What is your risk appetite in the capital market?

In the capital market, the risk is defined as the willingness to accept the possibility of losses, the ability to admit market fluctuations, and the inability to forecast what will happen next. Technically, risk appetite refers to the maximum amount of risk that you, as an investor, are willing to take to achieve your goals before the risk outweighs the benefits.

We all face some level of risk in our daily lives, whether it's simply walking down the street or investing in the stock market. Your risk appetite is influenced by your age, income, and investment goals, and it is subject to change over time.

For example, when you are young, it is obviously true that you don't bother to take higher risks, but if you are a bit older, then you will think of so many pros and cons of the outcomes.

The capital market is a financial market segment that offers investors the opportunity to invest in long-term securities like stocks and bonds. However, for short-term investments like day trading, every investment involves some level of risk by nature.

Here it shows you lucrative gains within a day. However, 70 per cent to 80 per cent of the day trading ended with losses. As a result, investors should understand the total amount of risk they are undertaking and must adjust the total amount of return accordingly. Otherwise, the investment decision would not be fruitful.

Over the years, I have seen that when a new investor comes to invest in Bangladesh's capital market, a majority of investors tend to hurry up. The tendency is to feel as if this is the last chance to become rich. The psychology is that the stock market will shut down in the next month, so I have to make the most of it to become rich. However, the reality is a bit harsher and different from people's perceptions.

Due to this perception, investors' objective becomes to make a quick gain from the market despite any risk appetite. Thus, investors themselves become risky investors when they invest in risky companies, obviously increasing the market's volatility.

The capital market in Bangladesh is indeed very volatile compared to other frontier markets around the world. The idea is that here, investors tend to do more day trading than invest for a certain period.

It's not wrong to have a day trading; it's happening all over the world. The wrong idea is that you can't expect a miracle overnight to double or triple the capital gain from your initial investment within a couple of days.

When an investor comes to the market with such an appetizer or need, it apparently becomes high-risk for the market. In various cases, I have seen that those investors don't even have any financial literacy to invest in which companies or not.

In most cases, they go after rumours or follow gamblers' traps. They don't even hesitate to purchase junk shares. The shares were purchased at high prices, and when the price fell, they blamed the regulators and the government, which is totally unacceptable. As a result, I think, it will take a long time to break the shackles of the investors and face reality.

Even if the same investor invests in a term deposit scheme at any commercial bank for a year or two, they are happy with an interest rate of 5 per cent to 6 per cent. Unfortunately, when they invest in the capital market context, the expectation is sky-high, and even a 20 per cent to 30 per cent return, which is very lucrative if you're a rational investor, doesn't satisfy their needs.

As an investor, you have to be rational. As the number of irrational investors is higher in the market, riskiness increases, and from past bitter experiences, many investors lose their equity and become penniless. The blame eventually goes with our market because nobody goes deeply enough to understand how you would have lost your hardest money.

As a new investor, that negative feedback will buzz in your ears. From 1996 to 2010, the blame game had been going on. As far as my concern goes, the regulators are responsible for creating the platform (market). However, it's not their responsibility to advise you on the instruments in which to invest.

DON'T PUT ALL YOUR EGGS IN ONE BASKET

This is the famous quote from Warren Buffet that we all know. The exciting part is: how many people follow this theory while investing in the market?

The investment decision is yours, and the profit and loss all belong to you. You have to measure your riskiness and how much risk you can absorb as per your financial conditions. Understanding your risk tolerance enables you to make sound financial decisions.

Investors can apply various models that are risk-adjusted return models. One of them is the capital asset pricing model, which will adjust the expected return with respect to the total risk that a particular investor has undertaken.

AVOIDING SYSTEMATIC RISK

Systematic risk, also known as undiversifiable risk, affects the overall market, and we can't avoid it. For example, in the 2010's market crash, there was a systematic risk that investors would not save their investments through diversified portfolios. However, we can avoid the unsystematic risk by building a diversified portfolio.

If you want to know how much systematic risk a particular security, fund, or portfolio has, you can look at its beta, which measures how volatile that investment is compared to the overall market. A beta of greater than one means the investment has more systematic risk than the market, while a beta of less than one means less systematic risk than the market.

A beta equal to one means the investment carries the same systematic risk as the market. For example, an investor who is looking to invest in high beta stocks is generally expecting a higher rate of return to compensate for higher systematic risk.

An investor who is looking to invest in a lower beta stock is generally expecting a lower rate of return to compensate for the lower systematic risk. Hence, it can be said that investors should apply a risk-adjusted model in order to derive the expected returns when they are investing in the capital markets.

BEEFING UP DUE DILIGENCE

Another risk, especially one that most brokerage houses face, is that investors tend to have more leverage when investing in the market. Due to extreme market volatility and by nature, there is a high risk of not adjusting the margin loan accordingly when the market falls. As a result, when we have a prolonged bearish market, investors' equity depreciates day by day, and later on, the equity of the portfolios becomes negative, which makes both investors and institutions vulnerable.

Many brokerage houses don't even have any risk management tools to control the high margin loan exposure. Here, the institutions should be stricter in implementing the rules and regulations, especially the margin rules of 1999. In addition, we need an updated margin rules policy to string the due diligence in line with the present market scenario.

The author is the head of internal control and compliance at UniCap Securities Limited. He can be reached at shahriar@unicap-securities.com. Views are personal.