Are Alternative Mutual Funds Too Risky?

Why FINRA is telling investors to be careful.

Are Alternative Mutual Funds Too Risky?
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FPA New Income is an absolute return fund. However, unlike many of its brethren, it invests in fixed-income securities rather than taking long and short positions in stocks. The fund has a lengthy track record – it has been around since 1969 – and it has proven quite good at obtaining its objective of avoiding negative returns. Notably, since 1984, the fund has earned a positive return each year.

The fund is also large (with $4.8 billion in assets under management) and relatively cheap (its expense ratio of 0.57 percent compares favorably with the average for absolute return funds – 1.5 percent, according to S&P Capital IQ). Like most absolute return funds, though, its focus on positive returns has come with a cost: Over the past five years, the fund's average annual return has been under 3 percent.

[See: Mutual Fund Scorecard: How 6 Famous Stock Pickers Stack Up.]

Whereas FPA New Income's main audience is investors who are worried about losing money, PIMCO Commodity Real Return Strategy caters to those who are concerned about inflation. Despite its name, the fund doesn't invest directly in commodities. Instead, it puts its money in derivatives that give it exposure to commodities investments and in Treasury Inflation Protected Securities.

Unlike FPA New Income, the fund can gain quite a lot in a given year. For instance, it was up 39.5 percent in 2009. But the reverse is also true: The fund lost a painful 43.7 percent in 2008.

Ultimately, the key to investing in alternative funds is to make sure they fit well in your portfolio. "Alternative funds aren't for everyone," Rosenbluth says. "You really have to dig in and do your homework."