Investors Not Managing Risk Well Enough

Historically, U.S. investors have been known to be rather skittish when it comes to risky investments such as commodities and international, small-cap and aggressive stocks. However, recently they have been bullish when it comes to these asset classes, according to The Wall Street Journal.

"This is beyond clients just following our advice to be more balanced," said Mary Doucette, a senior vice president at Northern Trust. "It's startling that in almost every client meeting I go to these days, clients are saying the same thing: 'I want higher returns; I want higher risk.'"

Investors are chasing after gold and other precious metals and have become rather optimistic when it comes to emerging markets as well.

The only problem is, that investors are going overboard, and there seems to be more money invested than there are opportunities.

The total return for gold company stocks and Chinese-listed companies has been three times more volatile than the S&P 5000 index, according to research by Ibbotson Associates. Emerging markets have been 65% more volatile.

The risk lies in the fact that these sectors have already had their golden years, meaning they have had big returns, and this means they have farther to fall.

Emerging markets are up an annualized 32% over the last two years. China is up 24%. Small-cap U.S. shares were up 16% in the same period. By comparison, the S&P 500 is up an annualized 10% over the same time.

In two separate reports, both Lehman Brothers and Bank of America both warned investors and managers alike to lighten their exposure to small-cap U.S. stocks, emerging markets, high-yield bonds, and arbitrage funds.

"We're growing more cautious" because these investments are so expensive, according to Tom Fay, a BoA managing director. Fay also points out that investors and managers should consider the risk of these investments and then decide upon whether or not it is wise to take such risks.