The Legacy of RORO

Posted by Leland On June - 12 - 2013 0 Comment

 

RORO, while it may sound like something that Scooby Doo would say, is actually an investment strategy that has been followed religiously by some investors over the last several years. RORO stands for risk on/risk off, and essentially entails investing in risky assets when the economic outlook is good, and then switching to treasury assets at the first sign of trouble. While this central tenet may make intuitive sense, in practice it has reduced the ease of diversification and threatened investor safety. But why? Here, we’ll explain how RORO has changed the way to invest.

Portfolio diversification is a classic method that investors use to guard themselves against risk. RORO, though, destroys the effectiveness of that strategy. Volatility soars when investors are dumping all assets with any associated risk at the first sign of an economic dip. What that means for investors is that when domestic stocks crash, foreign stocks, real estate, commodities, and high-yield bonds are all much more likely to crash too. The HSBC RORO index, which measures how closely different assets move together, hit record highs in 2008 and has stayed there for the last several years. This means that, as we are all too aware of, even the most well-designed portfolio took a major hit during this recession.

Additionally, the safety that investors formerly experienced from holding treasury bonds is also at risk. Since all RORO investors are turning to these assets at the first sign of trouble, demand has skyrocketed. Returns on these are down to 1.8% on a ten year note. Since yields are so low right now, they are sure to rise in the near future. When yields and interest rates rise, investors will feel a sharp loss, and are vulnerable to even the smallest rise in inflation.

So what’s an investor to do in these troubled times? Diversify internationally with long-term protection in mind. Right now, globalization has led international stocks to move in tandem with the U.S., but who knows what could happen in the future. Think about tilting your portfolio by incorporating small cap stocks. Switch to shorter-term treasury bonds, and look into highly-rated corporate bonds as well.

There’s no formula to get the right diversification of assets, but by doing things differently than the RORO set, you’ll be miles ahead in the long run.

 

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