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Risk-off Mentality Could Benefit Contrarians in 2012

One of financial advisor David White’s clients, a wealthy 65-year-old real estate investor, told him recently, “For the first time in my life I’m scared.”

Amid a plethora of worries ranging from political unrest in the Middle East to slowing growth in China, the hope normally associated with the start of a new investment year has been trumped by fear. Rather than downplaying risk, investors are obsessing over it.

Photo: Peter Cade | Ionica | Getty Images

“You need to be a little risk averse,’’ says John Papa, an advisor with Diversified Planning Strategies in Caldwell, N.J., rattling off his main concerns — record debt limits, continued high unemployment and a lack of leadership from world governments.

Europe appears to be the tipping point in formulating investment strategies for the New Year.

White, who runs an advisory firm in Bloomfield Hills, Mich., says the best way to deal with the EU overhang is to bet against it by shorting the euro and European banks . He is placing clients with tactical fund managers who have a track record using shorting strategies .

While he couldn’t name funds, options here include ProShares Ultra Euro and ProShares Ultra MSCI EAFE , which aim to deliver double the inverse return of the euro and European stocks, respectively.

“It’s easier to make money in a down market than an up market,’’ he says.

White also favors hard asset investments that can thrive in a variety of outcomes. Should the Fed’s stimulus programs trigger inflation, he likesoil and natural gasdrilling stocks, gold and silvermining companies and well-managed REITs.

And if Europe and the U.S. solve their debt problems, ushering in a stronger recovery, demand for oil and industrial commodities like silver should increase.

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Investors won’t be willing to take on more risk only until Europe’s problems have been resolved, says Curvin Miller, a vice president with Dayton, OH investment firm Russell & Co. In the meantime he’s advising clients to stay conservative, recommending secure floating rate loan funds as a hedge against rising interest rates and non-traded commercial real estate and private REITs for dividend income.

His contrarian play is returning to beaten-up emerging markets stocks for growth. An easy way to gain EM stock exposure is through the Vanguard MSCI Emerging Markets ETF .

Charles Massimo of CJM Fiscal Management in Melville, N.Y., also advocates going against the grain in the current risk-off environment. “When the financial markets are in turmoil and European markets feel like they may implode, [most] investors stand on the sidelines,’’ he explains. “With valuations low and perceived risk so high, this offers the greatest opportunity for return.”

LPL Financial writes in its 2012 outlook that investors are best served by taking on risk selectively. Given its outlook for slow global growth, it recommends stocks in cyclical sectors which are expected to grow earnings at a faster pace than stocks in the more popular defensive sectors. LPL specifically likes the stocks of copperand other commodity producers, U.S. small and mid-cap companies and those in emerging markets.

While all investors are affected by the global headwinds affecting stocks, how much risk they should take on in 2012 is a matter of personal circumstance. In the short-term, Miller suggests a prudent approach of subtracting your age from 100 to determine your weighting to risk assets. A 55-year-old investor, for example, should have about 45% of their portfolio in stocks and other higher risk investments.

Most advisors advocating caution work with clients close to or already in retirement who can ill afford substantial losses. Younger investors, on the other hand, can benefit from a more aggressive, contrarian approach.

“As an investor, new risks will always emerge,’’ says Mossimo. “It’s a matter of how you react to those risks that will determine your success.”

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