Global Bonds Gain Luster From Higher Interest Rates

MOST people know about the advantages of overseas stocks. And investors know that it can be wise to own a mix of equities and fixed-income products. But only in recent years have average Americans begun to explore the world of overseas bonds - mainly through mutual funds.

Global bond funds offer diversification - offsetting risks in the US bond market. Moreover, the interest income and total return (including share-price gains) from overseas bonds can represent ''very good value,'' says Dale Christensen, co-portfolio manager of Warburg Pincus Global Fixed Income Fund in New York.

For the reasons, Mr. Christensen points to Europe, where the bulk of the fund assets he manages is invested. Continental Europe has slow economic growth, tight central-bank supervision over money-supply growth, and low inflation - all signals of a climate favorable to bonds.

This has brought unusually steep spreads between posted interest rates and inflation rates. Put another way, ''real'' (inflation adjusted) interest rates are high compared with those in the United States. The pattern is most visible in Germany, but extends to much of Europe and even parts of Asia (see chart).

In Germany, 10-year government bonds have been yielding about 6 percent. Subtract inflation running at about 2 percent, and you have real interest rates of slightly more than 4 percent. That real rate is well above the 2.5 percent rate in the US for government bonds of 10 years or longer.

''Over the next few months, the economic backdrop appears to be more favorable [for fixed-income investments] in Europe than in the US,'' Christensen says.

He suggests selective buying of overseas bonds, but cautions that ''you have to keep an eye on how central banks and overseas governments'' deal with their fiscal and monetary policies. Policy that results in higher inflation would be bad news for bonds.

Christensen also sees opportunities in the Pacific Rim. His fund is putting about 15 percent of its portfolio in Asia, buying convertible bonds with yields ranging from 1 to 3 percent above US government bond yields. (Convertible bonds can be converted at a stipulated price into common stock.)

Bond experts, while not necessarily touting overseas bonds, concede that caution may now be in order regarding the US bond market, particularly long bonds, given uncertainties about interest rates.

''I'm not suggesting that 1996 is going to be a repeat of 1994 [when the US bond market collapsed], but the risks in the market have clearly risen,'' says Raye Kanzenbach, senior portfolio manager at Insight Investment Management in Minneapolis. He says interest rates on long bonds could inch up, causing the value of those held in portfolios to decline. Thus, he suggests that investors cut back the average maturities in their US-bond portfolio to ''shorter time frames.''

Global bonds may represent an important form of diversification for older, conservative investors who put a lot of money into fixed-income products, says Mark Wright, a bond expert at Morningstar Inc., a mutual-fund rating firm in Chicago.

Overseas bonds are also useful to people ''saving for retirement,'' says Richard Hawkins, portfolio manager of the MFS World Governments Fund, offered by Massachusetts Financial Services in Boston. ''On a valuation basis,'' overseas bonds now ''look more attractive than US bonds.''

There are two ways of buying overseas bonds: individually, through a broker, or through a mutual fund. If you buy a bond through a broker, you will pay a commission. In addition to weighing interest rate and credit risks, you will also have to track the impact of currency fluctuations, which affect the underlying value of your bond product. Or you can buy bonds through a mutual fund, where fund managers do the tracking.

Some funds use futures contracts and options to insulate the fund from the impact of shifts in the value of a currency - a strategy known as ''hedging.'' But hedging can be expensive, sometimes costing up to 5 percent of a fund's assets. A fund's prospectus will identify hedging policies. There can be advantages to either approach.

''The case for buying overseas bond funds is that overseas bonds will often perform differently than the US bond market,'' Mr. Wright says. That does not always happen. In 1994, when the US bond market plummeted, so did many overseas bond markets. ''Financial markets are increasingly interlinked,'' he notes.

Still, Wright says the case for diversification has been underscored by recent favorable returns from abroad. For the last six months of 1995, the global bond funds tracked by Morningstar had a total return of 6.91 percent, compared with 5.82 percent for funds investing in general US corporate issues. Over the last decade, global bonds averaged 8.35 percent annual returns, versus 9.25 for US corporates and 7.98 for US government bonds.

Global bond funds have taken off in popularity. At the end of 1995, there were some 145 global bond funds, with assets of $33.4 billion, up from 37 such funds and $12.4 billion in 1990.