With the rapidly changing political situation and lofty promises of economic progress , investor confidence seems to be growing. However we must remember that with this rapidly evolving commercial environment business risk is also increasing

With the KSE bubble blowing up to mammoth proportions and the rampant restructuring of businesses, the investment scenario seems to be turning rosier. This leads to intense competition and ultimately to an increasingly fastidious and cautious customer.

Such a sophisticated customer is perennially on the lookout for lucrative avenues of investment. Moreover this customer has no meagre expectation of a return but after observing the upward motion of the KSE-100, he seems to be just asking for more and perhaps rightly so.

In such a situation, the challenge that financial institutions need to take on is that of first realizing that risk is dynamic and secondly, the means of identifying and mitigating this risk.

Customers need to realize that they cannot have their cake and eat it too. Since it is a two-way street, the higher the risk, the higher the return. So, in essence, there has to exist a trade-off. Risk may be systematic or unsystematic.

Systematic risk influences a large number of assets; it is sometimes called market risk. Unsystematic risk affects a small number of assets and is also known as unique or asset-specific risk. Unsystematic risk is essentially eliminated by diversification, so a relatively large portfolio has no unsystematic risk.

The principle of diversification tells us that spreading an investment across a number of assets will eliminate some, but not all, of the risk. Diversification is important, but as a practical matter, a small investor with a limited amount to invest cannot buy a large number of individual securities.

In this case, fortunately, mutual funds make it possible to diversify cheaply and easily. When you buy shares in a mutual fund, you actually purchase a claim against a large portfolio of stocks, bonds and/or other investments.

Different funds are designed to meet the objectives of different types of savers. Hence, there are bond funds for those who desire safety, stock funds for savers who are willing to accept significant risks in the hope of higher returns, and still other funds that are used as interest-bearing checking accounts (the money market funds).

There are literally thousands of different mutual funds with dozens of different goals and purposes. Mutual funds are managed by professional money managers who are presumably better able to follow and react to movements in the market than the average person.

Unfortunately, not all funds are created equal, and the differences can be quite significant. Understanding how risks are rewarded is important for everyone in business for the simple reason that business is risky and only managers that manage risk wisely will survive over the long haul.

In essence, diversification seems to be the answer to this riddle and investments in mutual funds may prove the key to sound investment decisions. The higher risk of a particular asset in a portfolio may be offset by another low-risk asset.