Risk Limits
Risk limits are predefined thresholds that restrict exposures or risk metrics to keep a portfolio within acceptable bounds.
Allocator relevance: The enforcement layer of risk budgeting—limits prevent drift, protect liquidity, and reduce tail risk.
Expanded Definition
Risk limits can include maximum exposure to an asset class, manager, sector, leverage, illiquidity, drawdown, or factor. In allocator governance, limits provide clear triggers for action. They are especially important where exposures are hard to unwind (private funds), making prevention more important than reaction.
How It Works in Practice
Teams monitor limits through dashboards and periodic reviews. If a limit is approached or breached, they adjust pacing, rebalance, or stop new commitments. For illiquid assets, limits often operate prospectively (before committing).
Decision Authority and Governance
Governance defines limit owners, exception approval processes, and documentation requirements. Without enforcement, limits become decorative.
Common Misconceptions
- Limits reduce returns by being “too conservative.”
- Limits are static across all market regimes.
- Limits can be enforced without good data and look-through.
Key Takeaways
- Limits are governance tools, not suggestions.
- Prevention matters most in illiquid portfolios.
- Data quality and look-through enable real enforcement.