In an increasingly volatile world, it is important to understand the various types of risk that come along with each investment you make – in the hopes that your understanding will go some way to mitigating the overall risk of losing money.

Unsystematic risk is exclusive to a specific business or industry, it can also be referred to as non-systematic risk, specific risk, residual risk or diversifiable risk.

In reference to an investment portfolio, Unsystematic Risk can be mitigated through diversification.

This is a stark difference when contrasted with systematic risk, which is inherent in the market.

Understanding The Concept

Unsystematic risk can be defined as the as the indecision in a business or the industry investment.

Forms of unsystematic risk can include a new competitor in the market with the potential to claim substantial market share from the company you invested in, or even a regulatory change.

Whilst some investors may be able to predict some sources of unsystematic risk, there is an increasingly low chance of anticipating when or how this might occur.

For instance, an investor in biotechnology stocks may be aware that a breakthrough is within close proximity, however, the investor will not know what the breakthrough is until it happens.

Therefore, the investor in biotechnology will not understand how consumers or the market will act.

Company-Specific Risk

Two fundamental factors contribute to company-specific risk, both of which the investor has no chance of controlling or decreasing.

Business Risk

Both external, as well as internal issues, have the possibility of contributing to a business’s risk.

Internal risk related to the operation efficiency of the business and their ability to act productively throughout the transformation processes.

For example, a company paying far too much for its natural resources would be considered a business risk when investing.

The external business risk that is key to investors is legislation that might affect the bottom line of the company.

Financial Risk

Financial risk is the other key company-specific risk factor.

Financial risk relates to the capital structure of the business, such as optimal levels of debt and equity – aspects crucial to growth and meeting financial objectives.

A fragile capital structure can potentially lead to inconsistent revenue and cash flow that could negatively impact earnings.

Outside business risk and financial risk there are also other unsystematic risk factors investors should consider, such as operational risks, strategic risks and legal and regulatory risks.

Operational risks can occur from unforeseen or negligible events such as the failing of a key supply chain or a manufacturing error that was overlooked during the design process.

A security breach might even occur, exposing company trade secrets and putting the future revenue of the company at risk.

A strategic risk that may occur is when a company corners itself into selling products to a dying industry/market without a plan for future expansion.

Moreover, strategic risk within a business can also be associated with a company entering a flawed partnership that is detrimental to the business objectives.

Legal and regulatory risks can provide companies with a plethora of liabilities and forthcoming lawsuits from customers, suppliers and competing businesses.

Companies can have a hard time guarding themselves against the actions of law enforcement, something which can seriously affect their bottom line.

Unsystematic Risk – An Example

An investor who owns a variety of different stocks will lessen the ability of one position to negatively impact their portfolio, therefore lowering the amount of overall unsystematic risk within their investments.

However, if an investor was to only purchase airline shares, they would be open to a large amount of unsystematic risk from various events such as outbreaks or oil prices.

The investor that owns majority airline stocks can add uncorrelated holdings to her portfolio outside of the aviation industry.

This is the process of diversification – a tool that is at the forefront of reducing unsystematic risk amongst investors portfolios.

Risk, Risk, Risk

All investments are risky – you’ll know that by now.

There is always a chance of losing your initial investment capital, however, seeing as there is no possible way to completely eliminate risk, investors must do the next best thing by reducing their susceptibility to different types of risk.

Researching companies before you invest is always a smart action to take to ensure that you are across as much of the potential business-specific risk as possible.