Oppenheimer Strategic Income Fund, for example, made fortuitous bets last year on Turkish and Brazilian currencies, garnering a 9.1% return, and was among the top-performing funds in Morningstar's multisector category. Loomis Sayles' two funds in this category also benefited greatly from investments in appreciating currencies in Asia and elsewhere, according to the firm.

Eaton Vance uses derivatives less to reduce risk than to generate higher returns in its foreign investments, the firm says. "Our global macro strategy is more nuanced than simple emerging-markets fixed-income investing. We pick values and particular markets, and we often cross-hedge to keep down volatility because we find there are certain things that are overpriced in those markets," says Mark S. Venezia, director of global fixed income at Eaton Vance and portfolio manager of the $1.4 billion Eaton Vance Strategic Income Fund, which returned 8.14% last year.

Rebalancing Gradually

Despite the market's doldrums, the multisector fund category has been expanding recently. Several fund houses, including Thornburg Investment Management and Hartford Mutual Funds, have rolled out new products over the last six months. Assets in the funds have also mushroomed. Lord Abbett's fund, for example, has more than tripled its assets since 1997.

For the most part, the funds have generated fairly consistent returns over the long term, says Morningstar. They suffered a major setback last year, however. While many of the bigger players did well, the group as a whole underperformed the general bond market, returning only 4.5%. "Many managers were caught off guard by the rapid deterioration in the high yields, especially during the second half of the year," says Morningstar's Herbert. The high-yield market returned just 1.7% last year.

Since then, managers have scrambled to adjust their high-yield positions. Eaton Vance, for example, has shaved high yield to less than 1% in its fund. Others see the carnage as a buying opportunity and are standing pat. Loomis Sayles and Lord Abbett, for example, have made only small reductions in their high-yield positions.

Bond veterans Dan Fuss and Kathleen Gaffney co-manage Loomis Sayles' two bond funds in this category. The funds have only slight differences. Gaffney says they have kept high-yield allocations pretty steady in both funds during the market's turbulence and are looking for bargains. High yields currently represent 23% of total assets in the bond fund, and 29% of total assets in the strategic income fund.

"We're comfortable with the specific high-yield credits we have," says Gaffney. "We've seen spreads widen at the beginning of the year, and we think they have further room to grow. We have plenty of room to add as the bargains come out. While the credit exposures [in high yields] may be higher than in other funds, we like certain credits that we think will do well through the full circle. We're really about picking bonds that have upside potential because the fundamentals are behind them." Loomis Sayles owns high-yield credits in General Motors, Ford, Lucent and Nortel, as well as other blue chip stocks.

Loomis Sayles Bond Fund posted an average total return of 8.53% last year compared with 7.23% for the Lehman Government/Credit Index, while the Loomis Sayles Strategic Income Fund returned 7.61%, compared with 6.97% for the Lehman Aggregate Index, a proxy for the broad bond market.
Towle says he has reduced credit risk in high yields in Lord Abbett's fund only slightly. "The credit spreads have widened out dramatically, and created tremendous value, so I reduced it somewhat prior to January, but now I'm finding that there is too much value there to reduce it any further."

The 35-year-old Lord Abbett Bond-Debenture Fund was among the first bond funds to invest in a variety of sectors. The fund, which is shepherded by     Towle, three senior Lord Abbett partners and a team of analysts, has posted an average annual return of 9.07% since inception.
Unlike most other strategic income funds, the T. Rowe Price Spectrum Income Fund invests only in T. Rowe Price mutual funds, making it a fund of funds. There is no fee at the Spectrum level. "It's as if you invested in the underlying funds yourself," says manager Notzon.

The fund invests in emerging-market bonds, nondollar bonds and high-yield bonds, as well as in equities, which are some 15% of total assets. "We designed the fund to have roughly the volatility and yield of the investment-grade bond market, but to have roughly half the assets invested in and out of benchmark sectors," Notzon says.