What is a systemic risk?

Systemic risk refers to the risk inherent to the entire market or market segment. The opposite of systemic risk is non-systemic risk, which affects a very specific group of securities or an individual security. Although systemic risk is unpredictable and impossible to completely avoid, investors can manage it by ensuring their portfolios include a variety of asset classes. Let's review what systemic risks are and how to manage them if they happen.

What is a systemic risk

Systemic risk refers to risk inherent to the entire market or market segment. Systemic risk, also known as non-diversifiable risk, volatility risk or market risk, affects the entire market, not just to a specific stock or sector. Systemic risk is unpredictable and impossible to completely avoid. It cannot be mitigated by diversification, but only by hedging or using the right asset allocation strategy. Systemic risk underlies other investment risks, such as sector risk. For example, if an investor has placed too much emphasis on cybersecurity stocks, it is possible to diversify by investing in a number of stocks from other sectors, such as healthcare and infrastructure. However, the systemic risk incorporates changes in interest rates, inflation, recessions and wars, among other important changes. Changes in these areas can affect the entire market and cannot be mitigated by changing positions within a public equity portfolio.

graph 1

Graph representing systemic risk. Source: UOC.

Differences between systemic risk and non-systemic risk

The opposite of systemic risk is non-systemic risk, that affects a very specific group of values ​​or an individual value. Non-systemic risk can be mitigated through diversification. While systemic risk can be considered as the probability of a loss associated with the entire market or a segment of it, non-systemic risk refers to the probability of a loss within a specific sector or security. If you want to know how much systemic risk a specific security, fund or portfolio has, you can look at its beta, which measures the volatility of that investment compared to the broader market. A beta greater than one means that the investment has more systemic risk (i.e., higher volatility) than the market, while a beta less than one means less systemic risk (i.e., lower volatility) than the market. A beta equal to one means that the investment has the same systemic risk as the market.

How can we face systemic risk

Although the systemic risk It is unpredictable and impossible to avoid completely., investors can manage this by ensuring their portfolios include a variety of asset classes, such as fixed income, cash and real estate, each of which will react differently to an event that affects the broader market. For example, a rise in interest rates will make some newly issued bonds more valuable, while it will cause some company stocks to lose value. So that, Ensuring that a portfolio incorporates abundant income-producing stocks will mitigate the loss of value of some stocks.

Systemic risk example

The Great Recession is also an example of systemic risk. Anyone who was invested in the market in 2008 saw the values ​​of their investments change dramatically in the wake of this economic event. The Great Recession affected asset classes in different ways, as riskier securities (for example, those that were more leveraged) were sold in large quantities, while simpler assets, such as US Treasuries, appreciated. We have recently witnessed different bank failures in the United States, where different banking entities such as Silicon Valley Bank, Signature Bank, Silvergate Bank or the most recent First Republic Bank, have suffered bankruptcies that have led them to bankruptcy. These events have spread panic in global markets due to fear of a repeat of the contagion effect that occurred in 2008 with the systemic risk that caused the great crisis and the subsequent wave of bank bankruptcies around the world. Fortunately for us, this time the central banks have acted quickly and decisively to prevent the panic from spreading to other entities, in exchange for printing more money. This event has suppressed the progress made in subsequent months to combat the inflation that has plagued us for two years.

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List of the largest bank failures in United States history. Source: FDIC.


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