What Are The Types Of Risk In Portfolio Management, And How To Manage Them?

22-Sep-2025
11:00 AM
Types of Risks in Portfolio Management
Table of Content
  • What Does Risk Mean in Portfolio Management?
  • Types Of Risks In Portfolio Management
  • How To Manage These Portfolio Risks?
  • Conclusion

Irrespective of over 21 crore people investing in the market, there is always some risk involved. If ignored and unanswered, your entire portfolio can face a huge risk. With time, these hindering threats can silently eat away at your returns, destabilize your financial goals, and even push you towards unexpected losses.

And that's where portfolio risk management comes into play!

But here's the catch. Risk management is incomplete without first identifying the exact type of risk that's eroding your portfolio returns. That's the first and most crucial step.

In this blog, we'll break down the meaning of risk in portfolio management, explore the 14 different types of risks you must be aware of, understand how to measure them, and learn practical strategies to manage them effectively.

Keep reading!

What Does Risk Mean in Portfolio Management?

In portfolio management, risk refers to the uncertainty of returns and the possibility of financial loss. Simply put, it is the potential that an investment may deliver outcomes different from what was expected - particularly lower or negative returns.

If risks are not properly managed, they can significantly erode portfolio value and, in extreme cases, cause severe losses. Hence, identifying and mitigating risks is central to successful portfolio management.

Types Of Risks In Portfolio Management

With respect to your investments and assets, there are different types of risk in portfolio management. It includes;

  1. Market Risk

    Also known as systematic risk, Market Risk consists of all those market-related factors that can drain your portfolio. In short, if the financial market performs poorly (in any case), your portfolio will suffer losses.


    Examples:

    Recession, inflation, geopolitical tensions, global economic slowdown, or currency volatility.

    Impact:

    An equity-heavy portfolio will likely fall in value during a market crash, regardless of stock-specific fundamentals.

  2. Operational Risk

    As the name suggests, Operational risk is subject to any risk arising from the operations of the business. Now, it can include the company's operations (such as audits) or even a delay in the fund manager's strategy execution.In the case of portfolio management, it can also mean delays in a fund manager's strategy execution or mismanagement in following the set investment plan.


    Examples:

    Trading errors, delays in portfolio rebalancing, regulatory non-compliance, fraud, or cybersecurity breaches.

    Impact:

    A back-office error or poor execution of strategy can directly reduce investor returns.

  3. Fundamental Risk

    Fundamental risk arises when the core financial health or performance of a company or asset weakens, leading to a decline in its value. Unlike market risk (which affects all stocks broadly), this risk is company-specific and tied to business performance, earnings, debt levels, or management efficiency.


    For instance:

    if a company has reported poor quarterly (or annually) results, the impact will be visible on the stock price – even if the overall market is performing well.

  4. Sectorial Risk

    Any risk specific to a sector/industry is known as "Sectoral Risk." Unlike market risk, which affects the entire economy, sectoral risk impacts only certain sectors due to factors unique to them.

  5. Concentration Risk

    In case a major concentration of portfolio stays in one asset, it is known as "Concentration Portfolio Risk." It means a fund manager allocates a huge proportion of funds to a certain asset.


    For example,

    suppose a portfolio follows a 50-30-20 asset allocation, and 50% equity concentrates more on the technology sector. A sudden slowdown in the tech industry or unfavorable government policies can cause significant portfolio losses.

  6. Liquidity Risk

    In situations where any investment cannot be redeemed or converted to money easily, "Liquidity risk" arises. It doesn't allow you to sell securities easily, making it problematic when you need funds during emergencies.


    For example,

    if you've invested heavily in real estate or low-volume stocks, finding a buyer at the right price may take time. In such cases, you may be compelled to sell at a discount, resulting in losses.

    Similarly, during market downturns, even otherwise liquid assets may not fetch fair value immediately.

  7. Event Risk

    While market risk covers a bird's-eye view, Event Portfolio Risk is more specific to major events happening in the market. These events are often sudden, unpredictable, and can trigger sharp volatility.


    For example,

    events such as corporate scandals, sudden mergers or acquisitions, natural disasters, terrorist attacks, or even global pandemics (like Covid-19 pandemic) can severely impact certain companies or entire markets.

    Due to its uncertainty, the company's stock may plunge overnight if it faces a major lawsuit, or oil prices may spike due to geopolitical tensions in the Middle East.

  8. Regulatory Or Political Risk

    In portfolio management, Regulatory Portfolio Risk refers to the impact (or losses) resulting from new policies proposed by the government.


    These changes can be specific to an industry/sector and can severely influence the stock price and related companies.


    For instance,

    the recent 2025 ban on the online gaming industry in India led to an immediate decline in the stocks of gaming companies. A good example is Dream11 (Sporta Technologies Private Limited, the parent company).

    In such cases, the impact also reaches tech service providers, payment platforms, and advertisers tied to the sector, showing how one sudden policy change can ripple across multiple industries.

  9. Inflationary Risk

    Often, Inflation Risk erodes the purchasing power of customers/consumers and investors. And when it rises rapidly, multiple industries and markets get impacted.


    For instance,

    if petrol prices rise due to inflationary pressure, the automobile sector takes a direct hit, and demand for vehicles may drop as running costs increase. At the same time, logistics and transportation companies face higher expenses, which can weigh down their profitability and stock performance.

    Similarly, a sharp rise in steel prices not only affects the construction industry directly but also increases costs for the automobile and real estate sectors, since steel is a key raw material in both.

  10. Credit Risk

    While the other types of portfolio risks majorly concentrate on the equity side, certain risks (like credit risk) also pertain to the debt securities.

    Credit Portfolio Risk refers to the losses occurring from the default of the issuer of debt securities held in a portfolio. So, if a major portfolio of your portfolio contains high-risk or low-quality debt instruments, you will face this credit risk.

  11. Interest Rate Risk

    Interest rate risk refers to the impact of changing interest rates on the value of fixed-income securities like bonds, debentures, and fixed deposits. Since bond prices and interest rates move inversely, a rise in rates reduces the market value of existing bonds, while a fall in rates increases it.

    • Example:When interest rates rise, existing bond prices fall, as newer bonds offer higher yields.
    • Impact:Investors holding long-duration bonds face mark-to-market losses.
  12. Currency Risk (Exchange Rate Risk)

    Currency risk arises when a portfolio has exposure to foreign assets and is therefore influenced by fluctuations in exchange rates. Even if the underlying investment performs well, changes in currency values can erode or amplify returns when converted back into the investor’s home currency.

    • Example:An Indian investor holding U.S. equities may see gains in dollar terms, but a weakening USD against INR will reduce returns when converted back.
  13. Climate & ESG Risk

    Seasonal changes in the climate give rise to Climate Risk in a portfolio. This type of risk impacts different industries in various ways, depending on the services or products they deal in.


    For example,

    an unusually long monsoon can hurt the construction and real estate sectors (or company stocks) due to project delays, while benefiting the agriculture sector by boosting crop yields. On the other hand, extreme heatwaves may reduce demand for outdoor tourism but increase sales in the beverage and cooling appliance industries.

  14. Reinvestment Risk

    Reinvestment Risk arises when the returns earned from an investment (like interest, dividends, or bond maturity proceeds) cannot be reinvested at the same rate of return.

    This portfolio risk usually occurs in falling interest rate environments, where investors are forced to reinvest at lower yields, reducing their overall income.


    For example,

    if you hold a fixed deposit or bond that matures when interest rates have declined, you won't be able to reinvest the principal at the earlier, higher rate. Similarly, dividend payouts from stocks during low market cycles may not find equally rewarding reinvestment opportunities.

How To Manage These Portfolio Risks?

No portfolio is entirely risk-free. Even the most conservative investments carry some degree of risk. The key is not to eliminate risk altogether, but to manage, diversify, and align it with investor goals and tolerance levels.

Effective risk management ensures that portfolios are better positioned to withstand shocks while still pursuing long-term growth.

Key Strategies in Portfolio Risk Management include:

  1. Diversification

    By spreading investments across multiple asset classes, sectors, geographies, and time horizons, diversification helps reduce concentration risk. This way, underperformance in one area can be balanced by stability or gains in another.

  2. Strategic Asset Allocation

    Here, the portfolio managermay re-allocate assets in your portfolio with a mix based on goals, age, and market conditions. Proper allocation ensures that risk exposure remains consistent with the investor’s profile.

  3. Portfolio Rebalancing

    Instead of rare visits, periodically adjusting holdings can maintain the desired asset allocation and control risk drift.

  4. Stress Testing

    Testing your portfolio against "what if" scenarios (like market crashes, interest rate hikes, or inflation spikes) is what "Stress Testing" means.

    • Historical Testing:Applying past crises (e.g., 2008 financial crisis, COVID-19 crash).
    • Hypothetical Testing:Modeling “what if” events like a sudden interest rate hike, commodity price spike, or geopolitical conflict.
  5. Dollar-Cost Averaging

    Invest fixed amounts (instead of a huge lump sum) regularly to minimize the impact of volatility and avoid timing the market. Over time, it helps average out the purchase price of investments.

  6. Quantitative Model

    Quant models are popularly used to assess, measure, and predict the probability and impact of risks in various sectors.

    These models are inclusive of data-driven algorithms, mathematical formulas, and statistical methods for more accuracy.

  7. Back Testing

    Generally, Backtesting is done to check if the model's predictions are in line with the realised data. In short, it uses historical market data to evaluate how it would have performed under different conditions. Though it is important to remember that past performance does not guarantee future results.

  8. Risk Budgeting

    As the name details, Risk budgeting is all about finding an investor's risk tolerance level and goals, and then allocating assets based on it.

  9. Stop-Loss & Price Targets

    Setting price targets (as a stop loss) to automatically sell them is what this strategy means. These predetermined entry/exit targets can insulate a portfolio from steep losses.

Conclusion

In portfolio risk management, there are several risks associated with market, political, inflationary, interest rate, and credit risk. However, some risk signifies how larger and indirect the impact can be, whether climate or reinvestment risk.

But, with all said, assessing, evaluating, and implementing risk management strategies (like diversification, backtesting, and quant models) can manage these portfolio risks.

FAQs

What Is Portfolio Risk Management?

In simple terms, Portfolio Risk Management is a process of identifying, evaluating, and assessing risks within a portfolio and developing a strategy to mitigate its concentration.

How to assess different types of portfolio risks?

One can use different tools and ratios like Standard Deviation (Volatility), Beta, VaR (Value at Risk), Sharpe ratio, Treynor ratios, etc., to assess risks in a portfolio.

Disclaimer:The information provided in this article is for educational and informational purposes only. Any financial figures, calculations, or projections shared are solely intended to illustrate concepts and should not be construed as investment advice. All scenarios mentioned are hypothetical and are used only for explanatory purposes. The content is based on information obtained from credible and publicly available sources. We do not guarantee the completeness, accuracy, or reliability of the data presented. Any references to the performance of indices, stocks, or financial products are purely illustrative and do not represent actual or future results. Actual investor experience may vary. Investors are advised to carefully read the scheme/product offering information document before making any decisions. Readers are advised to consult with a certified financial advisor before making any investment decisions. Neither the author nor the publishing entity shall be held responsible for any loss or liability arising from the use of this information.”

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