Active risk refers to the potential for deviation or underperformance of an investment portfolio compared to its benchmark or intended target. It arises from the active management decisions made by portfolio managers who aim to outperform the market rather than passively replicating a benchmark.

Active risk is a measure of the volatility or variability of returns that can result from active investment strategies. It indicates the level of uncertainty or potential downside associated with pursuing active management.

Key Matters and Considerations in ESG

When a portfolio manager makes active investment decisions, such as selecting specific securities, adjusting sector weightings, or timing market entry and exit points, they introduce active risk. These decisions can result in either positive or negative performance outcomes compared to the benchmark.

The magnitude of active risk depends on various factors, including the level of active management pursued, the investment strategy employed, the manager’s skill and expertise, and market conditions. A higher level of active risk typically indicates a more aggressive or active investment approach.

Investors who seek higher potential returns may be willing to accept higher active risk in their portfolios. However, it’s important to note that active risk also increases the potential for underperformance or higher losses compared to the benchmark.

To manage active risk, portfolio managers may employ risk management techniques, such as diversification, portfolio hedging, and ongoing monitoring and evaluation of investment decisions. Additionally, investors can assess the historical performance and risk measures of a portfolio to understand the level of active risk taken by the manager.

Active risk is an inherent component of active investment management, and portfolio managers strive to strike a balance between generating potential outperformance and managing the associated risks. By carefully monitoring and managing active risk, investors aim to achieve their investment objectives while considering the potential for both positive and negative outcomes.