Diversified portfolios minimize risk
What risks are involved in financing SMEs?
The biggest risk in financing a business is that a company to which you have financed defaults. In case of default, it is the investor (you) who assumes the risk and who may lose a part of his or her capital.
Diversification: the only strategy to protect you against the risk of capital loss
Diversifying your portfolio is very important, as it is the only strategy that allows you to minimise the impact a default can have on your overall profitability. If your portfolio is poorly diversified, your profitability is more likely to fall in the event of a default.
The diversification of your portfolio is represented on a scale of 1 to 5 stars.
Having a diversified portfolio is crucial to minimise the impact of defaults on the overall rate of return. In other words, the more diverse your portfolio, the steadier your return. The less diverse your portfolio, the more likely your return is to fall quickly.
A simple example:
If your portfolio contains 10 financed companies at SAR 1,000 (SAR 10,000 total), one default will have a significant negative impact on your rate of return;
If your portfolio contains 50 financed companies at SAR 1,000 (SAR 50,000 total), one default will only slightly decrease your overall return.
Your level of diversification is based on the maximum exposure:
Maximum Exposure = (Largest Financed Company) / (Total Financed Amount)
Example:
If you financed 100 companies, SAR 20,000 to the first one and then SAR 1,000 each time for the following financed companies, your maximum exposure is (20,000 )/119,000=17%
This means that your portfolio, composed of 100 financed companies (which at first glance could look like a well-diversified portfolio), is actually poorly diversified: if the SAR 20,000 financed company defaults, your rate of return will be substantially affected.
From your maximum exposure, we set your level of diversification. A correct diversification starts from 3 stars.
Maximum exposure
Diversification level
To better understand your level of diversification, you can also reduce these levels to the number of finance companies of the same amount.
0 stars = less than 10 finance companies of the same amount
1 star = between 10 and 20 finance companies of the same amount
2 stars = between 20 and 40 finance companies of the same amount
3 stars = between 40 and 80 finance companies of the same amount
4 stars = between 80 and 150 finance companies of the same amount
5 stars = above 150 finance companies of the same amount.