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On Wall Street, Selling Fear Is Good Business

·Michael Santoli

Years of financial tumult have given brokers a new and resonant sales message: "Be afraid." Whether it's good investment advice is almost beside the point — the financial-services industry has determined that fear sells:

-- In the current retirement issue of Money magazine, which lacks even a single article or advertisement that promises glorious investment returns, Prudential Financial bought a full-page ad to offer "A responsible answer to an era full of risk."

-- Elsewhere in the popular press, leading asset manager BlackRock begins its pitch for its funds by asserting, "Today's markets are as uncertain as ever."

-- Main Street brokerage house Raymond James, sympatico with the message of most of its peers, asks in a recent marketing brochure: "In these volatile times, is your portfolio structured as it should be?"

There's nothing mysterious about how things arrived at this point. By their words and actions, individuals have shown an abiding disdain for the stock market.

Apparently, a decade (beginning in 2000) in which the market produced zero net return while being savagely cut in half twice along the way was quite sufficient to scar the psyches of an investing generation.

A Wounded and Weary Populace

Such a wounded and wary populace becomes a ready customer cohort for products and strategies that promise not runaway riches but avoidance of losses.

Bond funds, most conspicuously, have been engorged with capital from folks seeking shelter and a bit of income. Despite historically low interest rates, the public has sent nearly $1 trillion in new money to bond funds since 2008, while pulling a net half trillion from equity funds.

A quick scan of the radio airwaves or cable-news commercials reveals that gold, history's portable emergency asset, is enjoying new-found resonance with a nervous citizenry, following a five-fold appreciation in dollar terms in the past 10 years.

Not content with ancient stores of value, the industry's R&D departments have been busy engineering products more acutely targeted to investment fashion and prevailing risk appetite levels.

Trading on Volatility

Easily the most successful new class of tradable instruments in recent years has been exchange-listed notes tied to the options market's S&P 500 Volatility Index, or VIX. Such products have attracted billions in assets from investors seeking a way to profit from violent, dangerous market action despite a generally steady decline in actual market volatility since the 2008-'09 crescendo of the financial crisis.

"Inverse" ETFs that gain value when an underlying index or sector drops in price have also been briskly adopted. Such products belong to what could be considered a whole new asset class, called "the downside."

The "hottest" exchange-traded fund launch of this month was probably one designed to be boring, Invesco PowerShares' S&P 500 High Dividend Portfolio (SPHD). It selects the highest-yielding stocks in the firm's risk-shunning Low Volatility Index fund (SPLV) -- thereby combining into one equity instrument two common techniques intended to strip out the inherent risk in owning equities.

In addition, once-obscure cul-de-sacs of the financial markets, such as publicly traded master limited partnerships containing hard assets, have tickled retail investors' fancy and produced some smash-hit ETFs in the past couple of years, thanks to their structurally high dividends in an income-deprived world.

The whole realm of "liquid alternative" funds, essentially hedge-fund-type capital-preservation strategies placed under the hood of a mutual fund vehicle, have about doubled to $330 billion since 2007, and consulting firm Financial Research Corp. projects another doubling within five years.

A survey of investors released last week by Natixis Global Asset Management, which looks after $700 billion in assets, found that 58% of U.S. investors say they "will take on only minimal investment risk, even if it means sacrificing returns."

After this psychological context is noted, the revealing bottom-line message arrives from Natixis: "Financial advisors are best-positioned to help investors become comfortable with alternative investments and other new strategies."

Now, this is probably true, assuming one has a conscientious advisor -- one who knows to ask whether "alternative" funds designed for only modest appreciation in a low-yield world are worth the above-average fees charged. Yet it's good business because, in this post-crisis environment, greed goes begging.

For a broker, addressing investors who are scared and perfectly willing to let the market go up without them is a pretty nice business proposition, especially when inherently unknowable political shifts, monetary policy and macroeconomic shocks can be cited in support of continued caution.

It's easy to sell sobriety to people who have already sworn off the hard stuff -- especially when the potential customers aren't even aware the market has been rising without them aboard.

In a fascinating pattern revealed in annual surveys by mutual-fund giant Franklin Templeton Investments, two-thirds of individual investors in 2010 answered that the stock market had fallen the prior year, when in fact it was up more than 25% in 2009. In both 2011 and 2012, half or more of respondents similarly claimed stocks were down the year before, when indeed the indexes had finished higher.

With the perceived riskiness of stocks embedded securely in the public mind, perhaps the stealth danger is that investors unintentionally assume more risk than they mean to, through something that seems to offer safety. For instance, bonds and dividend-paying stocks are widely being used as "cash substitutes," a role they are not nearly qualified to fill.

High-yield bonds are quite popular even as equities are disdained, yet both would be hurt by a U.S. recession. Slow economic growth is correctly touted as a healthy environment for high-grade corporate bonds. But current rock-bottom yield levels offer little buffer for even the passing shadow of an inflationary threat.

Indeed, stocks are popularly considered dangerous at current levels, yet they don't appear particularly misvalued relative to the rest of the asset-class chain, stretching from Treasuries to corporate debt to real estate investment trusts and beyond. All are being floated by central banks' money creation and their efforts, not yet entirely successful, to penalize risk aversion.