Comparing Systematic vs Unsystematic Risk in Indian Markets

• Risk is a part of daily life for all of us, including individuals and big companies. It is important to understand different types of risk so we can lessen the damage.
• There are many risks, including financial, operational, strategic, and reputational risks. In this article, I’ll explain these risks and share some tips on how to handle them.
• Knowing each risk and its effect on you or your company can help you take action to prevent bad results. A good plan and proactive steps make it possible for businesses to be ready for any risk that might happen.
• Now, let’s start talking about different types of risk.

What is a Risk?

• Risk is when you do something or invest in something that might make you money but could also lead to a loss.
• This can happen in many parts of life, like in business, putting money into stocks, or even in your personal choices. Generally, risks can be about money issues, like buying stocks, or about physical things, like driving a car.
• By planning carefully, you might be able to handle these risks better or reduce the chances of losing. Understanding risk and how to deal with it can help you make smarter choices when things are uncertain.

Systematic vs. Unsystematic Risk

Basis for Comparison	Systematic Risk	Unsystematic Risk
Meaning	Hazard associated with the market or market segment as a whole.	The risk associated with a particular industry or security.
Nature	Uncontrollable	Controllable
Factors	External factors	Internal factors
Affects	A large number of securities in the market	Only particular company
Types	Interest risk, market risk, purchasing power risk	Business risk, financial risk
Protection	Asset allocation	Portfolio diversification

What is  Systematic Risk?

• Systematic risk, also known as market risk, is the risk that affects the entire market or a broad segment of it rather than a particular stock or industry sector, including real estate. 
• This risk is inherent to the entire market and cannot be diversified away. It is typically caused by macroeconomic factors such as inflation, exchange rates, political instability, and natural disasters. In the context of commercial real estate in India, changes in property tax laws or steep inflation could be examples of systematic risks. 
• Systematic risk is not like other financial risks. It’s everywhere, always there, and touches every part of the market. That means anyone or any group involved in a market feels its effects. Systematic risk happens because of things outside of a company’s or person’s control, not because of what one company or person does.

What is Unsystematic Risk?

Systematic risks have the potential to impact the whole market if losses occur, whereas unsystematic risks are confined to a particular security type or a single investment instrument. 

Unsystematic risk is also known by other names, such as specific, residual, and diversifiable risks.

For example, a poor choice of location, construction delays, or decreased demand for office spaces are unsystematic risks.

What are some other types of risks?

In addition to systematic and unsystematic risks, there are other types of risks that investors should be aware of, such as liquidity risk, political risk, operational risk, legal or regulatory risk. 

• Liquidity risk occurs when an investor cannot convert their investments into cash quickly and easily and can arise from illiquid markets or low trading volumes. 
• Political risk is the chance that a government’s actions could affect the value of an investment and can include war, civil unrest, changes in tax laws, and other events out of investors’ control. 
• Operational risk involves the possibility of losses due to inadequate operations processes, equipment failures, human errors, or fraud.
• Legal or regulatory risk is related to the potential for a government to enact laws that adversely affect the value of an investment, such as changes in tax laws, controls on foreign investments, or limits on particular kinds of investments.

How to manage systematic risk?

Investors should make sure their portfolios contain a variety of asset classes, such as cash, real estate, and fixed income, each of which will react differently in order to successfully manage systematic risk.

1. Diversify your portfolio: Investors can reduce systematic risk by investing in various asset classes, such as cash, real estate, and fixed income, each of which will react differently in the event of a significant systemic change. 

For example, an increase in interest rates will make certain new-issue bonds more valuable, while causing some corporate stocks to fall in price. To reduce the loss of value in some stocks, make sure a portfolio has enough income-producing securities in case interest rates rise. 

2. Hedge against systematic risk: Investors can hedge against systematic risk by using financial instruments such as options, futures, and swaps. These instruments can help protect against losses in the event of a market downturn.
3. Use proper asset allocation strategy: Investors can use asset allocation strategies to manage systematic risk. For example, an investor may choose to allocate a certain percentage of their portfolio to low-risk assets such as bonds and a certain percentage to higher-risk assets such as stocks. This can help to reduce overall portfolio volatility.
4. Stay informed: Investors should stay informed about global economic and political events that can impact the market. This can help them anticipate and prepare for potential systemic risks.
5. Use risk management tools: Investors can use risk management tools such as stop-loss orders, limit orders, and trailing stops to manage systematic risk. These tools can help limit potential losses in the event of a market downturn.

How To manage unsystematic risk?

• Spreading Out Investments: To lower the risks that come with investing in just one company or industry, you can spread your investments over different types of assets, sectors, or even countries. This way, if one area performs poorly, the good performance of others can help even things out.
• Doing Your Homework: Before investing in a company, it’s key to really investigate its background. Check out its financial health, leadership quality, how it compares to competitors, and any legal or policy challenges it might face. This deep dive can help you avoid risky investments and make smarter choices.
• Keeping a Close Eye: Actively managing your investment portfolio can help reduce risks that are specific to certain investments. This means regularly reviewing what you’ve invested in, reassessing how risky each investment is, and making adjustments when the market or a company’s situation changes.
• Transferring Risk: You can also handle specific risks by passing them off to another party. For example, buying insurance can cover losses from unexpected events that affect your business, or using financial products like derivatives can protect you against certain risks. Using this strategy alongside others can be very effective.
• Choosing Where to Invest Wisely: Deciding how to divide your investments should be based on how much risk you’re comfortable with, your investment goals, and how long you plan to invest. Since individual investments can be affected by specific risks, managing these risks carefully can help you achieve a good balance of risk and potential reward tailored to your investment goals.

Bottom Line

Understanding the nuances between systematic and unsystematic risks in the context of India could be the key to unlocking your success in commercial real estate in one of the largest and fastest-growing markets in the world.  

By managing systematic and unsystematic risks, investors can increase their chances of achieving their investment goals and reducing the impact of market volatility on their investments.

Assetmonk is a pioneer in alternative real estate investment, and we understand the immense potential in the Indian commercial real estate industry. We make alternative assets, such as real estate, more accessible. We have customized investment options to suit individual financial goals like passive income capital appreciation and portfolio diversification. 

Our expertise is identifying opportunities with high yields within the retail, office, and industrial asset classes. This enables our investors to maximize profits while diversifying their portfolios. 

We offer various alternative investment options, such as fractional or joint ownership of high-end commercial properties, sub-leasing ventures, etc. Trophy locations with the potential for high Internal Rates of Return (IRR) are prioritized, and due diligence is done to ensure these provide profitable returns for our investors. 

FAQs

Q1. How can Indian investors navigate systematic and unsystematic risks in India’s growing economy?

A. Indian investors can navigate these risks by staying informed about macroeconomic trends and company-specific developments. Implementing a balanced investment strategy that includes a mix of asset classes and sectors can help mitigate risks. Employing hedging techniques and maintaining a long-term investment perspective may also provide resilience against market volatility.

Q2. Can diversification help manage unsystematic risk in India’s real estate and equity investments?

A. Yes, diversification can be a highly effective strategy for managing unsystematic risk in India’s real estate and equity investments. By spreading investments across different sectors, geographical regions, and asset classes, investors can reduce the impact of negative performance in any single investment.

Q3. How significant is the impact of unsystematic risk on the Indian stock market?

A. The impact of unsystematic risk on the Indian stock market can be quite significant, particularly for individual stocks or sectors. For example, a regulatory change affecting the telecommunications industry would impact companies within that sector differently from the rest of the market. Investors need to conduct thorough company-specific research to mitigate unsystematic risks.