Despite the recent concerns over a possible U.S. default on its debt and an accompanying array of international economic intrigues, it's been a tremendously profitable year for investors in both U.S. and global government bond funds. Often volatile, but quite invigorating.

Bond market returns for 1995 should be the third best on record, the market shrugging off the Washington face-off between Republicans and President Clinton as political foolishness. It hasn't been deemed a serious event involving a country truly incapable of paying its bills. After overreacting to the potential for inflation last year, the market is more interested this time around in the possibility of the Federal Reserve cutting rates.True financial default occurs in smaller, riskier markets forced to pay a high premium for inherent weaknesses, and that's not the case here. A decade ago, Mexico stopped payment on its debt because of a drop in oil prices, then suffered financial pain because no one wanted to buy its bonds.

Many foreign bond markets have performed remarkably in 1995 and there are prospects for continued success. Led by nations such as Germany, inflation and interest rates are coming down. That improves the value of existing bonds. Importantly, most fund portfolio managers are able to carefully pick among this planet's best opportunities.

"The U.S. government bond market has been unbelievably strong, and the investor can expect a period with none of the usual inflationary problems encountered when you get to full employment," predicted James Glassman, economist with Chemical Securities.

The outlook is also favorable for foreign government bonds as nations confront sluggish economies and high unemployment, he added.

"It's hard to say whether a year from now people will say we overreacted this year and bond yields shouldn't be as low as they are now," said Mark Wright, fixed-income analyst with the Morningstar Mutual Funds investment advisory.

Investors must realize bond prices don't just go in one direction, Wright cautioned. If interest rates don't go anywhere, investors would get a return of about 6.25 percent.

"Our fund has done well because we had low exposure to the Japanese bond market, our prospectus limits keep us from buying emerging market debt and we hedged our currency exposure," explained James Mulally, a portfolio manager with Capital World Bond Fund, up 17.61 percent in total return the past 12 months.

He's generally positive on bond markets everywhere, with the exception of Japan, and that is "more of a currency question than a bond market question."

Top-performing world bond funds in total return (yield plus value of underlying bonds) the past 12 months, according to Morningstar, were:

View Comments

- Franklin Templeton German Government Fund, Franklin Group, San Mateo, Calif.; $24 million in assets; 3 percent "load" (initial sales charge); $100 minimum; average bond maturity of 6.6 years; average bond yield of 4.94 percent; up 18.26 percent.

- Benham European Government Bond Fund, Benham Group; Mountain View, Calif.; $246 million; no-load; $1,000 minimum; average maturity 6.5 years; average yield 6.27 percent; up 18.24 percent.

- Capital World Bond Fund; American Funds Group; $653 million; 4.75 percent load; $1,000 minimum; average maturity 8.9 years; average yield 5.83 percent; up 17.61 percent.

"The investor must keep in mind how sensitive a fund's price is to changes in interest rates, so you should know its average maturity or its duration," counseled David Schroeder, who manages Benham Long-Term Treasury and Agency Fund, up 25.28 percent. That U.S. government bond fund has a lengthy average maturity and more price risk than the typical fund.

Join the Conversation
Looking for comments?
Find comments in their new home! Click the buttons at the top or within the article to view them — or use the button below for quick access.