A 360-degree approach to managing investment portfolio risks

In the ever-evolving landscape of financial markets, risk management and risk mitigation are important tools in portfolio advisory. It calls for a broad knowledge of market trends, keen insight into macro and micro risks, and spontaneity in wealth preservation.  Let’s explore a 360-degree approach to managing investment portfolio risks, reimagining traditional strategies to navigate the complexities of today’s investment world.

Understanding portfolio risk management

Portfolio risk management is making investment decisions with a financial objective while considering the limit of endurance of risks. It is about establishing, assessing and addressing risks inherent in a portfolio. The right way to assess risk is by considering the risk tolerance, risk required and risk capacity of an investor. The most important of these is the risk tolerance and risk capacity which delve into the finer aspects of money behaviour of an individual.

The 360-degree approach to risk management is based on the premise that risks associated with investments should be considered from all sides. This includes market risk, credit risk, liquidity force and even reputation. By referring to every factor indicated above, investors can make informed choices and develop a resilient portfolio.

Further, both quantitative risk management tools and qualitative aspects, which cover investor behaviour that checks responses in various market cycles, are important indicators of the risk tolerance of an investor.

There are several strategies that investors can employ to manage portfolio risk:

Diversification: The primary concept in investment management is diversification, which refers to mitigating risk through investing across various asset classes, sectors and even regions. Diversifying the portfolio enables investors to avoid losing all their investment in a single asset. This strategy helps cushion against market volatility and unexpected events, enhancing the stability and resilience of the investment portfolio.

Asset allocation: The asset allocation technique entails investing across various classes such as stocks, bonds, real estate and commodities depending on the investor’s risk appetite, investment objectives and time frame. Asset allocation aims to establish the best possible balance between risk and return and match it to an investor’s purpose. By diversifying across asset classes with different risk-return profiles, investors can potentially maximise returns while minimising downside risk.

Rebalancing: The process of regularly modifying an asset portfolio’s allocation to preserve the intended asset allocation is known as rebalancing. Over time, the initial asset allocation may deviate from its intended aim due to shifts in the market and asset performance. Rebalancing is reallocating the revenues from selling assets that have increased in value to underperforming assets to bring the desired asset mix back. This disciplined approach ensures the portfolio remains aligned with the investor’s risk tolerance and investment objectives.

The digital age has resulted in radical transformations in risk management. Progressive analytics, machine learning, and artificial intelligence are employed to predict market trends, risk management, and portfolio optimisation. Such technologies of real-time risk assessment allow investors to obtain relevant information promptly and make informed decisions.

By understanding the different types of risks, employing effective risk management strategies, and leveraging technology, investors can navigate the complexities of the investment world and build resilient portfolios.

(The writer is Founder, Managing Director and Chief Financial Planner at Dilzer Consultants Pvt Ltd )

(Published 26 February 2024, 00:32 IST)

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