When global markets got rough again this past summer, many investors found themselves wondering helplessly where shelter might lie. U.S. stocks were gyrating wildly up and down every day. International equities were taking a pounding. And the yield on 10-year U.S. treasury notes sank below 2 percent.
With options like those, it's no wonder investors have been turning to "go anywhere" and "world allocation" funds, which give portfolio managers considerable leeway in choosing different asset classes and in some cases give them carte blanche to trade in and out of anything they please.
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According to the research firm Morningstar, investors have poured nearly $15 billion into these funds since the beginning of 2011. While not new, the funds became popular following the 2008 market plunge, as investors worried that traditional fund managers were too hamstrung by their funds' guidelines. In times of extreme volatility, "people feel like Nero when Rome was burning. They don't want to sit still," says Tom Orecchio, a financial adviser in Westwood, N.J. Fund companies have launched some 56 such funds since the beginning of 2010.
Financial advisers warn that these funds are no slam-dunk solution. For one thing, it's hard to know what you're buying. World allocation funds range from conservative portfolios that hold a steady split between global stocks and bonds to "tactical" funds that can make bold swings into international stocks, precious metals, and real estate to goose their returns.
It's tough to compare a fund's performance to an appropriate benchmark. Through November 28, the average world allocation fund had lost 6 percent since the beginning of 2011 and gained an annualized 11.3 percent over the past three years. That's roughly similar to the performance of Morningstar's "moderate allocation balanced" category of funds, most of which hold 50 to 70 percent of assets in stocks and the rest in bonds or cash. But that's not necessarily a good yardstick. At any given moment, the category's tactical funds could have almost no money in bonds, for instance, or a relatively heavy weighting in commodities.
Yet another reason to be cautious: Many of the funds in this category charge loads, or sales fees, says Morningstar's associate director of fund analysis, Michael Herbst. For a more conservative option, Herbst likes MFS Global Total Return, which charges a load except in some cases. The fund invests in a fairly steady 60-40 percent split of global stocks and bonds and, Herbst says, could work as a core holding. Through November 28, it was down 1 percent in 2011; investors gained 6.85 percent annually over the past 10 years.
[See U.S. News's top-ranked World Allocation Funds.]
For a fund that truly goes anywhere, Herbst and Houston-based financial adviser Owen Murray both point to Ivy Asset Strategy, which also typically levies a sales fee. As of September 30, 82 percent of the fund's holdings were in domestic and foreign stocks; alternative investments like precious metals made up another 13 percent and the rest was in bonds and cash. The fund lost 7.8 percent this year through late November but boasts a 10-year annualized gain of 9.67 percent. Both pros cite the fund's veteran management team; Ivy's senior manager has been with the fund for 14 years. The MFS Global Total Return manager counts 11 years there.
In fact, advisers say the quality of the management team is the most important thing to look for. If managers who only have to be expert in one asset class have a hard time outdoing the market, you shouldn't expect the people running these far more complex funds to be any smarter, warns Craig Larsen, a financial adviser in St. Charles, Ill. The challenge is to distinguish skill from luck.