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Global allocation funds can go anywhere

World globe on dollar bills
Highlights
  • Go-anywhere funds can go across asset classes and geographical regions.
  • Some are portfolio anchors, with hedging strategies to cushion market blows.
  • Others assume a tactical approach and may even concentrate on just one sector.

An increasingly popular type of mutual fund investment has shed some of the constraints that hem in traditional funds. Colloquially called "go-anywhere funds" and more formally known as "global allocation funds," these investments can turn on a dime and zig and zag through asset classes as the management team sees fit.

With that kind of flexibility, global allocation funds should be able to protect you from market downturns and amplify returns in good times by finding great deals all over the globe. But do they shake out that way?

Investment research company Morningstar classifies these funds under the world allocation category. The three-year annualized total return for the category through Oct. 31, 2011, is 10.9 percent, compared to the Standard & Poor's 500 index return of 11.4 percent. But with 125 funds competing, it's a big field spanning wildly varied strategies and investments. Fund performance reflects this. For example, for the 10 years through October 2011, annualized returns run the gamut from 13.27 percent for First Eagle Global I to 1.77 percent for Oppenheimer Global Allocation B.

What are go-anywhere funds?

Global allocation funds can invest anywhere, across asset classes and regions. Some funds may take that mandate to an extreme whereas others may behave more like a traditional balanced fund.

"Funds in the world allocation category typically invest in a mix of stocks and bonds. Also a fair number of them invest in things like commodities and things along those lines," says Michael Herbst, associate director of fund analysis at Morningstar Inc.

Some of these funds give you exposure to alternative asset classes such as real estate investment trusts, or REITs, futures contracts and swap agreements in addition to stocks and bonds. Global allocation funds can also use alternative trading strategies -- for instance, using long and short positions.

What to look for

Before selecting mutual funds in this category, investors should be aware of what they want from the fund and the spot -- or spots -- they're looking to fill. Morningstar breaks down the category into funds suitable as a portfolio anchor, and more tactical funds that work better as supplementary holdings.

The characteristics of a portfolio anchor will differ from the more tactical fund. For instance, the former type often provides protection from volatility.

"World allocation funds that are designed to be a portfolio anchor are likely to try to strike some balance between capital appreciation and downside protection. Those trying to build some protection into the portfolio usually do so through exposure to fixed income, or other protective strategies such as holding gold or cash, or maintaining some kind of tail-risk hedging program," says Herbst.

"Tail risk" is a statistical term referring to the likelihood a portfolio move will exceed three standard deviations from the mean.

Think of investment returns as a bell curve. Normally returns will fall into the middle of the bell, but tail risk refers to the chance they fall under the "tails" of the curve -- either much higher than expected or much lower.

Hedging that risk involves mitigating a portfolio's potentially huge downside moves.

Conversely, funds that move more tactically may not necessarily build in those cushions against downturns. Instead, managers determine what investments look attractive and can load up on them -- so much, in fact, they may become extremely narrowly focused on only one asset class.

At first glance it can be difficult to ascertain what kind of global allocation fund you're looking at; just reading the fund's objective and investment strategy within the prospectus may not give you the entire picture.

If you think it sounds tricky, you're right.

In order to really get a feeling for how the fund moves over time, investors need to look at its historical patterns to see how the fund is actually managed.

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