Global Bond Funds -- Year-End 2002 Review

Foreign Currency Has the Edge

Jan. 7, 2003 -- As the U.S. dollar weakened against many foreign currencies, particularly the euro, non U.S.-dollar denominated global bond funds posted the highest returns in 2002 as the entire sector delivered strong gains.

The most appropriate benchmark for foreign-currency denominated bond funds, the J.P. Morgan Global Government Bond Non-U.S. Index, rose 22.1% in calendar 2002. In comparison, the average global bond fund tracked by Standard & Poor's posted a 10% return for the year.

Among the top performers in 2002 was the $48.7-million Federated International Bond Fund/A (FTIIX), which rose 22.6%. "Our portfolio has pure currency exposure to the countries we're in," said co-manager Ihab Salib, noting that most global bond funds are U.S. dollar denominated.

Salib attributes the fund's outperformance mainly to the team's insistence on currency strength and low credit risk. Out of the ten best-performing currencies versus the U.S. dollar last year, the fund was probably invested in five or six of them, he noted. "Aside from the euro, we were overweight in such currencies as the Norwegian krone and the Swedish krona, as well as the robust commodity-based currencies of Australia and New Zealand."

The portfolio is primarily invested in the developed countries of Western Europe and North America, although it has dipped into such resurgent economies as Hungary, Poland, Czech Republic and South Africa. It currently has about 58% of its assets exposed to the euro. About 20% of its assets are in corporate bonds, and the remainder in government issues.

"We think European economies will muddle through and not get worse, so bonds will perform relatively well," Salib said going forward. "More importantly, we believe the U.S. dollar will continue to weaken for the next 12-18 months relative to the euro and other currencies in Europe, primarily because of the growing U.S. current account deficit."

Emerging Markets Shine

Emerging markets bonds had a strong year in 2002. The JPMorgan Emerging Markets Bond Index Global (EMBI Global) rose 13.1%. Brazil's markets in particular, both equity and debt, have rebounded strongly. Bond spreads are narrowing and equity prices are rising. Not that long ago, Brazil had to devalue its currency, the real, by the maximum amount possible. Since the presidential election in October, the currency has appreciated.

While the Federated International Bond fund typically avoids emerging markets, the portfolio's lead manager, Robert Kowit, co-manages other Federated products that emphasize emerging markets, including the $103.4-million Federated International High Income/A (IHIAX).

"What happens in Latin America depends to a large degree on what happens in Brazil," he said. "This is because Brazil is the dominant economy on the continent -- it represents a big chunk of South America's overall market index capitalization." Kowit noted that despite some "devastating debt crises" in Brazil and Argentina in the past few years, other Latin American countries have not really suffered any spill-over effects.

One thing that has benefited emerging markets overall, the manager pointed out, is an improvement in the "quality of investors." In other words, investment-grade accounts, i.e., pension funds and insurance companies, increasingly invest there, he says, and thus the credit of emerging markets can be analyzed and evaluated. He added that more importantly, "many of these countries now have access to the capital markets."

Looking forward, Kowit believes emerging debt markets will deliver more modest performance in 2003, with returns in the high single, low double-digit range likely. "Brazil remains the wild card -- but the odds are better than even that their markets will continue to improve as long as they adhere to economic reforms," he said. "Spreads on Brazilian debt are currently hovering about 1400 to 1600 basis points over U.S. Treasuries," he noted. "Next year, I hope to see those spreads tighten to about 1000 basis points over Treasuries."

GLOBAL BOND FUNDS: Best Performers2002 Returns (%)Worst Performers2002 Returns (%)

Delaware Pooled Tr:International Fixed Income (DPIFX) +26.7Merrill Lynch World Income Fund/C (MCWIX) -4.6

Delaware Pooled Tr:Global Fixed (DPGIX) +26.2Evergreen Offit Emerging Markets Bond/I (EOEMX) -3.5

Evergreen International Bond/I (ESICX) +23.6AIM Strategic Income Fund/C (GSIDX) -3.1

American Century International Bond/Adv (AIBDX) +23.5Lazard Funds Strategic Yield Port/Instl (LZSYX) -2.9

Federated International Bond Fund/A (FTIIX) +22.6Van Kampen Worldwide High Income/B (MSWBX) -2.6

Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Data as of 12/31/02.

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