Risk Budget
A risk budget is an allocator’s framework for allocating total portfolio risk across strategies, managers, and exposures.
Allocator relevance: Turns “risk appetite” into enforceable sizing—prevents silent concentration in correlated risks.
Expanded Definition
Risk budgets can be expressed in volatility contribution, drawdown limits, factor exposures, liquidity risk, or scenario-based stress losses. In allocator portfolios, a risk budget ensures each sleeve contributes risk intentionally and within limits. In private markets, risk budgeting is harder due to lagged marks, but frameworks still exist using proxies and scenario analysis.
How It Works in Practice
Teams estimate risk contributions, monitor drift, and adjust sizing and pacing. They use correlation and stress testing to understand diversification benefits and hidden co-movement.
Decision Authority and Governance
Governance defines the risk budget framework, monitoring cadence, and who can approve exceptions. Strong governance prevents creeping risk build-up.
Common Misconceptions
- Risk budgets are only for quant shops.
- Risk can be managed solely with diversification labels.
- Private assets don’t need risk budgets because marks are stable.
Key Takeaways
- Risk budgets enforce sizing discipline.
- Stress tests matter more than point estimates.
- Look-through exposure improves budget accuracy.