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Beating risk on — risk off

By Sheyna Steiner ·
Friday, September 28, 2012
Posted: 12 pm ET

Traditional portfolio construction is being turned on its head by the ongoing risk-on, risk-off phenomenon that has asset classes moving in near lock step with one another. Risk on, risk off, or RORO, is what you see when rallies happen for reasons utterly unconnected to fundamental values or when stocks tank across the board based on tangential news.

"RORO is event-led and strongly coupled to uncertainty," according to HSBC's April report, "Risk on -- risk off: Fixing a broken investment process."

The cause of this new paradigm in market behavior, according to HSBC's report, could be a new systemic risk factor in the form of global interventions in economies and markets.

Keeps professional investors awake at night

Highly correlated asset classes are just one thing keeping institutional investors on their toes, a new survey has found. Institutional investors manage pension funds, mutual funds, endowments and generally huge blocks of money.

More than half of institutional investors around the world, 53 percent, believe that traditional asset classes are too highly correlated for returns to be distinguishable, the survey from Natixis, the 13th largest asset manager in the world, has found.

But professional money managers can handle that, right? Maybe not as well as might be imagined. Only 31 percent of global respondents said they had "above-average success" over the past five years constructing portfolios that reduce correlation among asset classes. Forty-one percent of institutional investors in the U.S. have triumphed over the asset-class-correlation conundrum.

Despite the relatively low rate of success, 91 percent of the global investors surveyed said that investing more in noncorrelated assets is an effective way of managing risk.

If finding noncorrelated assets is tough for institutional investors, it's even trickier for retail investors. There are alternative investments to the typical mutual fund fare however. Commodities, private equity and real estate can all play a part in an individual's portfolio. Even smaller investors can invest in alternative assets through mutual funds and exchange-traded funds.

In addition to diversifying asset classes, investors may benefit from mutual funds that use alternative trading strategies as well, such as those employed by hedge funds -- long-short funds, for example. Part of the investments in the fund is expected to appreciate, so they're long, while the fund bets other investments will go down, known as shorting.

Experts recommend keeping allocations to alternatives small, as they can be very volatile. Other alternative funds, such as those that use market neutral strategies, may have extremely low volatility but low returns.

Do you use any alternatives? Have you noticed your investments moving together since the financial crisis?

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