By Vineet Sachdeva
Risk management is a crucial aspect of managing investments, whether it is for personal finances or a large investment portfolio. The process of identifying, assessing and prioritising risks is essential to ensure the safety and security of the investments, since without proper risk management investments can be exposed to severe losses and market volatility.
Why is risk management important?
One of the primary objectives of managing capital is to preserve the principal amount and grow it realistically. By identifying and understanding the potential risks associated with different investment options, investors can implement strategies to minimise the impact of these risks. This involves detailed diversification of portfolio across asset, sectorial and strategy level.
Effective risk management can help in optimising returns. By carefully assessing the potential risks and rewards of different investment opportunities, investors can make informed decisions that have the potential to generate better risk adjusted returns. One of the ways to implement this is identifying an asset allocation goal and sticking to it.
Regulatory compliance
Effective risk management is also essential for regulatory compliance. Large financial institutions and investment firms are subject to strict regulations and guidelines related to risk management. By learning from and implementing robust risk management practices, individual investors can develop a framework for their investments.
Avoiding unregulated investment entities, investing in tips by unregistered advisers and over-leveraging the portfolio (directly or through F&O) have caused a lot of pain to investors. Trusting an experienced fund manager with your investment is always advisable for wealth creation. It is not only risk management that will help the portfolio to grow, but also the safety and liquidity of the investment. Let compounding do the rest of the job.
There are several risk-adjusted return ratios that help investors assess existing or potential investments. The ratios can be more helpful than simple investment return metrics that do not take the level of investment risk into account. Sharpe ratio considers standard deviation of the portfolio’s excess return while Treynor ratio looks at portfolio beta and Sortino ratio is focused on downside risk.
A portfolio manager will try to optimise returns with a given level of risk or will reduce the downside risk with the same level of returns. Additionally, non-correlated diversification aligned with your investment objectives is a great way to generate better risk-adjusted returns. Perhaps it is time to quiz your portfolio manager on the risk metrics of your portfolio.
The writer is entrepreneur partner, Quantitative Equity Investing, Alpha Alternatives
