Although U.S. investors wouldn't know it, world bond funds enjoyed a respectable year in 2005, a recent report from The Wall Street Journal indicates.

Collectively, according to Chicago-based fund tracker Morningstar, world bond funds returned a lackluster minus 3.2% in dollar terms. But that's mostly because the dollar, which many experts thought would weaken in 2005, gained nearly 14.6% against the euro and 15.2% against the yen. In local currencies, they actually performed nicely.

"Non-U.S. bond markets had decent performance, but overall, the movement in the currency led to the negative returns," said Andrew Gordon, a portfolio manager on BlackRock's International Bond Portfolio, a $628 million fund. It posted a negative return of 9.8% in 2005, versus a 5.7% average over five years and 9.7% over the last 10 years.

The currency discrepancy highlights the tricky landscape of overseas bonds. The funds are a great way for investors to diversify their portfolios, but since they come in so many different shapes and sizes, The Journal observes, allocation is extremely important. For example, the Global Bond Fund at Loomis Sayles, a typically consistently performer, returned a negative 4.6%. But emerging market bond funds in Brazil and Russia returned 12% on average because they're issued dollars.

To mitigate the risk of currency shifts, however, these world bond funds that employ hedging strategies against the dollar. In years when the dollar was weak, these funds performed particularly well.

"Over the long term, that is a pertinent thing to do; to diversify some of your assets away from the U.S. dollar," Gordon remarked.

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.

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