Understanding Market Exposure: Risk & Portfolio Allocation

Market exposure refers to the absolute amount of funds or the percentage of a portfolio that is invested in a given security, or a bundle of securities that are part of the same industry or market sector. It is usually expressed in the form of a percentage of the total securities held by a portfolio. It is a representation of the amount of money that an investor may lose due to risks associated with a given investment.

The higher the market exposure, the higher the risk associated with the specific security, industry, sector, or investment area. Exposure to risk determines how the assets are divided in a particular investment portfolio. Separating investment classes in such a manner enables investors to mitigate the risk.

Summary

• Market exposure refers to the absolute amount of funds or the percentage of a portfolio that is invested in a given security, or a bundle of securities that are part of the same industry or market sector.
• It is expressed in terms of a percentage of the total portfolio holdings of an investor.
• Market exposure is different from financial exposure and mark currency exposure.

Other Types of Risk Exposures in Markets

Market exposure is different from financial exposure, which evaluates the amount of money that may be lost due to risks associated with a particular security. In the foreign exchange market, mark currency refers to the exposure to fluctuations in currency.

For example, currencies such as the dollar and euro, fluctuate a lot. Thus, if an investor based out of Greece makes an investment in the US stock market New York Stock Exchange (NYSE)The New York Stock Exchange (NYSE) is the largest securities exchange in the world, hosting 82% of the S&P 500, as well as 70 of the biggestand the dollar weakens as opposed to the euro, they may lose money.

Market Exposure according to Investment Type

A portfolio is a mix of several securities. Consider a situation where a portfolio consists of 60% bondsBondsBonds are fixed-income securities that are issued by corporations and governments to raise capital. The bond issuer borrows capital from the bondholder and makes fixed payments to them at a fixed (or variable) interest rate for a specified period., 25% stocks, and 15% derivatives, such as options. Thus, the market exposure to the stock market is 40%, given that both shares and derivatives are subject to stock market risks. However, since the risk exposure to government bonds is 60%, this particular investor stands to lose more from bonds than in stocks.

Market Exposure according to Region

When an investor examines their holding according to region, it includes the separation of domestic investments from those made in foreign markets. They can further divide their investments into foreign markets according to region.

For example, a portfolio may include 30% domestic and 70% foreign investments, 50% of which can be made in Asian markets, and the other half in European markets. Thus, the overall exposure to the eurozoneEurozoneAll European Union countries that adopted the euro as their national currency form a geographical and economic region known as the Eurozone. The Eurozone forms one of the largest economic regions in the world. Nineteen of the 28 countries in Europe use the euro will be 35% of the portfolio.

Market Exposure according to Industry

During a given set of market conditions, different industries may perform and react differently. Consider a situation where 60% of the investments are made up of stocks of companies that produce consumer durables while the rest are from the luxury goods industry. The fast-moving consumer goods (FMCG)Fast-Moving Consumer Goods (FMCG)Fast-moving consumer goods (FMCG), also called consumer packaged goods (CPG), refer to products that are highly in-demand, sold quickly, and affordable industry exerts more influence on the returns of the portfolio than the luxury goods industry.

Risk Management

It is important to consider the overall risk exposure of a given portfolio while determining asset allocation. It is because a focus on risk exposure can greatly increase returns or minimize losses.

Market exposure must be classified in accordance with the long-term investment objectives of the portfolio holder. For example, a risk-averse person may want to minimize risk and will create a diverse portfolio with both bond holding and corporate shares. It will be less risky than a portfolio that consists entirely of stock market securities. However, the latter may provide a higher return to the investor.

Industry experts usually recommend that portfolios must include a broad range of assets in order to avoid being overexposed to one sector or class of assets. For example, holding stock in a company in the hospitality industry doesn’t just expose the investor to fluctuations in the stock market. They are also exposed to the prevailing conditions in the industry,

Thus, if the investor wanted to avoid high market exposure to the oil industry because of a war in the Middle East, they will sell the holdings.

Additional Resources

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• Asset AllocationAsset AllocationAsset allocation refers to a strategy in which individuals divide their investment portfolio between different diverse categories
• Portfolio Turnover RatioPortfolio Turnover RatioThe portfolio turnover ratio is the rate of which assets in a fund are bought and sold by the portfolio managers. In other words, the portfolio turnover
• DiversificationDiversificationDiversification is a technique of allocating portfolio resources or capital to a variety of investments.The goal of diversification is to mitigate losses
• Investment PortfolioInvestment PortfolioAn investment portfolio is a set of financial assets owned by an investor that may include bonds, stocks, currencies, cash and cash equivalents, and commodities. Further, it refers to a group of investments that an investor uses in order to earn a profit while making sure that capital or assets are preserved.