Target Practice: Risk Budgeting 101

It's a familiar concept - here's how to make it a useful tool.

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1141303_62950284With the significant equity market downturn of the second half of 2008 and the subsequent upward rally of 2009, we are all spending more time analyzing the various risks embedded within our portfolios. We are all wondering whether or not there is a more effective way to manage and/or allocate risk. Perhaps risk budgeting can help.

Risk budgeting is a familiar concept among financial professionals but due to the numerous and obscure definitions for risk budgeting and due to the seemingly complicated calculations required to build such a framework, I would argue that it has not become a familiar tool among financial professionals. The first objective of this paper is to eliminate the obscurity by providing a rather simple definition for risk budgeting. The second objective is to provide you with some additive risks that can be easily calculated no matter how you wish to disaggregate your portfolio; and the third objective is to provide a few risk budgeting examples that can be immediately implemented. Read the entire article here from the Winter 2009 edition of Canadian Investment Review.

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