Exposure depends on an individual’s goals and risk tolerance. There is no single way to determine it. In general, if a trader is bullish on a particular asset, he will have a larger exposure to the asset than he would if he was neutral or bearish towards the asset. In other words, if someone expects a particular investment to perform well, they will have a higher exposure to the investment, relative to other investments.
Here’s an example of breaking down market exposure: consider a UK investor who is bullish on US stocks and neutral on European stocks. This investor might allocate 30% of their portfolio to US stocks and 10% to European stocks. The exposure to US stocks is higher because the investor expects this region to do well.
Similarly, consider an investor who is bullish on technology stocks, but bearish on utility stocks. This investor might allocate 15% of their portfolio to technology stocks and 0% to utility stocks. The higher the exposure to a particular investment in percentage terms, the higher the risk associated with that investment. For instance, a portfolio with 100% exposure to equities has a higher risk from equities than a portfolio with 60% exposure to equities and 40% exposure to bonds. If equities perform poorly, the portfolio with the 100% weighting to equities is likely to perform worse than the portfolio with 60% exposure to equities.
Investors that are comfortable with risk often allocate a higher proportion of their portfolio to equities, and a smaller proportion to bonds. Because equities are more risky than bonds, these investors face higher total portfolio risks. In contrast, risk-averse investors often have less exposure to equities and more exposure to bonds. A risk averse investor may have 80% of his portfolio in bonds and only 20% in equities.
To lower risk, investors need to ensure that they are not overexposed to any particular investment type. Exposure can be reduced by selling an asset, by diversification or through hedging.
See more: how to trade bonds in the UK