Risk-on risk-off investing relies on and is driven by changes in investor risk tolerance. Risk-on-risk-off (RORO) can also sway changes in investment activity in response to economic patterns. When risk is low, investors tend to engage in higher-risk investments. Investors tend to gravitate toward lower-risk investments when risk is perceived to be high.
Key Takeaways
- Risk-on risk-off is an investment paradigm where asset prices are dictated by changes in investors’ risk tolerance and investment choices.
- In risk-on, investors have a high-risk appetite and commonly drive up some asset prices.
- In risk-off situations, investors are more risk-averse and sell assets.
Embracing High-Risk vs. Low-Risk Investments
Investors’ appetites for risk rise and fall over time. Risk is the uncertainty associated with investments that may negatively impact a financial portfolio. Because younger investors have a long-term time horizon, they commonly take more risk. In contrast, investors close to retirement may choose conservative investments and vehicles with lower risk.
Not all asset classes carry the same risk. Investors tend to change asset classes depending on the markets. Stocks, mutual funds, and exchange-traded funds (ETFs) are generally considered riskier assets than government-issued bonds. Risk capital is the money investors devote strictly to trades exposed to a possible loss in value.
The Thrill of Risk-On Investing
Asset prices commonly follow the risk sentiment of the market. Investors look for changing sentiment through corporate earnings, macroeconomic data, and global central bank action. An increase in the stock market or where stocks outperform bonds is said to be a risk-on environment.
Risk-on environments can be carried by expanding corporate earnings, optimistic economic outlook, accommodative central bank policies, and speculation. As the market displays strong influential fundamentals, investors perceive less risk about the market and its outlook.
Seeking Safety in Risk-Off Investing
When stocks are selling off, and investors run for shelter to bonds or gold, the environment is said to be risk-off. Risk-off environments can be caused by widespread corporate earnings downgrades, contracting or slowing economic data, and uncertain central bank policy.
Just like the stock market rises in a risk-on environment, a drop in the stock market equals a risk-off environment. Investors jump from risky assets and pile into high-grade bonds, U.S. Treasury bonds, gold, cash, and other safe havens.
Identifying Reliable Safe Havens
Investors look to safe havens to offer protection against market downswing or upheaval. Investment vehicles that may be considered safe havens are gold, cash, and U.S. Treasury bonds.
RORO ETFs: A Dynamic Investment Approach
Some financial institutions offer fund investment that follows a RORO strategy. A RORO ETF rotates offensively or defensively between higher-risk equities and lower-risk U.S. treasuries. The ATAC US Rotation ETF is an example of a fund that follows this strategy.
Effective Strategies to Limit Risk Exposure
Risk is inherent in all investments, but investors who use asset allocation and diversification and choose multiple types of investments in varying sectors can help manage risk.
The Bottom Line
Risk-on risk-off is an investment paradigm where asset prices reflect changes in risk tolerance. Risk-on environments thrive with expanding corporate earnings and an optimistic economic outlook. Risk-off environments occur under slowing economic data and uncertain market sentiment.
Related Terms: risk tolerance, time horizon, conservative investments, asset classes, risk capital.
References
- Financial Industry Regulatory Authority. “The Reality of Investment Risk”.
- Morningstar. “ATAC US Rotation ETF”.
