Even when your clients build diversified portfolios, systematic risk is still present. It is tied to events that affect the entire market, not just a single security. As a financial advisor, understanding this type of risk is vital when setting expectations and building strategies that can handle market shocks.
In this article, Wealth Professional Canada will explore what systematic risk is, how it differs from unsystematic risk, and how it shows up in real life. Want to see the latest systematic risk news from our team? Feel free to scroll below!
Systematic risk is the part of total risk that comes from forces outside any single company or security. It is tied to the overall market and the economy. This risk arises from macroeconomic and financial drivers such as:
These events influence the prices of many assets at the same time. Even strong companies with healthy balance sheets can see their share prices fall when the whole market declines.
Because systematic risk comes from these external forces, it is often called undiversifiable risk and categorized into types such as market risk and inflation risk.
You cannot remove systematic risk simply by holding more securities. Even a well-diversified equity portfolio is still exposed to interest rate shocks, inflation surprises, or a global recession.
Financial advisors can help manage the impact through:
The goal is not to eliminate systematic risk (which is impossible) but to combine assets that respond differently when the macro environment changes.
Watch this video for more on systematic risk:
To become an award-winning financial advisor, you must be able to explain systematic risk in clear, relatable terms that your clients can easily understand. Using this glossary entry as an educational piece is a good starting point!
Here are four types of systematic risks that impact investments:
Let's discuss them further below:
Market risk is the tendency of security prices to move together. Investors often act in groups, following the prevailing market direction.
When the equity market falls, even companies with strong earnings and sound fundamentals usually see their prices drop. Market risk is a large part of overall systematic risk and is often what people mean when they talk about "the market being volatile."
Interest rate risk comes from changes in market interest rates. It is especially important for fixed income securities such as bonds and debentures, because bond prices move in the opposite direction to interest rates.
This risk has two related parts:
When interest rates rise, existing bond prices fall, creating negative price risk, but reinvested coupons might earn more. When rates fall, bond prices increase, but future reinvested income might earn less.
Purchasing power risk arises from inflation, which is a sustained increase in the general price level. This is why it's also often called inflation risk. When prices rise and income does not keep pace, the real value of that income falls.
Fixed income securities are particularly vulnerable here because they pay a fixed amount in nominal terms. If inflation is high, the real income your clients receive is worth less over time.
Equities are often considered better hedges against inflation because earnings and dividends can grow, but they are still influenced by the inflation environment.
Exchange rate risk applies in a globalized economy where companies and investors are exposed to foreign currencies. This type of risk affects:
A sharp move in exchange rates can help or hurt earnings when foreign revenues are converted back into the home currency. For securities that involve foreign currency exposure, this becomes another form of systematic risk that cannot be diversified within a domestic equity portfolio.
If you want to know how sensitive a particular security or fund is to systematic risk, beta is a useful measure. This compares the volatility of an investment with the volatility of the overall market.
A beta that is greater than one means that the investment tends to move more than the market. If it is less than one, it tends to move less. If it is equal to one, the investment tends to move in line with the market.
For a financial advisor, beta can support decisions about whether a security fits your clients' risk tolerance and investment objectives. It also reinforces the idea that some risk is tied to the market itself and not just to company-specific news.
Short answer: no. Systemic risk is defined as the chance that a particular event triggers a severe shock to the entire financial system. It is related to, but distinct from, systematic risk.
Your clients might hear these terms used interchangeably, so it is helpful to make the distinction in your conversations.
To understand systematic risk better, it helps to contrast it with unsystematic risk. Both are parts of total risk, but they come from different sources and behave differently in a portfolio.
As discussed above, systematic risk:
This is the risk that inflation will surge, that a recession will hit, or that interest rates will rise sharply. It is always present when your clients invest in the market, and it is the risk they are compensated for taking.
Unsystematic risk is the opposite. It is tied to the "idiosyncrasies" of a particular company or industry. Examples include:
This kind of risk affects a narrow set of securities instead of the market as a whole. The important point is that unsystematic risk can be reduced or nearly eliminated through diversification.
As a financial advisor, when you spread investments across many companies, sectors, and even asset classes, the impact of any single company event becomes smaller. A problem at one firm might be offset by strong results at another.
If an investor holds a portfolio with both types of risk and expects to be rewarded for each, it makes sense to diversify. When they diversify across many securities that do not move together, they reduce or almost remove unsystematic risk. What remains is systematic risk.
In an efficient market, investors are not rewarded for risks they can easily avoid. Unsystematic risk is diversifiable, so there is no extra expected return for taking it. If an investor kept adding more diversifiable risk without diversifying, the added risk would not increase expected returns.
Systematic risk is different. It cannot be diversified away, so investors do receive compensation for bearing it. The expected return on a security is linked to its exposure to this market-wide risk, often expressed through beta.
For your clients, this means that building a diversified portfolio can help remove company-specific risk. It also implies that the return they expect over the long run is compensation for the remaining, non-diversifiable risk.
Unsystematic risk still matters in a concentrated portfolio, but it is not something investors are paid to take. Watch this video to learn more about systematic risk versus unsystematic risk:
With the prevalence of systematic, unsystematic, and other kinds of investment risks, it's critical to know your clients' real risk appetites. This will help you provide a more personalized service and as such, build your credibility as a financial advisor.
Systematic risk is an unavoidable part of investing in public markets. It arises from macroeconomic, political, and financial events that influence the entire market or large segments of it. For financial advisors, the real value lies in helping your clients stay committed to suitable strategies even when systematic risk is present.
When your clients understand that some risk cannot be diversified away, but that they are compensated for bearing it, short term swings become easier to accept. Combined with realistic discussions about asset allocation, income generation, and diversification, this understanding supports more resilient behaviour during market downturns.
In the end, systematic risk is not something to avoid at all costs. It is a big part of how markets work and how returns are earned over time. Your role is to help clients take the right amount of this risk, in a way that fits their goals. Prepare them for the inevitable periods when those risks become very visible.
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