Why should investors take risks? Because capital markets reward only those who accept uncertainty. Volatility is not a flaw, but rather a prerequisite for returns. For a multi-asset fund, this means:
- Safe investments (e.g., money market accounts, short-term government bonds) protect capital, but they usually offer only low returns and can barely keep pace with inflation over the long term.
- Higher-risk investments (e.g., stocks, corporate bonds, real estate, alternative investments) are more volatile but have historically delivered higher return potential.
Risk management, therefore, does not mean avoiding risks, but rather taking them on in a conscious, controlled, and targeted manner. A prerequisite for this is clearly identifying and measuring the various risks, because only what is defined can be managed.
“Risk arises when investors don’t know what they’re doing.”
– paraphrased from Warren Buffett
What is the purpose of risk management?
Risk management has three objectives: to protect capital, manage fluctuations, and optimize the risk-return ratio.
Capital protection limits significant losses, particularly during periods of crisis. Investors can remain invested and do not have to sell at rock-bottom prices. By managing fluctuations, the volatility of fund shares is limited so that it aligns with the target clientele’s risk profile. Optimizing the risk-return profile is not about asking, “How much return was achieved?” but rather, “How efficiently was the allocated or assumed risk utilized?”
Risk management is therefore not a hindrance but a control mechanism: it ensures that the fund can navigate even difficult market phases without losing sight of its long-term trajectory.
What risks need to be considered?
In the context of portfolio management, risks arise at multiple levels: from the organizational level through the overall market down to individual securities. The primary goal of a multi-asset fund portfolio manager is to capitalize on opportunities across many asset classes without allowing individual risks to dominate the overall picture. Before discussing the individual types of risk in detail, it is important to understand the difference between systematic and unsystematic risk.
In investing, every risk can be divided into two categories: systematic and unsystematic risk. Systematic risk, also known as market risk, affects all investments within a particular asset class or even the entire market. It arises from external factors such as economic cycles, changes in interest rates, inflation, geopolitical crises, natural disasters, or fundamental changes in the financial system. This risk cannot be eliminated through diversification within an asset class.
Non-systematic risk, on the other hand – also known as specific or idiosyncratic risk – affects individual companies, issuers, or industries. It arises from internal factors such as management errors, product failures, company-specific scandals, legal disputes, or industry-related structural changes. Unlike systematic risk, this risk can be significantly reduced or even largely eliminated through diversification.
It is important for investors to know that in the capital markets, a risk premium is paid only for systematic risk, since this is the only type of risk that is unavoidable. Unsystematic risk can and should be reduced through intelligent portfolio construction – there is no additional compensation for this. Systematic risk is primarily measured by the beta factor, which indicates how strongly a portfolio reacts to market movements. A beta of 1.0 means that, on average, the portfolio fluctuates just as much as the overall market. A beta above 1.0 indicates greater market sensitivity, while a beta below 1.0 indicates less.
The following section presents the most important types of risk in portfolio management in a way that answers the following questions for each: What is the risk? Is it more systematic or unsystematic? How is it measured, and how can it be managed?
Market risk describes the risk that the value of investments will fluctuate due to general market movements –for example, because stock markets fall, interest rates rise, currencies fluctuate, or commodity prices plummet. It represents the core of systematic risk and, in a multi-asset fund, primarily affects stocks, bonds, and commodity investments.
Market risk is primarily measured using volatility and loss metrics. The key metric is volatility, which is the statistical range of performance fluctuations. Other metrics include Value-at-Risk (VaR) and Expected Shortfall. These indicate the potential magnitude of a loss over a specific period with a given probability. Historical and hypothetical stress tests are used to simulate how the portfolio would have performed in crisis scenarios, such as a financial crisis, an interest rate shock, or a geopolitical escalation. In addition, betas and correlations to benchmark indices are used to analyze how strongly the portfolio reacts to market movements and how the individual components interact with one another.
In a multi-asset fund, market risk is primarily managed through asset allocation. The equity allocation, the average duration of the bond portion, the proportion of higher-risk segments (e.g., high yield, emerging markets), and the currency structure all influence how sensitive the portfolio is to market events. During favorable market conditions, market risk can be increased within defined limits. In tense market environments, it is reduced by lowering the net equity allocation, shortening durations, or reallocating to high-quality bonds or defensive sectors. In addition, equity index or interest rate derivatives can be used for temporary hedging to mitigate market risks without completely altering the strategic positioning.
Credit and issuer risk encompasses the risk that debtors – whether governments, corporations, or financial institutions – will be unable to make interest or principal payments as agreed. This risk has both systematic and unsystematic components. It is systematic when a broad economic or financial crisis causes many issuers to face difficulties at the same time. It is unsystematic when a single company defaults due to specific problems. In a multi-asset fund, this risk particularly affects corporate and government bonds. In addition to price risks, actual defaults or debt restructurings may also occur, leading to permanent losses.
To measure these risks, external and internal ratings, probabilities of default, loss given default, and market indicators such as credit spreads or CDS spreads are used. These metrics are incorporated into credit models that continuously assess an issuer’s credit quality. At the portfolio level, the impact of rating distributions, spread volatilities, and correlations on the overall portfolio is calculated. In addition, scenarios are analyzed in which multiple issuers are downgraded simultaneously or in which spreads spike sharply. This provides a better understanding of how the portfolio reacts in stress situations.
Credit and issuer risks are managed through strict diversification and clear limits. There are caps per issuer, per rating class, per industry, and per country. This prevents individual debtors or segments from dominating the overall risk – thereby effectively reducing unsystematic risk. Within these limits, care is taken to ensure sufficiently high credit quality, and riskier segments, such as high-yield or subordinated bonds, are used in a deliberately measured manner. If ratings, spreads, or internal credit assessments change significantly, positions can be reduced, sold entirely, or reallocated to more robust issuers.
Liquidity risk means that, while securities are valued theoretically, in practice they can at times be sold only at significant discounts – or not at all. This risk can have both systematic and unsystematic characteristics: it is systematic during market crises, when liquidity dries up across the board, and unsystematic for individual, infrequently traded securities. This risk is relevant to investors because a fund must always be able to honor redemptions without damaging the entire portfolio through fire sales.
Liquidity is measured, among other things, by bid-ask spreads, daily trading volumes, order book depth, and the estimated time it would take to liquidate certain position sizes in the market.
Liquidity risk is managed through a disciplined selection of securities whose underlying liquidity aligns with the fund’s liquidity requirements. If the situation deteriorates, the fund must gradually reduce positions that have become illiquid before an acute stress situation arises.
A concentration risk arises when a portfolio is overly focused on a small number of securities, sectors, countries, or themes. This risk is primarily unsystematic in nature, as it results from a lack of diversification. In a multi-asset fund, it can occur both within an asset class (e.g., only technology stocks in the equity segment) and across asset classes (e.g., high exposure to a country through stocks, bonds, and currencies).
Concentration risk is initially measured structurally through weightings: The proportions of the largest individual positions, issuers, sectors, countries, or themes are reported regularly and compared to defined upper limits. Risk contribution analyses are also used. These calculate the extent to which individual positions, sectors, or regions contribute to the portfolio’s overall risk. This allows for the identification of seemingly “small” components that nevertheless pose a significant risk due to high volatility and high correlation.
Concentration risk is managed through clear diversification guidelines and active rebalancing. In this process, it must be determined what the maximum weighting for individual positions may be and what ranges apply to sectors, regions, or themes. Escalation measures include both portfolio rebalancing and targeted investments in asset classes or segments that exhibit low correlations with the existing portfolio. This reduces overall concentration risk and actively mitigates unsystematic risk.
Currency risk arises when investments are made in currencies other than the fund’s reference currency. For example, if the euro appreciates against the U.S. dollar, a U.S. stock may lose value when calculated in euros, even if its price performance remains stable or is positive. Currency risk has both systematic and unsystematic components: Systematic factors include global interest rate differentials or macroeconomic trends, while unsystematic factors include country-specific events. In a globally invested multi-asset fund, currency risk is therefore an integral part of the return and risk profile. While foreign currencies can introduce additional volatility, they also offer opportunities for diversification and increase the potential for returns.
To measure this risk, open foreign currency positions are recorded for each currency and linked to historical volatilities and correlations with the fund’s currency. This allows us to calculate the extent to which currency risk contributes to the portfolio’s overall volatility and value-at-risk. By using various scenarios – such as a sharp appreciation or depreciation of certain currencies – the impact of such movements on the fund’s share price can be determined.
Currency risk is managed by deciding which foreign currency risks to deliberately assume and which to hedge. This creates a balance between additional diversification and manageable volatility.
Inflation risk refers to the danger that the purchasing power of an investment will decline because prices for goods and services are rising faster than the value of the portfolio. Since inflation is a macroeconomic phenomenon that affects all investors equally, this risk is systematic in nature. For investors, this means that a nominally positive return can be negative in real terms – that is, after adjusting for inflation.
Inflation risk is measured by comparing expected portfolio returns with current and expected inflation rates. Market-based indicators, such as break-even inflation rates derived from nominal and inflation-indexed bonds, help assess the inflation trend expected by the market.
Inflation risk is managed by integrating inflation-sensitive components into the asset allocation. These may include inflation-indexed bonds, real assets such as stocks, and selected commodities.
Operational risk arises from errors, inadequate processes, technical problems, or fraud – that is, from factors that are not directly related to market developments but can nonetheless lead to losses. Regulatory risk results from changes in laws, tax regulations, or supervisory requirements. These can affect the investment universe, the cost structure, or specific strategies. These risks are largely unsystematic in nature and primarily concern the internal organization and environment of individual fund companies.
Such risks are measured less by market metrics and more through internal control and reporting systems. These include statistics on incidents and losses due to operational errors, audit results, process reviews, and qualitative risk assessments. Regulatory risks are identified through monitoring of legal and compliance matters, scenario analyses, and assessments of the potential impacts of new regulations.
Operational and regulatory risks are managed through rigorous processes, clear lines of responsibility, the dual-control principle, independent control functions, and ongoing review of the legal framework. For investors, this means that, in addition to pure market expertise, the quality of the organization, systems, and governance is crucial to ensuring that the strategy can be reliably implemented.
What does this mean for investors?
It is important for investors in a multi-asset fund to understand that risks are not avoided but rather taken on in a targeted manner to generate long-term returns.
The distinction between systematic and unsystematic risk shows that some risks can be significantly reduced through intelligent diversification, while systematic risks must be consciously managed and compensated for through risk premiums.
A professional risk management process ensures that all risks are identified, measured, and deliberately managed. This keeps the portfolio within your risk comfort zone even during volatile market phases, while simultaneously offering realistic opportunities for long-term wealth accumulation.
The decision to take on risk is always accompanied by systematic measurement and monitoring. In this way, abstract “uncertainty” is transformed into a controlled process in which opportunities are exploited and losses are limited, without losing sight of long-term investment goals.
While risk management does not replace the need to focus on one’s own goals, it is a prerequisite for a fund to be able to meaningfully pursue those goals over many market cycles.
Note: This text was translated using AI and may contain translation errors. The German version of the text is authoritative.