Business Studies Paper on Diversification in Risk Management

Diversification in Risk Management

Risk is inherent in all business  sectors  including energy, housing, hospitals, supply chains, airport security, and infrastructure. Risks, both internal and external, can directly or indirectly affect an enterprise’s performance. Direct risks may include natural disasters such as fires and floods,  legal matters including insurance,  technological hitches,  environmental issues as  chemical spills,  and market fluctuations among others (Institute of Risk Management, 2018). Indirect risks may feature scenarios that affect suppliers or customers. Such situations can result in the lack of or inadequate stock or reduced demand for the goods and services that a corporation offers. Therefore, it is important to identify and assess risks and develop effective strategies to minimize them. The process of reducing threats is called risk management. One risk management strategy is diversification. HowRu, a private card organization, can diversify its portfolio to lessen the risks that it may face.

Diversification and its Importance in Risk Management

Diversification is a technique aimed at maximizing returns and lowering risks by allocating investment in a wide variety of financial instruments and industries (Lumsden, 2012). Business research and some mathematical models prove that reduction in costs as well as the risk element can be achieved if a company follows diversification    of an average of 25 stocks  (Lumsden, 2012).

The diversification of a portfolio is critical since it brings numerous benefits to an organization. Firstly, it lowers the overall risk. For instance, if company A has put  all its investments in a single stock and the stock loses a 60% value, the corporation will lose  60% of its portfolio. On the contrary, if enterprise B had invested only 3% of its portfolio in the same stock, a 60% loss would not have had a big impact on the portfolio. Secondly, diversification augments opportunities. While increased prospects mean exposure to more risks, it gives investors a chance to invest in areas that they would not have otherwise  because it is not their comfort zone. For example, an individual may be inclined to invest in the US stock market, but a lucrative opportunity arises in real estate. Diversification will allow the person to expand the investments to the real estate field, which would enable him or her to yield higher returns. However, investors should be keen not to over-diversify their portfolio because it can harm investment returns. The most recommended number of individual investments is between 12 and 25. This range, according to analysts, is sufficient to reduce unsystematic risk (Institute of Risk Management, 2018).

Steps to Diversify HowRu

  • Spread the money between various asset classes

Various assets tend to perform differently at distinct stages in the economic cycle. Therefore, HowRu should understand the benefits and risks of individual asset classes to establish strategies that maximize returns and lower the risks. Investing in multiple asset classes will lower the volatility of the overall returns since losses from one asset class will be neutralized by high returns of the other (Lumsden, 2012). These classes may include real estate, bonds, commodities, and equities.

  • Allocate assets in both high-risk and low-risk assets

High-risk assets have higher returns while low-risk assets deliver low returns. Since high-risk investments are quite volatile, HowRu can also invest in low-risk assets with lower short-term volatility to offset the risk.

  • Diversify between industry sectors

Sectors perform differently during different economic times. Furthermore, some sectors are more volatile than others. For instance, before the dot.com bubble in 2001 the technology sector had performed well and attracted huge investments. However, the sector experienced a massive crash after 2001, leading to great losses. Consequently, it is convenient to invest in various stocks to achieve growth.

  • Diversify in both local and international markets since the peak of the local and global market are at different times. HowRu can reduce its exposure to one market by allocating assets in both local and international markets.
  • Diversify between funds and product providers. HowRu can first research the market situation to get the appropriate mixture of investment options from a wide range of providers (Lumsden, 2012).

Fund Allocation for HowRu Company

The key elements that control asset allocation are expected return, risk, and correlation. For its new investments, HowRu can allocate the funds in the following asset classes

  • Equities (shares), which have historically outperformed options such as bank accounts and bonds as safer investments. HowRu can issue shares to raise more money from investors.
  • Property/real estate. Both commercial and residential properties are excellent drivers of growth in an investment portfolio. The organization in question can allocate funds in commercial property.
  • Various commodities exist in both local and international markets. These include oil and gas, agricultural commodities, and precious metals among others. HowRu can allocate funds in such commodities when their prices escalate.
  • When markets are rocky, cash can be the savior of business. HowRu can trade in currencies to increase its returns from cash when the interests are low.
  • The mentioned business can offer bonds, also known as fixed income stocks to acquire money from investors. Bonds pay fixed interest rates.
  • Alternative investment. Alternative investments are alternative asset classes such as hedge funds and bitcoins. They are mostly offered by high net worth individuals or institutional investors.

These suggestions can be helpful for HowRu company in the field of fund allocation.

 

 

References

Lumsden, G. (2012, Feb 20). The 5 asset classes funds invest in. Citywire Money. Retrieved from http://citywire.co.uk/money/the-5-asset-classes-funds-invest-in/a568135

Institute of Risk Management. (2018).About risk management. Institute of Risk Management. Retrieved from https://www.theirm.org/the-risk-profession/risk-management.aspx