On occasion, you may hear us refer to “risk on” or “risk off” market environments – which conjure up images of old Mr. Miyagi doing his ‘wax on/wax off’ training in the 80’s classic The Karate Kid. But we’re not the only ones leaning on the jargon. These terms have become part of the lexicon since the 2008 highs and 2009 low. It seemed as though everything was sold off together, and everything bought back together, all at the same time, bringing the correlation across previously non-correlated markets perilously high.
What is “Risk on”/”Risk Off”? Or the “Risk Trade” as it is also called at times. This all ties back to the financial crisis in 2008, when investors across the globe dumped everything which carried the risk of loss (meaning everything except US treasury bonds, priced in US Dollars – yes, even Gold) . The term risk on came back when stock markets made a low in March of 2009 and nearly everything else started to go back up with it. Investors were back in the market willing to risk money (thus…risk on). So, we have:
Risk On = Long: Stock Indices, commodity currencies (Aussie/Canadian/NewZealand), energy, grains, softs (cotton, cocoa, etc) and Short: US Dollar, Bonds, Yen, Swiss
Risk Off = Long: US treasuries, US Dollar, Jap Yen, Swiss Franc, Short: stocks, commodities, foreign currencies.
We typically here this ‘risk on’ or ‘risk off’ type of talk on days when there is green or red seemingly across the board (like this) following events like the Japan quake, another Greek bailout, and so on seemingly push everyone at the same time to go ‘risk on’ or ‘risk off’.
But what does it really mean? Is it real? Or just financial reporters’ go-to phrase when they see green or red across the board?
Taking a look at the CRB Commodity index compared to the S&P 500 since June of 2008 and seeing how closely they have tracked , the risk on/risk off buzz seems to have merit.
For managed futures, it is a dangerous pattern and worth watching. Thing is, in a global risk on/risk off movement, the benefits of portfolio construction and portfolio diversification are largely thrown out the window… and managed futures returns will likely be more volatile than in past, with few buffers in the portfolio against trend reversals. If it’s all moving the same way at the same time, everything could go down (or up) at once, with no lifeboat in sight.
But when looking at the performance of various assets since June 2008 – there is more to the everyone down/everyone back up trade than meets the eye. Sure, they generally all went down, then back up, together – but there have been many zigs while others have zagged, with Crude down 20% since mid 08, and Wheat up 40% over the same time. So while the general trend seems to be an overall risk on/risk off environment where markets can all move in tandem on a big up or down day – don’t forget about all of the other days in between.
Those days when markets are mixed are where managed futures are likely to make hay in our opinion, benefitting from portfolio diversification and those different zigs and zags.