Systematic and unsystematic risk are the two major categories of investment risk. The former is related to a single industry, whereas the latter is the overall risk associated with the market as a whole. Systematic risk can only be mitigated by completely avoiding market participation. Unsystematic risk, on the other hand, can be mitigated by diversifying your portfolio. You will learn about the most prevalent forms of unsystematic risk and examples of such risks in various sectors in this article.
Types of Unsystematic Risks
- A challenge to an organization’s growth caused by internal or external activities is known as a business risk. For example, a management strategy (internal factor) can result in underperformance.
- The risk of underperformance owing to operational activities is referred to as operational risk. Imagine a manufacturing company’s supply chain difficulties.
- Financing activities are the only cause of financial risk. It is the risk of losing money on financial investment. Needless to say, in the mortgage industry, this is a major risk.
- Regulatory risk refers to the probability of a negative impact on a business as a result of changes in a given industry’s regulatory framework. Financial services, telecommunications, and power are all susceptible to this risk.
Examples of unsystematic risks in different industries
- Cyclicality falls under business risk. Any business subject to cyclicality can see its performance change in sync with the economy. This indicates that if the economy is expanding, the industry also expands. However, if the economy is down, the industry’s growth shrinks. The idea behind this association is that some things are only purchased when a consumer’s disposable income is high. Still, they avoid such purchases when their finances are short because they are not necessary. The downturn in cyclical industries is one of the first indications of an economic slowdown, and as demonstrated in FY20, this is a critical risk in the automotive industry.
- The credit risk falls under financial risk. It is mostly found in the financial services business, and it refers to the risk of default that generally lenders face. Default risks arise for a range of factors, but in the microfinance sector, they are most often caused by the borrower’s poor credit profile because they serve the low-income and unbanked population. Another risk specific to the microfinance industry (MFI) is geographic concentration, as MFIs are often clustered. Geographical concentration comes with several risks, such as the potential of a natural disaster affecting the entire client base.
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To sum up, every industry has some level of risk. The best way to resolve these risks as an investor is to diversify your portfolio across multiple businesses, with different weightings allocated to different industries depending on your risk appetite.
Industries with low competition are susceptible to the pitfalls of competitive industry (business risk). When an industry has few entry barriers, it becomes more interesting to new entrepreneurs because the cost of entry is low, and the process is quicker. In businesses, where there is a lot of competition, margins are usually low because companies aim to gain a competitive advantage by lowering their prices. The logistic industry is most exposed to this risk.
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