It's important to understand the concept before looking at specific examples of systematic and unsystematic risk.

 

· Systematic risk is a non-diversifiable risk, otherwise known as market risk

· Unsystematic risk is diversifiable risk often referred to as investment-specific risk

 

In reality, systematic risk stands head and shoulders above unsystematic risk because it impacts the broader economies of the world and, ultimately, the markets. Now is probably the best time to look at specific systematic and unsystematic risk examples.

 

Systematic risk

 

Systematic risk is predominantly linked to macroeconomic events such as:-

 

Global recessions

 

Everything in the investment world is relative; therefore, in a recession, the economy shrinks, business falls, and ultimately, profitability will be impacted. So, even if a company is relatively strong within its sector, it will be affected by a reduced economy.

 

Geopolitical risk

 

Domestic and international political risk, often called geopolitical risk, can significantly impact investment markets due to the increased uncertainty. A lack of visibility makes investment planning and valuing companies on their future potential difficult.

 

Natural disasters

 

Some common examples of natural disasters include earthquakes and extreme weather conditions, which can impact local, national and international economies. For example, many areas in the US experience hurricanes, which can cause significant damage and disruption, not to mention costs to businesses and economies.

 

Monetary policies

 

There is a saying in the stock market: if the US sneezes, the rest of the world catches a cold, which is perfectly reflected in monetary policy. You will notice that global interest rates are heavily impacted by changes in the US, which is the leading global economy. Where the US leads, the rest tend to follow.

 

Currency issues

 

Over the years, we have seen many seismic currency issues emerge, such as "Black Wednesday", when the UK was forced to exit the European Exchange Rate Mechanism. Interest rates increased to 15% before the UK government was forced to throw in the towel and let the pound float on currency markets.

 

Global pandemics

 

The most obvious example is Covid-19 and its monumental impact on the global economy, the repercussions of which are still being felt today.

 

Unsystematic risk

 

Unsystematic risk tends to be associated with individual companies or sectors. Diversification is a valuable means of reducing unsystematic risk, but there will always be a degree of risk. Some of the more common types of unsystematic risk include:-

 

Operational risk

 

This type of risk is specific to one investment and how a company operates. However, another example is how your discretionary fund manager makes investment decisions.

 

Industry risk

 

Without risk, there is no reward, so all industries and all individual companies carry a degree of risk. Industry risk is the challenges facing a specific sector/industry instead of individual companies. For example, the oil and gas industry would be impacted if the use of oil and gas was to fall significantly in the future.

 

Business risk

 

Within any business/industry, there will be a range of target markets and risk/reward ratios. Business risk relates to the specific risks associated with how an individual company is set up and how risk is managed. For example, loss-making technology companies may be favoured when economies are growing. However, they tend to be impacted more by economic downturns because of their short term prospects - they may not be expected to make a profit until years down the line.

 

Regulatory risk

 

Whether we are looking at online sales, banking or, for example, businesses focused on cryptocurrency trading, regulatory risk tends to impact the broad industry. For instance, regulators worldwide are clamping down on cryptocurrency trading, which has affected the perceived value of trading platforms. In basic terms, the regulatory risk is that the regulator/government will move the goalposts for the industry.

 

Summary

 

While markets are ultimately influenced by supply and demand, it's crucial to recognise unsystematic and systematic risk. It also casts an essential light on diversification, which can at least help with unsystematic risk. Ask your adviser about their views on current systematic and unsystematic risks if in doubt.

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