Let This Be the Death of 'Risk-On/Risk-Off'

 | Jan 02, 2013 | 5:51 AM EST
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You know what didn't work in 2012? Risk-on/risk-off. As hard as I tried to stamp out this ridiculous bit of hedge-fund-ese, I was not able to. There are too many commentators out there, and too many traders who want to succumb to this kind of non-rigorous, intellectually lazy thinking, and it's impossible to shut them all down.

But let 2012 be a lesson to you: It was revealed that you would have underperformed these people if you'd followed them. Notice I say "underperformed," because one thing is for certain -- none of these blowhards will let you see their returns after what I bet was a fiasco year for what I can only call an "alleged" strategy.

Why did risk-on/risk-off lead you astray? Let's count the ways. First and foremost, the S&P 500 gained 13.5% last year, or 16% if you include reinvested dividends. One thing we know for sure is that those who played this on/off switch game -- this binary nonsense -- didn't get to reinvest those dividends. Again, these payouts were a hugely important component of the year's performance. Some of these trading machines may not have much of any of these dividends to show for their efforts, let alone reinvested ones, even as companies continued to deliver increasingly higher payouts and even though the tax rate on them was absurdly low. (At this point, let's just call that tax rate "low," as the increase in the new law only takes it to about half of what we were warned it could be.)

Second, the shorthand "risk/no-risk" let you down entirely as a daily allocation tactic. Let's take Europe. What was risky? Bonds? Stocks? Bonds were miraculous performers. But stocks were incredible, too. I guess if you flitted from risk-on to risk-off and back again, you sold low and bought high pretty regularly. After all, the biggest amounts of money were made from the riskiest moments -- theoretically what you were supposed to avoid if you were "playing" risk-off. The non-strategy might as well be called "buy high, sell low." Maybe if you do it enough times, it will work?

I don't think so.

Third, risk-on/risk-off totally backfired as a portfolio sector-management tool. The riskiest stocks were the least risky -- the utilities and the lower-yielding healthcare names. So you would have been hurt even by the term "risk" as a rubric. Secondarily, bonds as a "risk-off" strategy seems contradictory. Bond funds began to take it on the chin late in the year even as the environment got riskier and riskier, thanks to the fiscal cliff and its attendant spending slowdown by a more cautious U.S. consumer.

So, what's the conclusion of all of this? Simple. I ran money for 30 years before this "risk-on/risk-off" garbage came in to play. I am beginning to believe it is simply the refuge of those who refuse to do individual stock homework, or who can't think of anything to ask or say.

Let 2013 be the year when people who continue with this terminology get defrocked -- not that they were ever frocked to begin with. I know I will do my best to out them as short-term mental hooligans. Maybe this time, with the sterling performance of the risky S&P, it will become clear that the risk-on/risk-off nonsense is nothing but a travesty perpetrated by those seeking and offering sound bites that were nothing but costly diversions from true investing principles.



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