Gold Funds Have a Secret

Checking under the hood when you're shopping for a mutual fund is no less important than it is when you're buying a car.

After all, if you take a look at certain precious metals funds, you might be surprised to learn that their managers have been drifting toward holding assets that aren't closely tied to gold or silver.

With gold now hovering near its highest average price ever -- around $744 an ounce up from $640 in January -- the metal as an asset class is catching the limelight. So it should come as no surprise if retail investors flock to the precious metals funds.

"The problem is that small investors tend to chase performance," explains Joe Foster, portfolio manager for the $600 million (INIVX)Van Eck Gold fund and architect of the Market Vectors Gold Miners(GDX) exchange-traded fund.

"If you follow that logic, this year you would be buying the (VGPMX)Vanguard Precious Metals & Minerals fund, which holds over $4 billion in assets and has a year-to-date return of 33%," he adds. "But then you may not be getting what you really want."

Or in other words, not enough gold. The problem is that Vanguard's fund is meaningfully invested in shares of companies involved in producing industrial metals.

So what, you might say. But know that in many ways gold is unique -- it is effectively its own asset class. And just as someone wouldn't make the mistake of including stocks in the bond allocation of a portfolio, they shouldn't want something that isn't gold in the gold slice.