Risk budgeting is a portfolio construction approach in which the total risk of a portfolio — typically measured by volatility or Value at Risk (VaR) — is explicitly allocated across individual assets, sectors, or strategies, rather than allocating capital by rupee amount. Each allocation is sized so that its contribution to total portfolio risk equals its assigned risk budget. This ensures that no single position dominates the portfolio's overall risk profile, even if it represents a small capital allocation. For example, a high-beta small-cap stock may receive a smaller capital allocation than a low-volatility large-cap stock to ensure both contribute equally to portfolio risk. Risk budgeting is used extensively by Indian institutional investors including pension funds, insurance companies, and large multi-asset portfolio management services. It requires sophisticated risk modelling tools and continuous monitoring of position-level risk contributions as market conditions change.
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