Morgan Stanley IM: "Risk-on" Is a Misunderstood Risk that Needs To Be Hedged

• In a "risk-on" environment, investors tend to put more money into riskier assets like stocks, and whenever I say "risk-on" is itself a risk that needs to be hedged, I get funny looks.
• But it is important to emphasize this is a market with two fat tails. The right-tail is "risk-off," which many understand needs to be hedged, and the left-tail is "risk-on," one less understood, but one that also needs to be hedged.
• As a result, the investment profile for 2023 is one of a short and fat distribution of risk. By definition mathematically, volatility will be higher than historical averages.
• Context is important, where today a historically high $5 trillion in cash sitting on the sidelines (ICI as of 12/31/2022) hoping it’s the right place to be, but fearful it’s not.
• It is important to remember that there are two types of investor losses 1) a repeat of 2022’s negative performance, and 2) missing out on a potential 2023 rally to recoup some of those losses.
• So how to we invest in this type of market? Get balanced. One needs to construct a portfolio that balances both tail risks and manages towards the middle.

View Transcript

^{Risk Considerations}

^{Diversification does not eliminate risk of loss. There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this portfolio may be subject to certain additional risks. Fixed income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default, and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities purchased by the Strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. High-yield securities (“junk bonds”) are lower-rated securities that may have a higher degree of credit and liquidity risk. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. Foreign securities are subject to currency, political, economic and market risks. The risks of investing emerging market countries are greater than risks associated with investments in foreign developed countries. Sovereign debt securities are subject to default risk. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk).}