Foreign Bond Funds Offer Juicier Yields

NEW YORK (TheStreet) -- With investors racing into Treasuries, yields recently touched record lows.

To get fatter yields, consider foreign bond funds.

Although 10-year Treasuries currently yield 2.08%, comparable bonds from Australia yield 5.0%, and Brazilian issues yield more than 11%.

Besides offering greater potential returns, foreign funds can help to diversify portfolios. Bonds from countries such as New Zealand and Switzerland don't move in lockstep with U.S. markets.

Foreign bond funds also can provide the chance to profit from the falling dollar. When the dollar dips, the values of foreign bonds rise for U.S. investors. That has happened in recent months and helped to boost the total returns of foreign bond funds.

How much of your portfolio should go into foreign bond funds? Consider putting 10% to 20% of your fixed income allocation into foreign bonds. By buying a top fund, you may boost returns and protect against trouble in U.S. bond markets.

To take a cautious step into foreign bond markets, consider Putnam Global Income ( PGGIX), which has returned 9.0% annually for the past five years, outdoing 83% of peers.

The fund holds a mix of foreign and U.S. bonds, emphasizing high-quality issues in developed countries. Worried about debt problems, portfolio manager Bill Kohli is shunning most European countries, except Germany and Netherlands.

"We are waiting to see whether the Europeans can come up with a solution that averts disaster," says Kohli.

When Kohli has a neutral outlook on global markets, he keeps 55% of assets in foreign currencies and the rest in dollars. These days the fund has a 71% exposure to the dollar. Kohli is concerned that problems with the euro and yen could cause those currencies to weaken. He figures that the dollar could record a comeback.

"The dollar is very cheap right now, and it could surprise the markets by recovering," he says.

To hold a big stake in emerging markets, consider Oppenheimer International Bond ( OIBAX), which has returned 8.8% annually during the past five years.

In its neutral position, the fund has 30% of assets in emerging markets and most of the rest in developed foreign countries. Currently wary about Europe and Japan, Oppenheimer is keeping 50% of assets in emerging markets.

Portfolio manager Sara Zervos says that the balance sheets of emerging countries have been improving steadily for five years, while the developed world has become mired in debt problems.

In addition, emerging markets offer better yields. "You can get yields of 7% to 10% in the emerging markets local currency bonds," she says. "In the developed world you can't get more than 1% to 3% in government bonds."

Another fund that sees bargains in emerging markets is Wells Fargo Advantage International Bond ( ESIYX), which has returned 9.3% annually during the past five years.

Although the fund is underweight Western European countries, it has big weightings in the emerging economies of Eastern Europe, including the Czech Republic and Poland.

"We are emphasizing economies where the governments have healthy budget deficits," says portfolio manager Tony Norris.

He says that Poland and Czech Republic have deficits that total less than 3% of their gross domestic products.

In contrast, many developed countries have deficits that are more than 7%.

Norris also holds Mexican bonds. He says that the government has been improving its deficit. In the past, the Mexican economy depended heavily on the U.S. But now the country's economy is poised to grow faster than the U.S.

When Norris thinks that the dollar is likely to appreciate, he can hedge to avoid suffering currency losses in his portfolio.

In the late 1990s, the fund hedged. In recent years, the fund has been unhedged. That has allowed shareholders to benefit as the value of foreign currencies rose against the dollar.

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

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