A Brief Note on Downside Risk

Downside risk refers to the likelihood or probability that a particular asset or security will fall in price. It is the potential loss that may arise as a result of a dip in the price of an asset as a result of changing market conditions.

The downside risk is generally measured by the downside deviation of returns. In this case, the minimum threshold or the minimum acceptable return taken into account for the computation is zero. Downside deviation relates to the measuring of price volatility, or how stable it is over a specific period. It looks at the returns over time and calculates how likely they are to fall below the average return. Comparing the downside deviation of different stocks can aid an investor to avoid highly volatile stocks that may face significant losses in a short period.

Downside risk can be suitably controlled by investing in multi-asset allocation funds. These funds aim to invest in multiple assets. As per the mandate of the markets regulator Securities and Exchange Board of India (SEBI), these funds invest in about three asset classes with a minimum allocation of at least 10% in each.

Multi-asset funds look for generating modest capital appreciation while reducing overall risk to the investment portfolio from a combined portfolio of low-correlation assets such as equity, debt, and gold. Such funds offer better downside risk protection while improving the return potential of a portfolio. 

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