Foreign Bond Mutual Funds Mount a Comeback - TheStreet

Foreign Bond Mutual Funds Mount a Comeback

Now that foreign markets have dipped, this could be a good time to consider a world bond fund.
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NEW YORK (TheStreet) -- With the European credit crisis jolting markets, mutual funds that hold foreign bonds have suffered. During the past three months, world bond funds have lost 1%, according to Morningstar (MORN) - Get Report. In contrast, domestic intermediate-term bond funds have gained 1.8%.

Now that

foreign markets

have dipped, this could be a good time to consider a world bond fund. The average fund in the world category yields 4.1%, a solid payout at a time when 10-year Treasuries yield 3.2%. Foreign bonds can also provide diversification, since they sometimes rise when U.S. stocks and bonds sag.

Keep in mind that world bond funds follow a range of strategies. Some play it safe, emphasizing rock-solid government issues from developed markets, while other portfolios take riskier bonds from the emerging markets.

For a more aggressive choice, consider the

Oppenheimer International Bond Fund

(OIBAX) - Get Report

, which has returned 7.1% annually during the past five years, outperforming 94% of its competitors. Manager Art Steinmetz has considerable freedom to roam around the world, emphasizing countries that have attractive markets and staying away from shaky economies.

Oppenheimer compares itself to a benchmark that has 30% of its assets in emerging markets and 35% in Europe. Steinmetz currently has 45% of assets in the emerging markets, a big overweight. He says emerging markets have come through the global recession in fine shape, without the debt problems that plague much of the developed world.

Despite their sound balance sheets, many issues in emerging countries must offer rich yields to attract wary investors. Steinmetz is particularly keen on Brazil, where 10-year government bonds yield 12%. He said the bonds pay such a high yield because investors still have memories of the days when Brazil suffered double-digit inflation. But now its annual inflation rate is 5% and heading lower.

The fund currently has only 10% of assets in Europe. Steinmetz is wary of the troubled countries of Greece, Spain, and Portugal. "It is still possible that a country could default," he says. "The current yields don't compensate for the risks."

Investors who prefer a fund that takes moderate risk should consider the

Waddell & Reed Global Bond Fund

(UNHHX)

, which has returned 6.1% annually during the past five years, outdoing 87% of competitors. Waddell & Reed follows an unusual strategy. To hold down risks, the fund focuses on short-term bonds with maturities of three years or less. Those tend to suffer only limited losses during periods when interest rates rise and most bonds drop.

While short bonds can be safe, they can also deliver skimpy yields compared to long bonds. To fatten the payout, the fund buys corporate bonds, including some issues with junk ratings. The resulting portfolio has a solid yield and relatively little volatility. "We think that we can provide a reasonable return without trying to shoot the moon," says manager Daniel Vrabac.

The Waddell & Reed managers are free to roam around the globe, investing wherever they choose. When the managers can't find safe choices, they can hold cash. During the height of the market meltdown in 2008, the fund had more than 40% in cash. Now the figure is down to 10%. The fund has 40% of assets in the U.S. and 30% in the emerging markets. Holdings in the U.S. include solid bonds from utilities, including

Allegheny Energy

(AYE)

and

NorthWestern

(NWE) - Get Report

.

For a fund that emphasizes government bonds in the developed markets, consider the

AllianceBernstein Global Bond Fund

(ANAGX) - Get Report

, which has returned 7.4% annually during the past 5 years, beating 96% of its peers. The fund has 30% of assets in Europe. While the portfolio managers are steering away from weaker countries such as Greece and Portugal, they have big positions in Germany and France. Because the stronger countries have solid fiscal policies, their bonds should present little risk for cautious investors.

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Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.