How to measure risk?

How to measure risk?

Risk is inevitable and natural. It affects every investment decision you make as an investor. There is no solution to escape investment risks. Your best hope is to manage risk effectively.

What is a risk assessment? Well-managed risk is beneficial in the long run, as risk and return go hand in hand. Hence, risk measurement is a kind of risk assessment procedure which is the first step towards making a wise investment decision and building a well-managed investment portfolio. Let’s understand the types of risk assessment.

Types of Risk

Risk can be of two types:
- Qualitative risk
- Quantitative risk

Qualitative risk

This type of risk is based on these factors:

  • Financial goals
  • Time horizon 
  • Risk tolerance capacity 
  • The risk of the investment itself

How to do a risk assessment? The nature of the investment and its historical performance need to be considered in order to analyse the risk. This can help you compare different investments too. For instance, you have two investments. The investment that has steadily given you a return of 10% year on year is considered less volatile and risky. On the other hand, the second investment gives fluctuating returns, 14% one year, 4% the next year and 10% hereafter. Here, the second investment is considered volatile and a high risk investment option.

Quantitative risk assessment

Besides qualitative approach, risk can also be quantified using analytical tools. Thus, in quantitative risk management, risk is calculated on the basis of certain formulae. Some of them are:
• Standard deviation
It’s a commonly used statistical tool for measuring risk. Basically, standard deviation is used as a measure of volatility in stocks, stock portfolios and mutual funds. This number indicates how much a particular stock/fund return has varied from its average return over a number of years. An investment is considered risky if its return deviates more from historical averages.

For example, stock A and B have given an average return of 10% for last 5 years. But stock A is more risky than stock B as its standard deviation is more and the stock is highly volatile.

Let’s take a look at the performance comparison of the above table in a graphical manner below. The standard deviation graph suggests that stock A is prone to fluctuations as compared to stock B.


  • Alpha

Alpha measures investment performance on a risk-adjusted basis. Basically, Alpha means the excess return for any investment as compared to its benchmark performance, thus keeping the risk under adjustments.
Therefore, Alpha of more than 1.0 implies that an investment has outperformed its benchmark and compensated more than that of the risk taken.

  • Beta

Beta gives an idea of historical volatility. It is used to measure how a stock or a portfolio moves in comparison to benchmark index. For example, beta 2 implies that a particular asset is twice as volatile as the benchmark. Beta shows how sensitive an asset is to market movements.

  • R-squared

R-squared helps you gauge to what extent the investment portfolio movement reflects on the benchmark movement. The figure may vary from 1-100%. A higher percentage denotes good correlation between portfolio and benchmark return.

  • Sharpe ratio

Sharpe ratio is one of the widely used tools in tracking the performance of an asset. It is a risk adjusted measure of return that helps to compare two similar investments. In mutual funds, two funds are compared on the basis of Sharpe ratio. The fund having a higher Sharpe ratio is considered worthwhile.

  • VIX (Volatility Index)

VIX is a widely used measure of market risk. It was introduced in India in 2008 by the National Stock Exchange. VIX measures near-time or upcoming risk. It is based on future and options data and hence gives an approximate idea of near-time volatility expected in the market.

In a nutshell, a correct blend of both qualitative and quantitative risk measurements is ideal for performance assessment and to construct a healthy investment portfolio. It is always good to use more than one mathematical measure to analyse risks. Risk measurement techniques are useful in evaluating the risk associated with an investment, thus helping you analyse and compare to make a smart investment decision.


Risk mitigation through diversification

Risks are a constant in the world of investment. They cannot be eliminated. But, there are strategies to minimise them. How to reduce investment risk? Investment risk can be reduced by risk mitigation strategies to ensure that the end goal is not adversely affected. How to manage investment risk? Risk management can be adequately managed through a fundamental component of in investment approach. It is needed to improve investment outcomes. The right strategy keeps losses within an acceptable boundary during hard times and helps to cover up losses during good times. Diversification is one such time-tested risk mitigation strategy. Here are some tips to diversify investment risk. What is diversification?Diversification is a means of managing an investment portfolio. Through this one can invest in a wide range of financial assets. So, even if a certain set of your assets do not perform well, it can outweigh the declining performance of the rest of your portfolio. Diversifying balances out and reduces the overall risk associated with a portfolio. Every asset performs differently based on the prevailing market conditions. Diversification is all about investing in various non-related assets to balance out the risk exposure. Non-related assets are assets like equity, bond and gold, whose performance does not depend on each other.Some assets are also co-related to each other’s performance. For example, equity markets tend to slump during an economic downturn. During such times, the Reserve Bank of India (RBI) tries to stimulate economic growth by lowering interest rates. As interest rates start to fluctuate, co-related assets such as bond prices also tend to go up and down. Thus, equity and debt are inversely correlated to some extent. In short, diversification simply refers to ’don’t put all your eggs in one basket’. Instead of investing in a single investment avenue, you can invest in multiple financial assets such as stocks, bonds, mutual funds and real estate etc. Moreover, you can also choose to diverse the investments within the same asset class. For example, you can invest Rs. 10 in different shares of varied sizes, industries and sectors. In doing so, you are at a minimal risk of loss in the event of a fickle market environment.Thus, a well-diversified portfolio helps you in the long run by spreading out the risk of an asset and minimising overall investment risk, thus helping you to pursue your investment objective. Here it is important to note that though diversification effectively reduces overall risk, it cannot completely erase it. *The table suggests that the average risk of the portfolio reduces with the rise in the portfolio size.How to diversify investment risk? Spread your investments across different assets. The risk and return profile of each asset class could vary. Equities are riskier than bonds. Hence, choosing a proper mix of less, moderate and high risk investment avenues can also help in diversifying as per your risk profile and time frame to achieve investment objective. Every asset class responds differently to economic changes. Therefore, figuring out the right mix based on your investment plan is the key to diversification. Consider different assets within the same asset category. To build a diversified equity portfolio, buy 15-20 stocks across varied sectors. Opt for negatively correlated stocks. For example, you can choose to invest in shell stock (oil production companies) and airlines (oil consumer) as the price of these company shares are negatively correlated. Negatively correlated stocks perform better if the other one drops, i.e. contra performance. Thus, diversification helps in averaging out the returns so that if one asset class does not perform well in a timeframe, the other one would make up for it. Remember diversification is an ongoing process. You need to constantly review your portfolio and rework on your diversification strategy based on your current need and situation. A disciplined approach can help you survive the ups and downs of a volatile market. Take expert help. Seeking help of financial experts can help you in building a well-diversified portfolio. Financial experts can help in designing a diversification strategy that can effectively reduce risks and maximize your potential returns in the long run. ConclusionIn a nutshell, diversifying your investment among various asset classes protects you against significant losses by mitigating risks. Follow an asset allocation strategy as per your risk tolerance, investment goals and financial circumstances. Diversify among and within various asset classes to reduce risks and achieve your financial goals. Get guidance from a financial professional on asset allocation and diversification for your portfolio. IndiaNivesh expertise in the field can help you mitigate the risk through diversification to achieve your financial goals.

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Creating Wealth One Step at a Time

Introduction:With the right outlook and approach, building wealth can be one of the most gratifying and pleasing experiences in an investor's life. Every investor dreams of building a profitable investment portfolio. However, the question arises, what is portfolio investment? Portfolio investment is a strategy that covers financial goals and mitigates all possible risks. Understandably, it's an uphill task. You will need to set up your financial goals, understand your risk appetite, decide allocations and accordingly pick the right investments. But it is not over yet. Investing prudently also calls to have your ear on the ground, make sense of market information and discern the news to make it work for you. Through investment analysis and portfolio management you can track your investments as you keep building wealth. Keys for Successful InvestingTo evolve as a successful investor, it’s essential to keep an eagle eye on key changes in the market and know how stock market reacts to key economic data. Equity markets are highly susceptible to market changes and actively react to various political and economic changes. Let’s take two major events to understand this. Example 1: The Government’s decision to demonetize currency at the end of 2016 had a massive impact on the stock market. Demonetisation resulted in withdrawal of nearly 86% of circulated money in the market. This led to the BSE Sensex’s immediate and huge crash by 1690 points. Some of the sectoral indices of cash-driven sectors such as realty and consumer durables also witnessed a tremendous plunge.  Example 2: In 2017, the passing of the GST bill had a similar impact on the stock market. The Government’s decision to keep the tax rate low on mass consumption items and exemption of tax on cereals, milk and grains worked positively for FMCG stocks such as Nestle and Marico. Likewise, it had varied impact on various sectors. In order to make sense of market volatility, investors need to consider various data points such as inflation, GDP trends, global changes and the economy as a whole. The Higher the GDP, greater is the level of income and spending, which ultimately results in higher corporate earnings. Market sentiments vary with such data changes. Making a smart moveApart from the bigger picture, some specific elements mentioned below can be taken into account before investing: Corporate earnings: Being aware of what is happening in the company whose scrips you hold can help you make a rational decision. Company quarterly reports representing earnings provides a broader picture of the company’s progress towards its targeted annual growth. Along with net profit it is important to pay attention to other details like debt structure, earnings per share, net sales and operating expenses etc. However, analysing these numbers can sometimes, be, easier said than done.  Analyst ratings: Stock ratings by industry analysts give a measure of the stock’s expected performance for a particular period. Ratings are sometimes simply labelled as ‘buy, ‘hold’ or ‘sell’. Sometimes, ratings are given as ’equal-weight’ ’under-weight’,‘ ‘outperform’’ and ’underperform’. These ratings are assigned based on various valuations, market trends, competitive advantages, company’s earnings, prospects and other factors. It is worthwhile to consider such informed opinions.  Smart decisions always needs smart skills. Some skills required to make sense of news and use it for portfolio success include: Critical thinking: Strong critical thinking is important to make SWOT (Strength, Weakness, Opportunities and Threats) analysis of financial reports. Anticipate: Evaluating possible impact of major events and its effect on the financial market is important in making smart investment decisions. Outside the box research: Being mindful of various scenarios and being able to associate their possible impact on various market activities is crucial.  Competitiveness: It is required to stay innovative and tap good opportunities. Every investment decision needs extensive research and a constant check on the financial market. Being informed on market developments and analysing them is highly crucial in making a smart move. Thus, it is advisable to avail professional help. You could use the services of a stock portfolio manager to guide you in how to create an investment portfolio. Portfolio management services offer a customised portfolio investment process strategized and managed by experts or portfolio managers. Conclusion:The bottom line to building a successful investment portfolio is to make sense of the news, interpret data while analysing events and predicting every possible outcome. Portfolio managers help build a successful and customised investment portfolio with their knowledge, skill and strategy. Make use of their expertise and proficiency in navigating your financial future and pursuing your investment goals.

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The above mentioned are a few things that one must know before indulging in commodity trading in India. As a beginner or seasoned investor, you can contact IndiaNivesh for any assistance relating to the Indian commodity market. Our experts and professionals can help you in finding the best commodity to trade in India according to your risk-taking ability and financial goals. Our aim is to exceed the client’s expectation in all endeavours and we will be glad to serve you.   Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing. 

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  • Systematic Withdrawal Plans – How to use SWP?

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  • Commodity Investment – Reasons to Invest in Commodity Market

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Diversification with regards to investment portfolio means investing in various assets that are not correlated to each other of your portfolio in different asset classes. Most of you would be diversifying your portfolio in five major asset classes which include cash, shares, fixed income securities, real estate, and gold. In times of increased volatility in the markets, you are either holding on to cash or investing in gold. Gold is considered the safest haven for investment in turbulent times and Indians tend to invest in gold because it is considered as a symbol of wealth and has ornamental value. However, in reality, the gold in your portfolio is your investment in commodity and just like all the other commodities the returns from it are independent of the returns generated by stocks and bonds. Just like gold, there are other commodity investments whose returns are not correlated to equities and bond markets. The price of any commodity investment is a function of demand and supply and by doing proper research and analysis you can make profits from commodity market investments.2. To provide a hedge against inflation Inflation is the general rise in the price of goods and services over time. For any investment to be fruitful, it is important that the returns generated beat the rate of inflation.  Higher inflation effectively erodes the real returns generated by your investments in stocks and fixed income securities. However, in the case of commodities, higher inflation relates to the higher price of commodities. So, unlike other investments, your commodity investments will result in a strong performance when inflation is high. Given the current situation when inflation is constantly on the rise, investing in commodities will provide a hedge against inflation.3. To improve potential returns The prices of individual commodities can fluctuate significantly due to several factors such as demand and supply, the impact of natural calamities, exchange rates and the economic health of the nation.  The rise in infrastructure projects in a developing country like ours and also globally has had a positive impact on commodity prices. As the commodity market is still an untapped arena, many of them are trading at a lower price than their actual potential. Proper research and effective implementation of investment strategy in commodities can help investors improve the overall returns on their portfolio. What are the various options to invest in commodities? The commodities market is a very deep market and investors have many investment vehicles to access it.  Let us look at the various options available for investors to buy and sell commodities1) Investing in the physical form Commodities such as gold, silver, etc., are bought by investors in physical form.  However, not all commodities can be bought in physical form as it has its drawbacks of storage and spoilage. Even in the case of precious metals security and insurance increase the cost of your investment. Moreover, most of the time you want to invest in a commodity, not for end-use but to make profits if you anticipate that the price will increase. So, buying a commodity in physical form, except for precious metals, is generally not recommended for retail investors.2) Investment through commodity futures One of the most common ways to trade in commodities is through a commodities futures contract. It is a standardised agreement to buy or sell fixed quantities of the underlying commodity at a predetermined price on a specific date as mentioned in the contract. Also, commodity trades happen electronically through commodity exchanges where investing real-time commodity is possible.  Multi Commodity Exchange of India (MCX), National Commodity and Derivatives Exchange (NCDEX) are two of the many commodity exchanges present in the country which help investors trade in commodities. All the commodity exchanges come under the regulation of the Forward Markets Commission (FMC). 3) Commodity ETFs Commodity ETFs are another popular investment option available for retail investors to diversify their holdings in commodities. Commodity ETFs invest in a single commodity and physically hold and store it, invest in a commodity futures contract or invest in a commodity index that tracks the performance of multiple commodities. Investors can invest in commodity ETFs electronically in their Demat account. 4) Commodity Stocks Investors who are not comfortable with investing in commodity futures or ETFs can diversify their portfolio in commodities is by investing in commodity stocks. Commodity stocks are stocks of those companies which are directly or indirectly related in the manufacturing process of the commodity and hence have a positive correlation with the commodity.  For example, if you feel that the steel prices are going to increase, then you can invest in the stocks of various steel companies listed on the exchange. 5) Mutual funds One of the biggest reasons for an investor to shy away from commodity investment is that commodity investments require a lot of time, knowledge and expertise to make the right investment choices. However, now SEBI has permitted mutual funds to invest in the commodities market through the exchange-traded commodities derivatives (ETCD) route.  Thus, retail investors can now participate in commodity markets in a structured manner through professionally managed mutual funds. Takeaway Commodities are a broad and diversified asset class that offers a great investment opportunity to investors. Given the high inflationary pressure and volatility in the markets, dedicating a small portion of your portfolio to commodities will help enhance the overall performance of your investments. Investing in commodities may look intimidating and you may feel a little hesitant to explore your options, but correct guidance from an experienced financial advisor can help you understand the nuances of commodity markets and make the right investment decisions as per your investment needs. Financial advisors at IndiaNivesh possess the requisite expertise and experience to help and guide you with investments in commodities markets.Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.

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