Risk Budget

Definition

A risk budget is a framework for allocating “risk capacity” across a portfolio. Rather than focusing only on dollar allocations, it considers how much volatility, drawdown exposure, leverage, liquidity risk, and concentration the portfolio can absorb while meeting objectives and obligations. Allocator Context Institutional allocators often define risk budgets explicitly through policy, stress testing, and sleeve-level constraints. Some allocate risk by volatility targets or factor exposures; others use more practical risk controls, like concentration limits and liquidity budgets. Family offices may use implicit risk budgets shaped by principal comfort, lifestyle needs, and tolerance for drawdowns. Decision Authority Risk budgets are typically governed by the IPS and overseen by committees. A strategy may be rejected not because it is “bad,” but because the risk budget is already allocated elsewhere. Deviations or expansions to risk capacity often require formal approval. Why It Matters for Fundraising Managers should explain risk in allocator language: expected drawdown behavior, liquidity risk, correlation profile, and how the strategy behaves in stress environments. Matching to the allocator’s risk budget is more persuasive than maximum-return narratives. Key Takeaways Risk capacity is scarce and governed Allocation is constrained by risk, not only capital Stress behavior and correlation matter Fit within risk budget determines sizing