Why Your Portfolio Needs More Risk

How taking on some risk can make your portfolio safer.

FE_DA_0520gambling.jpg
By + More

Microcaps. Microcap funds own shares of some of the smallest companies on the market. Often, several of the names in their portfolios have market capitalizations of less than $300 million. Sam Dedio, the manager of Artio U.S. Microcap, isn't shy about the risks associated with such stocks. "You're dealing with much smaller companies," he says. "With smaller companies, there are all kinds of risks. Management experience comes up. Typically, they have only one or two products. Often they don't have a lot of research coverage, [and] oftentimes it's hard for smaller companies to get access to capital, so they can go through some growing pains."

Still, especially for investors with long time horizons, these tiny stocks offer plenty of room for growth. In particular, microcaps usually rally coming out of a recession. In 2009, for instance, Dedio's fund gained 64 percent. Microcaps certainly aren't for all investors, but those who lack exposure to them run the risk of having to play catch-up during strong markets.

Currency plays. For years, retail investors in international bond funds have had access to currency plays. Basically, what this entails is managers owning some bonds denominated in currencies other than the U.S. dollar. For investors who have most of their holdings in American companies, this exposure to other currencies can offset losses if the greenback struggles. In other words, investors can take on risk in one currency to protect themselves against falloffs in another. This also cuts the other way. For investors who have large stakes in emerging markets stocks, which generally do well when the dollar is weak, it could be wise to make a few bets in favor of the dollar to limit risks, says Konstantinos.

Investors looking to make currency plays have seen their options increase considerably in recent years, largely thanks to the proliferation of exchange-traded funds. For instance, PowerShares offers an ETF for investors who want to be bullish on the U.S. dollar (UUP), and a separate one for those who want to be bearish (UDN).

Leverage. This is perhaps the riskiest strategy of them all. After all, excessive amounts of leverage largely caused the crisis that gave rise to the recession. For fund investors, there's a niche set of leveraged options, such as those offered by Direxion. These funds promise returns that are a certain multiple of a given index. For instance, Direxion Monthly S&P 500 Bull 2x looks to get monthly returns that are twice as high (or low) as those of the S&P 500. When the index goes up, so does the fund, and vice versa. On the other hand, Direxion Monthly S&P Bear 2x uses leverage to achieve monthly results that are equal to two times the inverse of the S&P 500. When the index loses, the fund wins. Small exposure to such funds can be used as a hedging technique, but this strategy is generally for speculative investors who have sophisticated approaches.