15 lakh behaves like a hydropower cascade with independent intake gates, not one dam with a single point of failure.

Lesson 60.1 — Why Diversification Means More in NEPSE Than "Buy Different Stocks"

Start with the word itself. Diversification means spreading your money across investments whose fortunes do not all rise and fall for the same reason. A Nepali household's daily food basket is a useful picture. A family that eats only rice depends entirely on the rice harvest — a bad monsoon and the household goes hungry. A family that eats rice, lentils, vegetables, and some meat is protected, because a poor lentil harvest does not usually coincide with a poor vegetable harvest. The protection comes not from eating four different things, but from eating four things that fail for different reasons at different times.

Now translate this to shares. If you buy shares in Nabil Bank, Global IME Bank, NIC Asia Bank, and Machhapuchchhre Bank, you technically own four different stocks. But you have not built a diversified food basket — you have built a household that eats four kinds of rice. All four are commercial banks. All four borrow at rates NRB sets, lend at rates NRB caps, hold capital by ratios NRB dictates, and get squeezed the same week when NRB tightens the credit-to-deposit (CD) ratio — the regulatory limit on how much of their deposits a bank may lend out. When that ratio gets enforced strictly, every bank that was lending near the ceiling has to slow down lending at once, and every bank stock feels the same pressure at the same time.

This is the single most important idea in equity portfolio construction for NEPSE: the number of stocks you own matters far less than the number of independent risk sources those stocks are exposed to. A risk source is anything that can move a group of stocks together — an interest rate decision, a monsoon, a tourism season, a global copper price, a change in fuel subsidy. Two stocks are genuinely diversifying each other only when a shock that hurts one does not automatically hurt the other in the same direction and at the same time.

Why does this matter more in Nepal than in a market like the United States or India? Because NEPSE is structurally tilted toward one industry. As you will see in the next lesson, more than half of NEPSE's entire market value sits in banks, development banks, finance companies, microfinance institutions, and insurers — businesses that are all, at their core, in the business of lending money and are all regulated by the same central bank. In a market that broad and that varied, an investor who avoids financial stocks entirely can still build a fifty-stock portfolio. In Nepal, avoiding financial stocks entirely means giving up access to over half the investable market. So Nepali diversification is not about avoiding banks. It is about being deliberate: knowing how much of your equity sleeve sits inside the "lending" turbine versus other turbines, and sizing that exposure with your eyes open rather than by accident.

There is a second, quieter reason correlation runs high on NEPSE specifically. Nepal's economy itself is narrow. A large share of national income arrives as remittances — money sent home by Nepali workers abroad — which flows into bank deposits, which funds bank lending, which funds construction, trading, and consumption, which in turn feeds bank profits again. Hydropower depends on monsoon rainfall across the same river basins. Tourism depends on the same handful of trekking and pilgrimage seasons. Manufacturing depends on the same import routes through Kolkata and Vishakhapatnam. When an economy's underlying drivers are few, its listed companies — even ones sitting in different "sectors" on paper — often end up dancing to the same underlying music.

None of this means diversification is pointless in Nepal. It means diversification has to be done with a clearer map of what actually drives each sector, not just a longer list of ticker symbols. That map is the subject of the next lesson.

Lesson 60.2 — Mapping NEPSE's Sectors: Where the Market's Money Actually Sits

Before you can diversify across NEPSE's sectors, you need an honest picture of what those sectors are and how big each one actually is. NEPSE organises its roughly 286 listed companies into sector categories, and as of early 2026 those categories break down as follows by market capitalisation — the total value of all listed shares in that sector, calculated as share price multiplied by number of shares outstanding.

Two things should jump out immediately. First, the Banks, Financial Institutions & Insurance group — commonly shortened to "BFI" — is not really one sector. It is a bundle of several sub-sectors that trade under related but distinct rules: commercial banks (the large "A-class" banks like Nabil, NIC Asia, and Global IME), development banks ("B-class," typically smaller and more regionally focused), finance companies ("C-class," the smallest deposit-taking lenders), microfinance institutions (which lend small amounts to low-income and rural borrowers, often women's cooperatives), and insurers, which are split further into life insurance and non-life (general) insurance companies. Grouping all of these under one 52% figure hides real differences: a life insurer's income depends on long-term policy premiums and investment income, not short-term lending margins, so it behaves quite differently from a commercial bank even though both sit inside "BFI."

Second, notice the mismatch between number of companies and share of market value in hydropower. Roughly one in three listed companies on NEPSE is a hydropower company, yet hydropower is only about 16% of total market value. This tells you hydropower companies are, on average, much smaller than banks. A portfolio built by simply counting "one stock per sector" would badly overweight hydropower relative to its actual economic footprint, and badly underweight the sheer scale of the banking sector.

Think of NEPSE's sector map the way you would think of a Nepali household's monthly budget. A family might spend on rent, food, school fees, transport, and festivals. Rent is the largest line item, the way BFI is the largest sector — but a family does not stop paying for food just because rent is bigger. It budgets deliberately across categories, knowing some categories (rent) are unavoidable and large, while others (festivals) are smaller but still matter for a full life. A NEPSE equity sleeve works the same way: BFI will almost always be your largest sector allocation simply because it is the largest part of the investable market, but that does not mean it should be your only allocation.

A practical way to build this map for yourself is to separate the BFI bundle into its true sub-sectors before you diversify, rather than treating "financial stocks" as one bucket:

• Commercial banks (A-class) — roughly twenty licensed banks after years of NRB-encouraged mergers reduced the count from over thirty. These are NEPSE's largest, most liquid, most closely watched stocks.
• Development banks (B-class) — smaller, often regionally concentrated lenders, generally less liquid than commercial banks.
• Finance companies (C-class) — the smallest deposit-taking lenders, often thinly traded.
• Microfinance institutions — lenders to low-income borrowers, historically NEPSE's highest-growth but also highest-volatility financial sub-sector, sensitive to loan-loss cycles in rural lending.
• Life insurance companies — premium-and-investment-income businesses, less sensitive to short-term interest rate swings than banks.
• Non-life (general) insurance companies — property, motor, and health insurers, sensitive to claims cycles and reinsurance costs rather than lending margins.

Once you see BFI as six sub-sectors rather than one, and hydropower, manufacturing, trading, hotels, and "others" as five more genuinely distinct sectors, you have eleven meaningful buckets to think about — not just seven headline categories. This finer map is what lets you build real diversification rather than the appearance of it.

Lesson 60.3 — How Many Stocks Is "Enough"? NEPSE's Correlation Problem

International finance textbooks often cite a rule of thumb: somewhere between fifteen and thirty stocks, chosen across unrelated industries, is usually enough to eliminate most of the risk that is specific to any single company, leaving mostly market-wide risk that no amount of stock-picking can remove. That rule of thumb was built using data from broad, deep markets like the United States, where "unrelated industries" genuinely means unrelated — a software company, an oil refiner, a hospital chain, and a shoe retailer really do respond to different forces.

NEPSE is not that market. Because more than half its value sits in businesses that are fundamentally lending institutions regulated by one central bank, and because Nepal's real economy runs on a small number of shared engines — remittances, monsoon-fed hydropower, tourism seasons, and cross-border trade — many NEPSE stocks that look unrelated on paper move together in practice. Correlation is the technical term for this: it measures how closely two things move in the same direction at the same time, on a scale from -1 (they always move in opposite directions) to +1 (they always move together). A portfolio of stocks with high correlation to each other behaves, in terms of risk, much closer to a portfolio of two or three stocks than to a portfolio of fifteen.

Picture two water tanks. One tank is fed by fifteen separate pipes, each pipe drawing from a different, unconnected spring. If one spring runs dry, the tank barely notices — fourteen other pipes keep filling it. The second tank is also fed by fifteen pipes, but all fifteen pipes draw from the same underground reservoir. If that reservoir's water table drops, all fifteen pipes slow down together, and the tank empties no matter how many pipes were built. NEPSE investors who buy fifteen bank and finance-company stocks have built the second tank. They have fifteen pipes, but one reservoir: Nepal Rastra Bank's monetary stance.

This does not mean the old rule of "buy twenty to thirty stocks" is wrong in Nepal — it means the twenty to thirty stocks must be chosen for genuine independence, not just for being different tickers. A realistic, workable guideline for a Nepali retail equity sleeve looks like this:

• A portfolio concentrated in eight to twelve names, all drawn from within the BFI bundle, gives you almost no diversification benefit beyond owning three or four names, because the underlying driver — NRB policy and national credit conditions — is shared.
• A portfolio of twelve to eighteen names spread deliberately across the true sub-sector map from Lesson 60.2 — some commercial banks, one or two development banks or finance companies, a microfinance name, a life insurer, a non-life insurer, two or three hydropower companies (ideally from different river basins so they don't share a monsoon shock), a manufacturing name, and a hotel or trading name — captures most of the practical diversification NEPSE can offer a retail investor.
• Beyond roughly eighteen to twenty-two names, adding more stocks on NEPSE usually adds monitoring burden and transaction cost without adding meaningfully more diversification, because you eventually run out of genuinely independent risk sources in a market this size. You end up owning a second or third bank that behaves almost exactly like the first.

There is a second layer to this correlation problem: even outside BFI, some NEPSE sectors share hidden risk sources. Most of Nepal's hydropower generation depends on monsoon rainfall between June and September, and a below-average monsoon reduces river flow — and therefore power generation revenue — for nearly every run-of-river hydropower plant at once, regardless of which company built it. Two hydropower stocks from rivers in the same region are not much more diversifying than one. Genuine diversification within hydropower comes from spreading across projects on different river systems, different generation technologies (storage versus run-of-river), and different stages of operation (already generating revenue versus still under construction, which carries construction and financing risk rather than rainfall risk).

A simple test you can run yourself, without needing a statistics background, is to pull up price charts for two candidate stocks over the last one or two years and look at the big turning points. If both stocks bottomed in the same week during the 2022 liquidity crunch, and both rallied in the same month when NRB cut the policy rate, they are highly correlated in practice, whatever sector label NEPSE has assigned them. If one stock's big moves line up with monsoon news and the other's line up with interest rate announcements, they are genuinely offering you something different.

Lesson 60.4 — Position Sizing and Concentration Limits: Sizing Bites You Can Actually Swallow

Choosing which stocks to own is only half the job. The other half is deciding how much of your equity sleeve goes into each one — a decision called position sizing. A thali set is a useful picture here. A good thali has rice as the largest portion, because rice is the staple, but no single item — not even the rice — fills the entire plate. Lentils, vegetables, pickle, and meat each get a portion sized to their role: substantial enough to matter, small enough that if one dish turns out badly, dinner is still edible. Position sizing in a NEPSE equity portfolio follows the same logic: your largest holding should never be so large that a single company's bad news ruins your entire equity sleeve.

Part XI of this book introduced the average daily traded value rule, or ADV rule, for individual stock trades: a position should generally be sized so that it could be sold within a reasonable number of trading days — often cited as five to ten days — without needing to sell more than a modest fraction of that stock's typical daily traded value, so an exit does not itself crash the price. That rule was framed there mainly around entering and exiting a single trade. In portfolio construction, the same rule becomes a ceiling on position size at the portfolio level: if a stock's average daily traded value is thin, no matter how much you like the company, your position in it should stay small enough that you are never trapped holding a large stake you cannot sell without moving the price sharply against yourself.

Part XI's free-float allocation concept matters here too. Free float is the portion of a company's shares that is actually available for public trading, excluding shares locked up with promoters, founding families, or government holdings that rarely trade. A hydropower company might have a large total market capitalisation on paper, but if promoters hold 70% of its shares and only 30% trade freely, the real liquidity pool available to retail investors is far smaller than the headline market cap suggests. A position that looks modest as a percentage of total market cap can be uncomfortably large as a percentage of free float.

With that liquidity ceiling in mind, a workable set of concentration limits for a Nepali retail equity sleeve looks like this:

• No single stock should typically exceed 10-12% of your total NEPSE equity sleeve at the time you buy it, regardless of how confident you are in the company. This caps the damage any one company's scandal, regulatory penalty, or earnings collapse can do to your overall equity return.
• No single sub-sector — commercial banks, or hydropower, or microfinance — should typically exceed roughly 35-40% of your equity sleeve, even though BFI's true weight in the overall NEPSE market is over 50%. This is a deliberate underweight relative to the index, chosen precisely because BFI sub-sectors share so much correlated risk, as covered in Lessons 60.1 and 60.3.
• Positions in thinly traded small-cap or micro-cap stocks — including many newer hydropower and microfinance listings — should be sized smaller than the general 10-12% ceiling, often capped around 3-5% of the equity sleeve, purely because of the ADV and free-float liquidity constraints above.
• Cash or near-cash reserved for rebalancing and opportunistic buying should not be counted as "diversification" — it is a separate, deliberate buffer, not a thirteenth stock position.

It helps to translate these percentage limits into an actual worked example. Suppose an investor has decided, following Chapter 59's asset-allocation process, to place NPR 12,00,000 (twelve lakh rupees) into NEPSE equities. A concentration-limit-respecting starter allocation across fourteen names might look like this:

Notice the BFI sub-sectors here — commercial banks, development bank, finance company, microfinance, life insurance, non-life insurance — sum to about 47% of the equity sleeve, still the single largest bloc, but deliberately below NEPSE's own roughly 52% index weight, and spread across six sub-sectors with genuinely different drivers rather than concentrated in three or four bank names. Hydropower is split across three projects on different river basins rather than one large position. No single name exceeds 10%. The cash buffer, held back rather than fully invested, gives room to add to positions if prices fall or to fund a new opportunity without having to sell an existing holding at an inconvenient time.

Lesson 60.5 — Screening for Quality: Building Your Selection Filter

Diversification and position sizing tell you how to spread and size your bets. They say nothing about whether any individual stock is worth owning in the first place. That is the job of screening — running every candidate stock through a consistent set of checks before it earns a place in your portfolio, the way a careful shopper at Kalimati vegetable market checks a sack of rice for weight, moisture, and grain quality before agreeing to a price, rather than buying whatever sack is nearest the entrance.

A workable screening filter for NEPSE stocks should cover four broad categories: financial health, liquidity, governance, and valuation.

Financial health starts with the basics that Part IX of this book covered in depth: is the company profitable, is that profit growing or shrinking, and how is it funded? For a bank, development bank, or finance company, this means checking capital adequacy ratio (a regulatory measure of how much loss-absorbing capital the institution holds relative to its risk-weighted lending), non-performing loan ratio (the share of loans that have stopped being repaid on schedule), and return on equity. For a hydropower company, it means checking whether the plant is already generating revenue or still under construction, what its power purchase agreement terms are with the Nepal Electricity Authority, and how much debt was used to build the project. For an insurer, it means checking the claims ratio and the size and quality of its investment portfolio. A single financial-health checklist cannot be identical across sectors, because a bank's balance sheet and a hydropower company's balance sheet are answering fundamentally different questions.

Liquidity screening applies the ADV rule from Lesson 60.4 as a pass/fail filter, not just a position-sizing input. A stock with almost no trading volume on most days should be treated with extra caution even if its fundamentals look attractive on paper, because you may not be able to exit when you want to, at a price close to what you see quoted.

Governance screening asks whether the company treats minority shareholders fairly. Warning signs include frequent related-party transactions with promoter-owned businesses, a history of delayed or restated financial disclosures, auditor qualifications or auditor changes without clear explanation, and a pattern of rights issues or bonus share announcements that seem timed to prop up the stock price around promoter share sales. SEBON disclosure filings and NEPSE's own corporate announcements are the primary sources for checking these red flags before buying, not after.

Valuation screening asks whether the price you would pay is reasonable relative to what the company earns and how it is growing — using tools like price-to-earnings ratio and price-to-book ratio, covered in earlier chapters, compared both against the company's own history and against peers in the same sub-sector. A well-run bank bought at an inflated price can still be a poor investment; a mediocre bank bought cheaply enough can still work out reasonably.

Screening should not be a one-time event at purchase. NEPSE companies report quarterly, and a stock that passed every check a year ago can quietly fail one or more of them today — a rising non-performing loan ratio, a delayed audit, a hydropower project running over budget. Revisiting the same four-question filter each quarter, for every holding, is what keeps a portfolio honest over time rather than just at the moment of purchase.

Lesson 60.6 — Building Your Starter Portfolio: A Step-by-Step Walkthrough

With sector mapping, correlation awareness, position sizing, and screening all in hand, the last step is mechanical: turning a plan into an actual set of holdings inside your Demat account, the electronic account that holds your shares in dematerialized (paperless) form, linked to a trading account with a licensed broker.

Step one is confirming the equity sleeve size decided in Chapter 59, and translating it into a target number of holdings, using Lesson 60.3's guidance of roughly twelve to eighteen names for most retail portfolios below a few tens of lakh rupees. Fewer names below this range often means too little sector diversity; many more names above it often means either too many correlated bank holdings or positions so small that brokerage and transaction costs eat into returns disproportionately.

Step two is drafting the sector map, using Lesson 60.2's finer eleven-bucket breakdown of BFI sub-sectors plus hydropower, manufacturing, trading, hotels, and others, and deciding roughly how many names and what combined weight each bucket will get — deliberately underweighting the BFI bloc relative to its actual ~52% NEPSE index weight, per Lesson 60.4's concentration guidance.

Step three is screening candidates within each bucket, applying Lesson 60.5's four-question filter, and shortlisting two or three candidates per bucket before choosing the final one. This matters because the first name that comes to mind — often the largest, most-discussed company in a sector — is not automatically the best value at the current price.

Step four is checking liquidity and free float on every shortlisted candidate before finalising position sizes, using the ADV rule and free-float check from Lesson 60.4's practical tool, and shrinking planned position sizes for any stock that fails this check rather than skipping the check because the fundamentals looked good.

Step five is placing orders in tranches rather than all at once. Buying a full position in a single order on a single day exposes you to that one day's price, which may be unusually high due to short-term noise. Spreading purchases across three to six weeks — sometimes called phased buying — averages your entry price across a range of market conditions and reduces the chance of committing a large sum right before a short-term pullback.

Step six is recording the portfolio in a simple tracking sheet — sector bucket, stock name, purchase date, purchase price, quantity, and current concentration percentage — updated at least monthly. This is not optional bookkeeping; it is the only reliable way to notice when a stock's price has risen or fallen enough that its actual weight in the portfolio has drifted meaningfully away from the target weight set in step two, which is the trigger for a rebalancing decision.

Step seven, which belongs mostly to the next chapter but deserves a preview here, is setting a review calendar: a quarterly check of each holding against the Lesson 60.5 screening filter, alongside NEPSE's quarterly and annual disclosure cycle, and a portfolio-wide sector-weight check against the concentration limits from Lesson 60.4. A starter portfolio built carefully today will drift out of its intended shape within a year simply because different stocks grow at different rates — the discipline is not in the initial construction alone, but in returning to check it.