He also believes that corporate defaults will subside. Defaults impacted high-yield bonds most dramatically last year, but cast a pall over the entire corporate bond market.

The default rate for all corporate bonds reached a record 14% in 2002. "But since defaults are a lagging indicator, it is not necessarily unusual for default rates to stay stubbornly high even after a recovery begins," Mark Durbiano, Federated's high-yield bond specialist and fund co-manager, noted in a recent report. "On the plus side, most of the weak issuers of the late 1990s have been flushed out of the market. And with so many distressed bonds already gone, we think defaults could fall below Moody's forecast for 2003, which currently is about 8% on a par value basis."

Despite that outlook, high-yield bonds represent a small portion of the fund because of strict investment parameters that, while designed to limit investment risk, also limit allocation leeway. Federated Total Return Bond Fund's 200 or so holdings include a diversified mix of mostly investment-grade securities, including mortgage-backed bonds, investment grade and high-yield corporate bonds, U.S. Treasury securities, U.S. agency issues and a sprinkling of foreign bonds. Fund policy allows for deviation of no more than 50% from the benchmark's sector weighting.

Mortgage-backed securities account for 37.6% of assets, about even with the benchmark. Corporate bonds account for 35% of assets, compared with a 26% allocation for the Lehman index. Most of the fund's corporate bonds carry single-A and triple-B ratings from Standard & Poor's, which represent the lowest rungs of the investment grade spectrum. Balestrino says the positioning allows him to keep the fund true to its charter of keeping the portfolio in investment-grade territory, while reaping the higher yields these bonds offer compared with issues with top-tier credit ratings. Overall, the portfolio's weighted-average credit quality rates an A+ from Standard & Poor's and Aa3 from Moody's.

About 8% of the fund's corporate bond holdings are in lower-rated, high-yield bonds, close to its historic 10% maximum allocation. Because of slow investor demand and default jitters, junk bond prices are low and their yields unusually high, relative to investment-grade securities.

Historically, high-yield bonds tend to put on their strongest showing as the economy emerges from recession, and those returns can be powerful. Coming out of the last downturn, the Lehman Brothers High Yield Index gained about 75% on a total return basis over the three years ending in 1993.

Such performance may be difficult to repeat, since the powerful tailwind of falling interest rates during that period isn't likely to provide the same push in today's low interest rate environment. This time around, an improving economy could send interest rates higher, and put pressure on bond prices.

Under such a scenario, Treasury issues, which tend to be more sensitive to interest rate fluctuations than most other types of bonds, would feel the pinch of rising rates than most other sectors of the bond market. That potential threat, plus a belief in the potentially superior returns of corporate bonds over Treasuries this year, is one reason Balestrino has just 11.5% of fund assets invested in the latter sector, compared with the benchmark's 21% allocation.

He believes that certificates of deposit, commercial paper and other securities at the shortest end of the yield curve will likely see the biggest yield boost as the Federal Reserve raises the cost of borrowing slightly later in the year. Right now, the yield curve is unusually steep, with short-term rates at record low levels. Historically, a steep yield curve signals the bottom of a recession and indicates that economic improvement is on the horizon, he says.

"Generally, you can earn about 1.2% more moving from cash to five-year Treasuries," he says. "Now, the difference is 1.8%." Extending Treasury bond maturities from five to 30 years usually adds 40 basis points to yield, compared to a 195 basis point pickup today.