MANAGING RISKS

When I started my career on Wall Street, one of the first books given to me was about trading risks. At first, I thought it was only about trading stocks, something I was not interested in. But it wasn’t entirely. It was literally about trading risks.

So naturally I began thinking about tradeoffs. What risk levels am I comfortable with? What risks can I hedge or protect against? Now this opened my eyes to a different world of investing.

You see, the single skill that differentiated good from great investors was risk management on Wall Street. Even the best hedge fund managers make the mistake of taking on too much of the wrong risk. Which means there are risks worth taking. And in this section we will breakdown which ones.

MARKET RISK

• accept you can't control everything

• Systematic risk is the risk inherent to the entire market, attributable to a mix of factors including economic, socio-political, and market-related events.

• how can i manage market risks?

  • Market risk is the risk of loss from changes in market prices, such as interest rates, foreign exchange rates, and equity prices. Here are some ways to manage market risk:

    • Diversification: Investing in a variety of assets can help spread risk and reduce overall market risk exposure.

    • Hedging: Hedging strategies, such as using financial instruments like options or futures contracts, can help mitigate market risk.

    • Monitoring: Regularly monitoring market conditions and adjusting portfolios as needed can help manage market risk.

    • Avoiding over-concentration: Avoiding over-concentration in a particular security or market sector can help manage market risk.

    • Investment policy: Establishing clear investment policies and guidelines can help manage market risk by providing a framework for decision-making and reducing impulsive actions.

    • Professional advice: Seeking the advice of financial professionals, such as a financial advisor or portfolio manager, can help manage market risk.

COMPANY RISK

• if you work at a corporate job, then you know how many moving parts exist

• how can i manage Operational risk?

  • Operational risk can be managed through various methods, including:

    • Developing and implementing effective internal controls and policies

    • Maintaining and regularly reviewing disaster recovery plans

    • Implementing a robust risk management framework

    • Conducting regular internal audits

    • Providing training and education to employees to raise awareness of risks

    • Building strong partnerships with suppliers and vendors to mitigate risk

    • Regularly monitoring and assessing key processes, procedures, and systems to identify and mitigate risk

    • Maintaining an open and effective communication channel between employees and management to report potential risks

    • Diversifying business operations to reduce dependency on specific business units or products

    • Establishing a risk management committee to review and manage risks on an ongoing basis.

ECONOMIC RISK (INFLATION)

different from macro market risks. i split this out because it has become a serious concern overtime

How can I manage economic risks like inflation?

Economic risks such as inflation can be managed through diversification of investments and holding a mix of assets such as stocks, bonds, and real estate. Additionally, investing in assets that are not tied to a specific currency can also help manage inflation risks. Another strategy is to invest in inflation-protected securities, such as Treasury Inflation-Protected Securities (TIPS) which offer a fixed rate of return plus an adjustment for inflation. It's important to consider the long-term horizon of investments and seek professional financial advice to make informed investment decisions that align with your risk tolerance and financial goals.

Systemic vs systematic risks

During the Great Financial Crisis, there were a lot of discussions around systemic vs systematic risks. You see, the banking industry was on tilt. No one knew if the spillover from one sector (systemic) would impact the entire market (systematic). Well 2008 was the first time this was a serious possibility.

Banking is unique because it finances industry. The same happens with mission critical industries like energy where countries sometimes go to war.

GEOPOLITICAL RISK

Another unknown unknown. Politics is tough to tame. There are too many parts and the incentives are misaligned. Investors can’t control much in these situations.

How can I manage political risks?

Political risks refer to the uncertainties and potential losses that may arise from changes in government policies, laws, or regulations. To manage political risks, investors can take the following steps:

Conduct thorough research and analysis of the political environment in the country where they plan to invest.

Look for investment opportunities in countries with stable political systems and predictable government policies.

Consider investing in countries with strong rule of law and protection of property rights.

Use hedging strategies such as options, futures, or currency swaps to mitigate the impact of political risks on their investments.

Diversify investments across multiple countries and sectors to reduce the impact of political risks on their overall portfolio.

Monitor political developments closely and regularly review their investment strategy in light of changing circumstances.

Consider seeking advice from experienced professionals, such as political risk consultants or financial advisors.

WHAT ARE THE DIFFERENT TYPES OF INVESTMENT RISK?

Market risk: The risk that the value of an investment will decline due to changes in the stock market or the overall economy.

Credit risk: The risk that the borrower will default on their debt obligations.

Liquidity risk: The risk that an investor will be unable to sell an investment due to a lack of buyers.

Interest rate risk: The risk that changes in interest rates will impact the value of an investment.

Currency risk: The risk that changes in currency exchange rates will impact the value of an investment.

Inflation risk: The risk that the value of an investment will be eroded over time by rising prices.

Political risk: The risk that government actions or political instability will negatively impact the value of an investment.

Operational risk: The risk that business operations will be disrupted, leading to a decline in value.

Reputation risk: The risk that damage to a company's reputation will negatively impact its financial performance.

Legal risk: The risk that legal or regulatory changes will negatively impact the value of an investment.