However, access to investments through traditional mutual funds has sometimes lagged index inception by many years, such as in the case of commodities. Though the Goldman Sachs Commodity Index has been in existence since 1969, commodity portfolios have only become prevalent in the mutual fund market in the past five years. The reality is that many investors remain unexposed to some important diversifying asset classes, including commodities, a circumstance that led to exacerbated losses when asset class correlations converged during the financial crisis of 2008.

The reason for this disconnect is that mutual funds historically have been developed and managed around narrowly defined asset classes, requiring investors and their advisors to assemble numerous portfolios to create an adequate asset allocation. This process can be challenging, particularly for smaller investors; however, with the financial crisis has come a deeper understanding of the need to not only improve diversification, but also to adjust allocations to respond to opportunities and risks that can quickly develop in the macroeconomic environment.

Absolute return portfolios fill a unique and timely role by providing exposure to a number of asset classes to which many investors have traditionally been unexposed or underexposed, including commodities and inflation-protected securities. Additionally, absolute return portfolios allow investors to flexibly manage their exposure to various asset classes by adjusting positions to capitalize on opportunities and, perhaps more importantly, to reduce volatility. This ability to access and navigate a broader investment universe provides absolute return investors of all sizes with the opportunity to optimize their asset allocation and achieve their investment goals regardless of the market environment.

While inflation may not yet be cause for alarm — and some is actually necessary for economic growth — investors should be aware of its impact. Inflation rates in the United States today are still fairly benign but it is important to note that inflationary pressures can build over time, as Michael J. Atkin, Director of Sovereign Research at Putnam, wrote in a recent Manager Insight.

Experienced investors understand that inflation can have a corrosive effect on the buying power of a portfolio’s returns, reducing the post-inflation, or “real,” return.

An absolute return allocation may help mitigate this phenomenon by specifically targeting securities or strategies that may be poised to perform well in periods of increasing inflation or rising interest rates. Managers have the flexibility to “go anywhere” and use modern investment tools, such as commodities, REITs, currencies, and derivatives contracts, as they seek out returns.

Putnam Absolute Return 100 Fund seeks a positive return that exceeds the rate of inflation, as reflected by Treasury bills, by 1% over a period of three years, regardless of market conditions. The fund is not tied to a benchmark and seeks to provide a positive risk-adjusted return with lower volatility than securities markets.

See performance of Putnam Absolute Return Funds vs. Treasury bills

Managing this type of risk is challenging, but critical to the goal of trying to mitigate the potential erosion of long-term returns. Investors concerned about the impact of macroeconomic events on their portfolios may want to learn more about market-neutral strategies. This type of strategy is not tied to a traditional benchmark that fluctuates with the market’s ups and downs. Market neutral strategies seek to produce returns largely independent of market volatility.

In recent weeks:

• The Chicago Board Options Exchange VIX — viewed as an indicator of investor sentiment and fear — had its biggest one-day jump in nine months on February 22, following concerns about political unrest in Egypt and Libya. On March 14, in the days after the Japan earthquake, the index reached 24.32, its highest level since August 2010.
• With political unrest and violence erupting in the Middle East and Northern Africa, concerns about oil supplies fueled volatile swings in the oil sector. Oil prices, as measured by the West Texas Intermediate (WTI) grade, rose as high as $105.44 per barrel on March 7, up from the recent low of $84.32 on February 15.
• Equity markets around the world experienced broad losses following Japan’s 9.0 magnitude earthquake and tsunami, which caused thousands of deaths and widespread destruction, including a nuclear power plant catastrophe. Japan’s Nikkei 225 Index shed nearly 17% in two days. The events sent shockwaves through equity markets across the globe. The Dow Jones Industrial Average posted two consecutive days of triple-digit losses in the aftermath.

Investors seeking to lessen the impact of market gyrations could consider market-neutral strategies, such as Putnam Absolute Return Funds. These funds seek positive 3-year returns of 1%, 3%, 5%, or 7% above inflation, as measured by T-bills, regardless of market conditions. The funds:

• Allow managers to invest in a wide range of strategies, with global flexibility
• Use investment tools to obtain exposure to markets and capture gains, regardless of whether the markets are flat or negative
• Have ultimate flexibility to invest beyond benchmark constraints

More on Putnam Absolute Return Funds.