What are risk on and risk off assets?

“Risk-on” and “risk-off” are terms used to describe the prevailing sentiment in financial markets, indicating whether investors are generally willing to take on risk or are seeking safety during a given period. These terms often reflect the broader economic or geopolitical conditions and investor mood. Here’s what each term means:

Risk-On Assets

Definition: Risk-on assets are investments that tend to perform well when investors are more willing to take on risk, typically during times of economic growth, stability, or optimism. These assets are generally more volatile and can offer higher returns, but they come with a greater potential for loss.

Characteristics:

Investors are confident in the economy or market conditions.

They seek higher returns and are willing to take more risk in hopes of capital appreciation.

These assets are often associated with growth and speculative investments.

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Examples of Risk-On Assets:

Equities: Particularly growth stocks or stocks in cyclical sectors (like technology, consumer discretionary, and industrials).

High-Yield Bonds: Bonds with lower credit ratings that offer higher yields but carry more risk.

Commodities: Like oil, industrial metals, and agricultural products, which tend to perform well in periods of economic expansion.

Emerging Market Assets: Stocks and bonds from emerging market countries, which can provide higher returns but are more volatile.

Currencies such as the Australian dollar.

Risk-Off Assets

Definition: Risk-off assets are investments that are favoured when investors are feeling more cautious or uncertain about the market, often due to concerns like economic slowdowns, political instability, or market volatility. These assets are considered safer, lower-risk options but tend to offer lower returns.

Characteristics:

Investors seek to preserve capital rather than seek higher returns.

Typically associated with a more defensive stance in response to market or economic uncertainty.

These assets tend to be less volatile and may underperform during strong economic growth but provide stability in times of distress.

Examples of Risk-Off Assets:

Government Bonds (Especially U.S. Treasuries): Bonds issued by stable governments, particularly long-term U.S. Treasury bonds, are considered safe-haven investments.

Gold and Precious Metals: Seen as a store of value in times of uncertainty and often perform well when inflation or geopolitical risks rise.

Cash and Cash Equivalents: Such as money market funds or short-term government securities, which are very low-risk but offer low returns.

Defensive Stocks: Stocks in sectors like utilities, health care, and consumer staples, which tend to be less affected by economic cycles.

Low-Risk Corporate Bonds: Investment-grade corporate bonds, which are less risky than high-yield bonds.

Currencies such as the US dollar.

Key Differences:

Risk-On assets are favoured when investor sentiment is positive and the economic outlook is strong, as investors are more willing to take on risk for the possibility of higher returns.

Risk-Off assets are preferred during periods of market volatility, economic uncertainty, or when there is a flight to safety, as investors seek to preserve capital and reduce exposure to potential losses.

Market Behaviour:

When the economy is expanding and confidence is high, investors tend to adopt a risk-on mindset, leading to higher demand for equities and other higher-risk assets.

When there is a market downturn, recession fears, or geopolitical tensions, investors may shift to a risk-off stance, leading to higher demand for safe-haven assets like government bonds and gold.

Understanding these dynamics helps investors position their portfolios according to broader market conditions.

Lauren Hua is a private client adviser at Fairmont Equities.

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