Investors' Focus on Risk Could Lead to Missing an Unexpected Rally

BNY Mellon Report Says Cost of Hedging Against Negative Developments Has Become Expensive

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Jan 30, 2012, 07:46 ET

LONDON and NEW YORK, Jan. 30, 2012 /PRNewswire/ -- Investors appear overly focused on the downside risks to the markets and are not allocating sufficiently to take advantage of possible upside surprises, according to a white paper from BNY Mellon Asset Management's Investment Strategy and Solutions Group (ISSG).

The paper, A Radical Proposal for a Square Root Recovery: Don't Forget the Right Tail, focuses on the bearish view that has been incorporated into asset prices. It was written by Robert Jaeger, senior investment strategist for ISSG, and Stephen Kolano, investment analyst, ISSG.

The "square root recovery" in the paper's title refers to a jobless recovery, where employment growth chronically lags gross domestic product growth. In such a recovery, there is a gap between the potential output of the economy at full employment and the actual output at lower employment rates. A graph displaying this gap in the report forms a square root symbol for the years 2008 to 2011.

"The costs of hedging against negative news has become so expensive that many investors could find themselves in a situation where they are selling low and buying high," said Jaeger. "The issue is compounded when investors sell cheap assets that have the potential for significant appreciation if 2012 unfolds better than the consensus is predicting."

"Among the factors that could surprise on the upside would be a quicker-than-expected resolution to the European sovereign debt," said Kolano. "Already, we're seeing better economic indicators for a U.S. recovery than we saw just a few weeks ago. Also, China might not have a hard landing."

As the U.S. economy oscillates between slow growth and stalling, markets are likely to react dramatically to new information, both positive and negative, the report said. Upward movements would be lost opportunities for those not properly positioned, according to the white paper.

"We are not arguing that the economy will experience a prolonged square root recovery," said Jaeger. "The crucial point is that the square root scenario seems to have become the consensus scenario. That means that actions to sell growth/aggressive assets and buy income/defensive assets might lead to expensive mistakes."

Notes to Editors:
BNY Mellon Asset Management is one of the world's leading asset management organizations, encompassing BNY Mellon's affiliated investment management firms and global distribution companies. Information about BNY Mellon Asset Management can be found at www.bnymellonam.com.

BNY Mellon is a global financial services company focused on helping clients manage and service their financial assets, operating in 36 countries and serving more than 100 markets. BNY Mellon is a leading provider of financial services for institutions, corporations and high-net-worth individuals, offering superior investment management and investment services through a worldwide client-focused team. It has $25.8 trillion in assets under custody and administration and $1.26 trillion in assets under management, services $11.8 trillion in outstanding debt and processes global payments averaging $1.5 trillion per day. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation (NYSE: BK). Additional information is available on www.bnymellon.com or follow us on Twitter@BNYMellon.

All information source BNY Mellon Asset Management at December 31, 2011. This press release is qualified for issuance in the UK and US and is for information purposes only. It does not constitute an offer or solicitation of securities or investment services or an endorsement thereof in any jurisdiction or in any circumstance in which such offer or solicitation is unlawful or not authorised. This press release is issued by BNY Mellon Asset Management (US) and BNY Mellon Asset Management International Limited (ex-US) to members of the financial press and media and the information contained herein should not be construed as investment advice. Past performance is not a guide to future performance. Registered office of BNY Mellon Asset Management International Limited: BNY Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England no. 1118580. Authorised and regulated by the Financial Services Authority. A BNY Mellon Company(SM)

SOURCE BNY Mellon