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Technical Analysis

Part 1: Risk Management of an Investment Portfolio

by Patrick Oberhaensli, on Dec 16, 2019 4:45:00 PM


In this four part article series, we examine the most important aspects of risk management in regards to an investment portfolio. We begin with an overview of the typical investment risk framework and continue with a discussion on how human nature plays a role with risk related biases. Finally, we will address the possibilities with different risk-adjusted performance measures within an investment portfolio. Adopting a risk-adjusted approach solidifies the risk management process since the achievement of objectives (at least a portion of them) can be easily evaluated.

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Overview: The Risk Management Framework

The risk management framework of an investment portfolio requires a consistent system (from conceptual to physical- at all levels) in which the risk management process can work effectively and efficiently. The overall structure should account for the interactions that occur with associated processes (for example: quality assurance). One dimension that is too often partly-overlooked by many traders, is connecting the risk framework to an activity objective. In this four part article series, we will certainly include a thorough explanation of the topic: risk-adjusted-return objective.

One should remember that in its simplest terms, a risk is an event possibly occurring in the future which would have a negative effect (that is more or less impactful), should it take place. The key risks associated with investing are the following: 


Market Risk

Market risk are losses due to adverse price developments in the market (versus the investor’s portfolio). An investment portfolio which includes options, market elements such as volatility can affect the price of the option. The related measures are called risk-sensitivities.

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Liquidity Risk

Liquidity risk are losses are due to a reduction of liquidity in the market in which the investor is active. It can also refer to loss which occurs from the change in the capacity to raise cash (new cash or replacement of a current liability). However, this doesn't often occur with investments (only in the case it is leveraged via a loan, for example).

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Credit Risk

Credit risk is associated with the failing of a business counterparty, in particular the specific broker the investor uses. A credit situation might also arise when a market shock occurs similar to the event on the 15th of January 2015, where the Swiss Franc suddenly became much stronger after the target pricing was abandoned.

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Operational Risk

Operational risk are losses directly related to the use of resources, whether human or material, including Information Technology (IT).  For example, the risk can be caused by natural disasters. Natural disasters, are especially critical in terms of analysis since their unpredictable nature makes it difficult to develop a consistent framework.

Operational risk also encompasses model risk which is an important aspect when quantitative strategies are used by the investor. In general, operational risk plays a major role considering that all organizations run diverse (operational) risks... in order to achieve returns. This also means that operational risk within potential investment decisions needs to be analyzed on an individual basis.

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Inflation Risk

As its title suggests, inflation risk is when there is loss of value within the portfolio due to inflation: it refers to unexpected inflation. Inflation should be accounted for within an investment analysis to understand the value of the real return, not only the nominal return.

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Reinvestment Risk

When cash is reinvested at a lower interest rate (than expected), reinvestment risk occurs. For example, the Long-Term "Big Rally" we’re “still” observing in the USD and in the EUR, and there's the chance it could last.

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Concentration Risk

Concentration risk is related to a loss coming from overly concentrated (and therefore not diversified) positions in the investment portfolio. It is important to note that this type of risk can exist across asset classes (equity and bonds, etc.) which is often forgotten by many traders. However, it is less common of a cause of risk for private investors if institutionals put policies into place to prevent concentration risk.

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Legal Risk

Legal risk is simply losses due to an unexpected change in the legal system or its (subjective) interpretation which in-turn affects the investment portfolio.

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Tax Risk

Similar to legal risk, tax risk is when losses are due to an unexpected change in the taxation system, affecting the investment portfolio. For example, tax risk can be triggered when the of the income taxation (income from the portfolio) is changed, not only within the parameters of the investor's domicile.

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Political Risk

Political risk is caused by an unexpected changes in the political system domestically or internationally which have a negative effect on the investment portfolio.

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Investment Horizon Risk

This is when loss occurs due to an unexpected change(s) in investment horizons of the investor.

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Now, every investor will likely have his/ her own definitions for each area of risk. But, what is essential is that there is a common understanding between the involved parties (the investor, the advisers, the broker etc.) in order to achieve and maintain a high level of consistency.

Beyond the common understanding of the investment risks involved, there is a principle that needs to be strictly respected: it is the original (or starting) risk that matters…

In the second part of this series of article, we examine the role of the key risks mentioned above in terms of the risk management process…


  • This content is not intended to be a solicitation nor an offer
  • The preparation of the information provided herein is done with a high level of care. Nevertheless, errors are possible


Topic:Trading SignalsOnline Trading PlatformAsset AllocationActive TradingRisk Management
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About this blog is a personal finance blog. The articles posted provide relevant trading information, aspects, and opinions from expert professional traders and data and analytics providers.

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