6 Risks Threatening Your Portfolio Today

While there’s no way to create a portfolio that’s totally immune to market changes, it is possible to create one that provides the lowest levels of risk even in highly volatile markets. In the creation and management of a de-risked, diverse, low-volatility portfolio, investors are able to identify and better understand the traits that are indicative of a low-risk asset. The characteristics of these holdings help determine their risk level, and in turn, they may be successfully navigated and managed through a low volatility approach.

Many investors make just one attribute of an asset their main focus, but it is critical to factor in a variety of elements when considering building a portfolio. Some of the most important traits of a low-risk portfolio are:

Being able to identify these characteristics helps protect from the pervasive risk factors that threaten to damage a low volatility portfolio’s potential for capital preservation and returns. The risks are both quantitative and qualitative in measurement and impact different aspects of the holdings and portfolio. (For more, see: Tips for Investors in Volatile Markets.)

1. Beta

A primary factor in portfolio risk is beta. Beta calculates the volatility measurement of an asset’s price movement in comparison to a representative market index. Beta observations can help display the trending volatility of a position in relation to the index. By carefully monitoring individual and aggregated assets, it is possible to see how price movements impact the entire portfolio.

2. Standard Deviation of Price Volatility

Standard deviation of price volatility is another measure of risk that shows how widely returns vary over a certain period of time. Measuring standard deviation displays the price fluctuations of the holdings. Higher standard deviation implies greater price fluctuation and when combined with beta measurements, enables a more accurate read of risk and potential loss.

3. Covariance

Another vital risk measurement, which plays an important part in modern portfolio theory, is covariance. Covariance shows how assets relate to one another within the portfolio and the impact that relationship has on both risk and the probability of loss. A higher measure of covariance suggests a portfolio lacking diversification. Covariance risk to a portfolio indicates that asset values will fall and rise at the same time, creating more risk exposure to loss.

4. Governance Risk

Outside of quantitative risk factors, qualitative risks, such as governance risk, can affect portfolio performance. Governance risk is the risk associated with how a company’s Board and “C” level management govern the organization in accordance with stated policies. (For more, see: Volatility's Impact on Market Returns.)

This threat requires more fundamental analysis and interpretation and is common among organizations with high turnover at key positions, such as the chairman of the board, CEO or CFO. The risk also becomes a key factor in times of mergers or acquisitions, where key positions are being eliminated or combined. Governance risk may change at any time based on the internal controls and decisions of the company.

5. Operational Security Risk

Not only does governance risk threaten an organization and investors’ portfolios, but operational security risk can also damage holdings. This risk is qualified as a hazard to a company’s operations, and appears in the form of a threat to key operating personnel, plants and equipment, data breaches and more.

6. Legal Risk

Before incorporating an organization’s stock into your portfolio, it is important to also weigh any legal risks facing the company. This particular risk is common among firms with outstanding Securities and Exchange Commission investigations or a lack of transparency in regard to such investigations.

The unpredictability of the stock market may leave portfolios and investors vulnerable due to any of the numerous risk factors at play. However, by understanding that the market is cyclical in its movements and volatility, investors can position themselves in a way that reduces risk and retains returns, regardless of the market’s fluctuations. With so many risks circling the market in addition to volatility, a low-risk investment strategy is a prudent way to maximize the upside potential of a portfolio while minimizing downside risk. (For more from this author, see: An Investment Strategy for Market Volatility.)