Investors Find It Harder to Sort Risky From Safe : Securities: Arenas that at one time were considered vulnerable are no longer so, and vice versa.

The ongoing tumult within the U.S. economy and financial markets is forcing a radical shift in how individual investors perceive the “R” word--risk--in the ‘90s.

Over the last year, the traditional lines between “risky” and “safe” investments have become blurred. Some securities that many investors had for years viewed as far too risky, such as small stocks and Latin American stocks, have taken on a new aura of respectability, if not stability.

At the same time, markets that for most of the 1980s were considered completely secure--the Treasury bond, municipal bond and insurance businesses, for example--have suddenly become tainted by scandal, chicanery and in some instances shocking defaults.

The upending of long-held investing beliefs is happening across a broad front, and it’s affecting investors of all stripes:

* Revelations that brokerage Salomon Bros. essentially cornered the market on some Treasury bond issues last spring showed that even the mammoth government securities market isn’t immune to price-rigging and deceit. Though the government’s ability to repay its debt isn’t in question, there now is less certainty about investors’ ability to get a true and fair price in buying or trading that debt.

* In the Southland, long a hotbed for fast-money swindlers promising outrageous returns, the Securities and Exchange Commission says the newest scams involve securities aimed at conservative, safety-seeking investors. For example, the SEC alleges that now-defunct FSG Financial Services of Beverly Hills sold at least $250,000 in “top-rated” municipal bonds to investors over the past 20 months, but that, in fact, the bonds don’t exist.

* Another favorite “safe” investment of wealthy Southern Californians in the ‘80s--lending money to individuals or businesses in the form of second or third mortgages on homes or commercial property--also has turned into a risky business as the real estate market has cracked.

Property Mortgage Co. of Sherman Oaks, which collected $102 million from investors for second mortgages in the 1980s, has seen a stunning 77% of its loans go bad, according to a recent report of the examiner overseeing the company’s Chapter 11 bankruptcy reorganization.

* In the stock market, many of the industries previously considered immune to recessions proved otherwise this year. Waste-management companies such as Browning-Ferris have seen their stocks crushed as their sales and earnings have slowed with the economy. The same has happened to some supermarket chains, such as A&P; in the Northeast. And worries are growing that Southern California supermarkets will suffer the same fate.

At the other end of the market spectrum, the investments most in demand now--and whose performance has been consistently strong all year--include small-company stocks, Latin American stock funds and high-yield junk bonds. Investors are perceiving that the risk in these securities is far lower now than in the ‘80s, relative to the potential returns.

While the Dow Jones industrial average is up 13% year-to-date, the average small-stock mutual fund is up 35%, and the average junk bond mutual fund has soared 28%. Meanwhile, the Mexico Fund, which invests exclusively in Mexican stocks, has rocketed 85%.

Of course, the changing nature of these markets, and the change in investors’ willingness to put their money into one security and not another, is to some degree cyclic: What is hot eventually becomes cold, and vice versa, in the natural rhythm of the markets.

Small stocks, for example, endured a seven-year drought from 1983 through 1990 before blossoming this year. At the same time, the real estate market is clearly overdue for a setback after the astounding appreciation of the ‘80s.

“The risk for any asset class certainly changes, depending on where you are in the cycle,” says William Dudley, economist at Goldman, Sachs & Co.

But the revised concept of investment risk in the ‘90s also is being shaped by much larger forces outside the normal, shorter-term market cycles.

The unprecedented failure of hundreds of banks and S&Ls; in recent years has changed forever many individuals’ notions of a “safe and secure” banking system. Even though federal deposit insurance has protected the vast majority of depositors in bank and S&L; failures, Americans can no longer view the banking system as a Rock of Gibraltar.

Likewise, many of the nation’s insurance companies have suffered irreparable damage to their once-sterling reputations because of the failures of Mutual Benefit Life, First Executive Corp. and a host of others. The so-called guaranteed investment contracts (GICs) and annuities that insurance companies sold to conservative investors in the 1980s now are viewed as far riskier instruments than originally believed.

In fact, C. Richard Lehman, founder of the Florida-based Bond Investors Assn., a watchdog group for individual investors, worries that the fallout among insurance companies from the national commercial real estate bust is only beginning.

The assumptions that many insurance companies made about their ability to pay off policyholders was built to a large degree on a belief in the ever-rising value of their real estate investments, says Lehman, an accountant by training. “That works well until, instead of inflation in real estate, you have deflation,” he says.

And unlike the banking business, where a federal safety net protected depositors, there is no federal safety net to protect insurance policyholders, Lehman notes.

Besides the increased default risk involved in many once-ultra-safe investments, conservative investors in this decade may also have to contend with another form of risk: the “opportunity cost” of staying in low-yielding investments as interest rates fall.

With an aging American population likely to consume less and save more in the ‘90s, many economists believe that the long-term trend in interest rates is down. If that comes to pass, the investors who leave all of their savings in short-term bank accounts or money funds risk seeing their standard of living decline with their falling interest earnings.

How does the average investor cope as the risk equation changes in the ‘90s? The answer isn’t for conservative investors to convert all of their bank CDs to small stocks, of course. Rather, what’s important is that you reconsider the risk entailed in different investments versus the potential reward.

What you may find is that most investments’ inherent risk hasn’t changed, but that there has been a change in the expected return in the ‘90s. You can’t necessarily keep thinking the way you did in the ‘80s about markets, because investment viewpoints, like fashion, can become outmoded.

“Risk is a relative thing, not an absolute thing,” says Jeffrey Werbalowsky, an expert in distressed securities with the Los Angeles firm of Houlihan, Lokey, Howard & Zukin. Rather than avoid risk at all costs, the key is to manage it, to judge whether you can handle a particular level of risk for the return the investment may pay.

As an example, he cites the decision some savvy investors made about junk bonds at their low point last year. If a bond had dropped from $1,000 to $500, an investor could have sketched out some odds on what might happen next.

If there seemed to be an 80% chance of a rebound, and only a 20% chance of a further plunge, the risk versus the return favored purchasing the bond, Werbalowsky says.

“Really sophisticated investors are attuned to that risk-return trade-off,” he says.

There also is no substitute for another trade-off: Striving for a reasonable overall return by diversifying your investments across a broad spectrum of options, rather than trying to shoot the moon with a handful of securities. In the changed risk environment of the ‘90s, diversification may be your best protection from the perils of shifting markets.

Protecting Yourself in the ‘New Market Order’

The concept of what is risky and what is safe in investing is changing in the 1990s. But there still are some general guidelines you can follow to avoid getting caught in securities that aren’t right for you--or worse, in outright fraud. Some tips:

* Never buy securities through unsolicited phone calls. Demand to see a description of any investment in writing before you consider it.

* Beware of salespeople who use high-pressure tactics--especially someone who insists that you must act “immediately.” They are almost certainly frauds.

* Conservative investors must be more alert than ever: The Securities and Exchange Commission’s L.A. office says the newest frauds involve promises of steady, safe returns on such “no-risk” investments as muni bonds and second mortgages. The scamsters take your money and run.

* Never assume that an investment can pay you in the future what it earned in the past. In fact, the greater the past return, the more likely it is that the near-term return will be far less.

* Diversify. No investment should make up too large a percentage of your portfolio. Investors who put 60% to 70% of their retirement funds in junk bonds in the ‘80s learned that the hard way. In the ‘90s, investors whose retirement funds are too heavily invested in their own company’s stock may also learn that painful lesson.

* Remember that risk takes many forms. A highly speculative investment is risky, but in another sense it also can be risky to leave all your money in super-safe passbook savings accounts paying 4%. That is “opportunity risk”--missing other investment opportunities that may pay you more over time.

Source: Securities and Exchange Commission, Times research