What are unsystematic risks?
Risk is one of the most important things to understand about investing, but not all risks are the same. In fact, there are a whole bunch of different types of risk.
Systematic risks (also known as market risks) are risks that affect the entire market or economy, like wars, recessions, and global pandemics (like COVID-19). These risks are considered inherent, and while it’s important to be aware of these risks, it can be hard to mitigate their potential impact on your investment portfolio.
Unsystematic risks are risks that are specific to a company or industry. These are risks that you might consider when you’re doing your due diligence on a company, and managing and diversifying your investment portfolio.
In this blog, we’ll look at five examples of unsystematic risk.
Strategic risk is the risk of a company being stuck with a product or service that it can’t sell because people either don’t want it anymore, or they can get it elsewhere at a better price, higher quality, or both.
Most companies need to constantly adjust what they offer, and how they offer it, to respond to changes in what people want, and what they can get elsewhere. If they don’t, the odds of losing value from strategic risk become higher.
For example, Blockbuster, an American company that rented out videos and DVDs, were doing great in the 1990s. But fast forward to today, and it no longer exists, thanks to competitors like Netflix. Blockbuster was renting videos and DVDs when customers wanted streaming services—and now, partly because of that, Blockbuster is gone.
Liquidity risk and solvency risk
Liquidity risk refers to a company’s ability to cover its short-term bills and debts, like paying employees and suppliers. It’s about whether the company has cash, or has the ability to quickly turn its assets into cash, to cover any short-term expenses.
Solvency risk refers to a company’s ability to cover its long-term debts, like paying interest on loans. If a company becomes insolvent (unable to cover its debts), it may need to make some changes to the business (like laying off employees, or selling off assets) in order to become solvent again.
One way to assess these risks is to check the company’s liabilities (what they owe) versus their assets (what they own); also known as liquidity and solvency ratios. You can find this info in the company’s annual report.
Laws and other regulations change all the time. These can have significant impacts on how some companies operate, and how much money they can make.
Regulatory risk has an impact on companies in tightly-regulated industries more than loosely-regulated industries. For example, banking, medicine, and cannabis are all examples of tightly-regulated industries, with lots of rules to follow. Companies in these industries may be subject to more regulatory risk than companies in less tightly-regulated industries.
Operational risk is the risk of a company being unable to deliver products or services to customers due to problems in its internal processes. One example is when car companies need to recall cars due to problems in the factories. These problems can come from internal processes, and they often cost a lot of money—so they may affect investors.
One way to assess operational risk is to look at a company’s track record. Does it have a strong record of delivering quality products to its customers, or have there been bumps along the way? However, it can be difficult to predict these risks and company track records don’t necessarily correlate to what the future holds.
Due diligence and diversification
These are just a handful of the risks that can exist when you invest in a company. As part of your due diligence, you can try to identify some of these risks by, for example, reading news articles about the company, or looking at the company’s annual reports.
For US companies specifically, you can search for the company on the US Securities and Exchange Commission (SEC) website, and find a list of ‘Risk Factors’ in the company’s ‘10-K (annual reports)’. These reports not only highlight the risks that the company may face, but also how the company plans to mitigate them.In saying that, it’s very hard to predict exactly what types of risk will affect which company, and to what extent they’ll be affected. That’s why it’s so important to diversify your investments and spread your risk, so you take less of a hit if one of those investments is impacted.
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.