JonnelleMarte

With inflation worries mounting, the fund industry is touting its latest offerings: An expanding roster of easy-to-buy funds designed to protect your portfolio from rising prices without all the hassle—and hefty expenses—of buying commodity futures and gold bullion. But will they deliver?

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Inflation-fighting funds have been around for a while, but recently, there’s been a second boom driven both by fund companies and investors. At least seven new funds have hit the market with the specific aim of hedging against inflation, including new offerings from Fidelity, Eaton Vance and JPMorgan, according to Morningstar. So great is the demand that even traditional growth shop Janus Funds is planning to launch its first-ever inflation-protected fund, the Real Return Allocation fund, as part of its expansion into fixed income. And these inflation-fighters come in many flavors and strategies, from so-called real return funds to inflation-protected bond funds and bank-loan funds.

Regardless of strategy, investors are diving in: Flows into bank-loan funds hit a record $5.6 billion in January, five times the figure a year earlier. At the same time, $2.6 billion went into global bond funds, an about face from two years ago when flows were negative. And after a slow start in 2010, flows into inflation-protected bond funds hit $1.7 billion in the fourth quarter, more than three times the flows in the previous quarter.

What’s driving all the demand? For starters, fears of inflation seem to be spreading daily as the Mideast turmoil has helped push oil prices above $100 a barrel for the first time since 2008, and food prices to their highest levels since 1990. And as baby boomers retire, there will be fewer workers to provide services like health care, which experts say could put even more pressure on prices. For investors, buying inflation protection in a mutual fund makes plenty of sense – especially for those who need liquidity and don’t have the time or resources to purchase traditional hedges like gold, commodities and other investments themselves, says Joseph Montanaro, a financial planner in San Antonio with USAA financial planning. The time to get the insurance is before the house is burning down, so there’s still value to adding these types of holdings in your portfolio.

But none of these funds has been truly tested. The oldest inflation-protected fund, the only dates to 1997 – almost two decades after the last real period of inflation. Indeed, the great majority of these funds were launched after 2000, according to Morningstar. Another risk: Some of these funds, particularly real return funds that invest in TIPs and other types of bonds, could get walloped if interest rates rise faster than inflation, says Matthew Toms, head of U.S. public fixed income for ING Investment Management. As a result, financial planners recommend putting no more than 10% of your portfolios into such funds. Here are three varieties of inflation-fighting funds to choose from.

Real Return Funds

There are roughly 50 mutual funds in Morningstar’s inflation-protected bond fund category and are called either inflation-protected or real return funds. While many of these funds invest mainly in TIPS, some also hold floating rate bonds, real estate investment trusts, high yield bonds and other investments. For example, the top two holdings of the launched in March, are agency mortgage-backed securities and corporate bonds. The biggest in the inflation-protected category, with about $32 billion, is the which has 96% in TIPS and has gained an average 4.15% a year for the past three years. The fund charges .25%, or $25 for every $10,000 invested.

Investors may want to steer clear of funds in this category that are too heavily invested in TIPS. While TIPS have traditionally been the purest way to keep pace with inflation, advisers say they’re not the deal they once were. Strong demand for the investments — in January investors had about $616 billion in TIPS, up 9% from a year earlier — has pushed yields down to just .01% for 5-year TIPS. In other words you’re not getting any yield, you’re basically just getting that inflation protection, says Ed Keon, managing director and portfolio manager at Quantitative Management Associates, a subsidiary of Prudential Financial. Another reason why they may not be a great bet now, says Toms: If interest rates rise, TIPS may plunge with the rest of the bond market. They are protected against a move higher in inflation but they are not protected by a move higher in interest rates, he says.

Global Bond Funds

Global Bond Funds

Global bond funds seek to help investors diversify from U.S. debt by investing in sovereign and corporate debt from other countries. One way to stay ahead of inflation: Invest in countries that will benefit as commodity prices rise. Historically the economies of Australia and Canada have been heavily dependent on natural resources companies so some people might consider increasing exposure to their debt, says Keon. Plus, yields on debt in other countries, such as New Zealand and Indonesia, are still high and therefore not as vulnerable to a boost in interest rates as in the U.S. says Toms.

By diversifying a bond portfolio with a global bond fund investors can still win if interest rates fall or, at the very least, lose less money than they would owning domestic Treasurys when rates rise. On the other hand, foreign debt, especially from emerging market economies, can be more volatile that U.S. bonds, says Keon — the ups and downs of these funds may not be well suited to more conservative investors. Todd Rosenbluth, a mutual fund analyst for Standard & Poor’s Equity Research, says a strong fund in the global fund category is the which has gained an average 11% over the past three years and charges .91%, or $91 for every $10,000 invested.

Bank-Loan Funds

These funds, which allow investors to own pieces of loans made to companies and whose yields move along with interest rates, have become the most popular among taxable bond funds, raking in $21 billion over the last 12 months, nearly five times the year-earlier period. Also known as floating-rate bonds, bank loans are a favorite in a rising rate environment because their yields keep pace with the London Inter-Bank Offer Rate, or the Libor rate, that banks charge each other for loans. Bank loans also do well during inflationary periods because some of the conditions that typically cause inflation — a growing economy and rising interest rates — are a boon for bank loans because companies are more able to keep up with their debt payments, says Jeff Bakalar, head of the senior loan group for ING Investment Management. Loan defaults declined to 2.49% in January from 11.50% a year before, according to Moody’s Investors Service.

Still, these funds invest in loans made to riskier, below-investment-grade companies, so investors could see big losses if firms suddenly couldn’t keep up with payments, says Eric Jacobson, director of fixed income research for Morningstar.

A top performer in the category is the fund, which has gained an average 6.82% annually over the past three years compared to an average 5.72% gain seen by the Barclays Capital Aggregate Bond Index over the same time period, according to Morningstar. It charges 1.12%, or $112 for every $10,000 invested. Another option: the which has gained an average 7.03% over the past three years and charges .73% or $73 for every $10,000 invested.