Table of Content

• Diversify your portfolio to manage concentration risk
• Tweak your portfolio to mitigate interest rate risk
• Hedge your portfolio against currency risk
• Long-term thinking is the best way to get through volatile times
• Avoid high-impact names and avoid liquidity risks
• Asset –liability Mismatch: Fight Horizon Risk
• Triumph over reinvestment risk

Risk is present when you invest in any asset (equity, debt). What is meant by risk? Ask any market participant this question, and they will typically answer that risk is volatility. This is a subtle distinction. Volatility does not equal risk, but it is a manifestation of that risk. Volatility increases when a bond or stock becomes riskier. This does not, however, define risk.

The probability that a bad thing will happen or a good thing won’t happen is called risk. In the context of financial markets, the risk for an investor is the possibility that they will suffer losses due to factors that influence the performance of the market in which they are engaged. It follows that risk should always be understood in terms of expectations.

Short story: The higher the risk, the greater your expectations.

Here are eight types of specific market risks and how you can handle them.

Diversify to manage concentration risk.

The concentration risk occurs when you invest a large amount of your money in a single theme or industry. Your entire portfolio could be thrown out if something happens to the sector. Diversification is the answer to concentration risks. Although you don’t have any control over the performance of the company, you can choose which stocks/themes to invest in.

Tweak your portfolio to mitigate interest rate risk.

Interest rates and inflation are linked because higher inflation usually leads to higher rates of interest. This has an impact on both equities and bonds. Bond prices rise when rates are lowered, improving the NAV for bond funds. Lower rates also boost valuation in the case of equity. When rates increase, the opposite occurs. You can change the maturity of your bonds, and if you’re in stocks, you should adjust your exposure to sectors that are sensitive to rates, such as autos, real estate, banks, and NBFCs.

Hedge your portfolio against currency risk.

You might wonder why currency risks would affect your rupee portfolio. Currency risk is a problem because the companies you invest in can impact your rupee portfolio. IT, pharmaceuticals, and auto-ancillary industries, for example, are export-oriented and benefit from a stronger dollar. Capital goods, telecom, and power are all importers, so a strong rupee is beneficial to them. To hedge your risks, mix dollar defensives with rupee defensives when creating your portfolio.

How to survive volatile times

You cannot avoid volatility whether you invest in bonds or stocks. You can manage volatility with a systematic and long-term approach. Short-term traders are hit by volatility. Over time, the volatility of equities will tend to level out from a long-term view. A systematic or phased strategy can also help to even out volatility.

Avoid names with high-impact costs to reduce liquidity risks

You run the risk of liquidity when you cannot exit or enter an investment within your price range. The problem is magnified when markets are volatile. Liquidity may be difficult in a volatile market. In normal market conditions, you can reduce this risk by investing only in low-impact stocks.

Fight the horizon risk that arises from an assets-liabilities mismatch.

This risk is not related to market conditions but rather to your investment decision. IL&FS is in a crisis today because it borrowed money on short terms and lent it for infrastructure projects. This is a great example of horizon risks on a large scale. You could end up in serious trouble if you invest in equity for a three-year goal. Structure your investments according to the time horizon of your liabilities.

Triumph over reinvestment risk

Compare a dividend plan with a growth plan for a mutual fund to understand this. Dividend plans pay out dividends, and unless the dividends are reinvested at the same rate of return, it is unlikely that you will create wealth over the long term. Growth plans, on the contrary, keep reinvesting their returns. A growth plan has no reinvestment risks, but any regular payout, such as interest or dividends, does. It is simple. You can choose growth plans in mutual funds and low dividend and high-growth stocks in equities.

Geopolitical risks are also included in the volatility risk of an asset or market.

Risks can be numerous, but an informed, disciplined and phased approach will help you to mitigate them.