After a Wild Year, Time for a Sober Look at Risk By FRANCESCO GUERRERA

CURRENT ACCOUNT   Updated January 1, 2013, 3:56 p.m. ET After a Wild Year, Time for a Sober Look at Risk  By FRANCESCO GUERRERA   We all have a period of our lives that we like to think of as "the wild years." For most of us, the degree of transgressions may have fallen well short of Mick Jagger circa 1972, but in our mind, boy, those were the days.  Many investors will remember 2012 as such a year. Money managers, hedge funds and even individual investors and universities all scrambled for that elusive "yield"—a rate of return that would vault their results past the measly interest rates paid by Treasurys. The search took them to ever-riskier places, from junk bonds and mortgage-backed securities to strange corporate concoctions such as "business development corporations" and "master limited partnerships." These investments can be found in financial glossaries under the rubric "buyer beware" and could turn out to be losing bets in years to come. But in 2012, there were few blowups there—a sign that, after the risk purge that followed the financial crisis, the dangers lurking in the financial system remain manageable. For those searching for yield, the past 12 months weren't so much "the year of living dangerously" but "the year of trying to live dangerously." Enlarge Image   Agence France-Presse/Getty ImagesEconomic uncertainty, banking crises in Europe and the potential of a military conflict with Iran are helping to keep investors from diving headlong into stocks. Above, demonstrators in front of a Caixa Catalunya bank in Barcelona last month. To be sure, some small investors had an entirely different experience. Uncertain about the economy and scarred by stock exchanges' persistent inability to run themselves (as shown by the botched listings of Facebook Inc. FB +2.73%and BATS Global Markets Inc.), a cohort of average Joes and Janes pulled money out of stocks. Not even the stock market's strong gains during the year were enough to entice them back in. Nevertheless, the majority of the investing world begins 2013 with a strong appetite for risk and a willingness to look for it in exotic and dangerous corners of the market. Whether this is the right strategy or just the first step toward inflating another painful bubble will depend on two factors: the direction of the economy and the price of different assets. As Fredrik Nerbrand, global head of asset allocation at HSBC Holdings HSBA.LN 0.00%PLC, wrote in a Christmas missive to clients, "there are two predominant drivers of returns at the moment: the global business cycle and relative valuations." On the first point, Europe is mired in a recession, while Asia is likely to contribute its fair share of global growth. That leaves the U.S. as the differentiating factor for the global economy this year. U.S. economists love to draw up long lists of "headwinds" (things like Washington policy stalemate, lack of household income growth and lackluster consumer confidence) and "tailwinds" (a recovering housing market, an improving trade balance, the energy revolution and the like). But the fundamental issue centers on the ability of the superloose monetary policy pursued by the Federal Reserve to stimulate consumers' demand for goods and services, and companies' desire to invest and hire. Without those elements, the U.S. economic recovery will remain sluggish, patchy and fragile even if politicians fill the fiscal policy vacuum of the past few years. Enlarge Image   Getty ImagesThe Bushehr nuclear-power plant in Iran in 2010. As for relative valuations, investors and strategists are stuck in a paradox: Many experts agree that in the long run, bonds will yield lower returns than in previous decades, but few are prepared to bet that stocks and other asset classes will do better in the short term. Mathematics and common sense suggest that with bond yields at record lows and the likelihood of interest rates rising at some point, fixed income isn't an investment for the ages. In fact, the riskier parts of the bond market so beloved by fund managers in 2012—high-yield debt, mortgage-backed securities and other structured products—are even more exposed to rising rates. When the CFA Institute, a global association of investment professionals, polled more than 6,000 members about their 2013 outlook, half of them said that stocks would provide the best returns this year, up from 41% last year. Only 8% chose bonds. But the economic uncertainty and the potential for external shocks such as a big conflagration in the Middle East, a banking failure in Europe or a crisis in China's wobbly financial sector are keeping many fund managers and individual investors from plunging headlong into stocks. In a recent note to clients, Bruce Bittles, chief investment strategist at Robert W. Baird & Co. describes the dilemma this way: There is no conclusive evidence yet that the bond markets' stellar run is coming to an end but "the historical pattern…suggests it may be getting long in the tooth." His advice for 2013: "Investors should still focus on managing risks rather than chasing returns." Fund managers' paths to get to that ill-defined goal vary. But most seem to entail increasing exposure to stocks while keeping a substantial part of portfolios in high-grade corporate bonds and hedging the risk of future inflation by buying gold. On paper, these steady-as-she-goes strategies are sensible. But they are unlikely to satisfy those clients who demand results every quarter or small investors, pension funds and academic endowments that have suffered years of below-par returns. After a year marked by the obsessive search for yield, the investment Holy Grail for 2013 is hidden in the murky gray zone between risk and return. Happy hunting