Term of the day: Systematic Risk.

What is ‘Systematic Risk’
Systematic risk is the risk inherent to the entire market or market segment. Systematic risk, also known as “undiversifiable risk,” “volatility,” or “market risk,” affects the overall market, not just a particular stock or industry. This type of risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the correct asset allocation strategy.

BREAKING DOWN ‘Systematic Risk’
Systematic risk underlies other investment risks, such as industry risk. If an investor has placed too much emphasis on cybersecurity stocks, for example, s/he can diversify this by investing in a range of stocks in other sectors, such as healthcare and infrastructure. Systematic risk, however, incorporates interest rate changes, inflation, recessions and wars, among other major changes. Shifts in these domains have the ability to affect the entire market and cannot be mitigated by changing around positions within a portfolio of public equities.

To help manage systematic risk, investors should ensure that their portfolios include a variety of asset classes, such as fixed income and cash, each of which will react differently in the event of a major systemic change. An increase in interest rates, for example, will make some new issue bonds more valuable, while causing some company stocks to decrease in price as investors perceive executive teams to be cutting back on spending. In the event of an interest rate rise, ensuring a portfolio incorporates ample income-generating securities will mitigate the loss of value in some equities.

Systematic Risk and the Great Recession
The Great Recession also provides an example of systematic risk. Anyone who was invested in the market in 2008 saw the values of their investments change drastically from this economic event. The Great Recession affected asset classes in different ways as riskier securities (e.g. those, which were more leveraged) were sold off in large quantities, while simpler assets, such as KE. Treasury Bonds, became more valuable.

If you want to know how much systematic risk a particular security, fund or portfolio has, you can look at its beta, which measures how volatile that investment is compared to the overall market. A beta of greater than 1 means the investment has more systematic risk than the market, while less than 1 means less systematic risk than the market. A beta equal to one means the same systematic risk as the market.

The opposite of systematic risk, unsystematic risk affects a very specific group of securities or an individual security. Unsystematic risk can be mitigated through diversification.

Read more: Systematic Risk https://www.investopedia.com/terms/s/systematicrisk.asp#ixzz5BFlEubQo
Follow us: Investopedia on Facebook