For managers in the Canadian bond fund market, the opportunity to make a difference has historically been restricted to a few choices. They could experiment with the yield curve, creditworthiness or sector allocation — with all their accompanying risks.

But global bond markets have historically held a broader range of value-added strategies. And that simply gives fund managers more to work with.

Now that foreign fixed-income investments no longer eat up valuable RRSP foreign-content room, Canadian investors are looking at this asset class for diversification. This rising demand comes despite almost non-existent returns recently, largely because of the Canadian dollar’s climb. In fact, hardly any global bond funds at all can lay claim to positive returns for the past three years.

With these lacklustre results in mind, AIC Ltd. ’s $24-million AIC Global Bond Fund and AGF Management Ltd. ’s $140-million AGF Global Government Bond Fund are two smaller global bond funds to consider.

As with virtually all their peers, both funds generated only modest results in the past five years. Nevertheless, both garnered solid four-star risk-adjusted ratings from Morningstar Canada. In addition, the AGF fund was named the top global bond fund at the Canadian Investment Awards for the past three years running.

Relatively speaking, both funds’ returns have been fairly consistent, producing first-quartile performance in two of the past five calendar years and second-quartile results in other calendar years.

After posting a 2.8% annual return in calendar 2003 vs the S&P/Citigroup world government bond C$ benchmark’s 6% loss, the AIC fund held its own in 2004, delivering a 1.6% return. Last year, although it was a losing year in which the fund dropped 4.6%, the fund still outperformed the median performer and the benchmark by a significant margin. As of Sept. 30, the fund had lost about 0.5% for the year-to-date.

The AGF fund has had a similar ride over the past five years, delivering good relative numbers but little in the way of real returns. After a break-even year in calendar 2003 and a 3.1% jump in 2004, it also has struggled recently. It lost 6.7% in 2005 against a benchmark loss of 9.8%. So far this year, it is down about 3%.

With an average annual compound return of 3% for the five years ended Sept. 30, the AIC fund has been the stronger performer of the two, but only by a narrow margin. The AGF fund delivered only a slightly thinner return of 2.3% in the same period.

Randy LeClair, who manages the AIC fund, joined the firm eight years ago. Prior to that, he worked as an analyst for CUMIS Group Ltd. and subsequently spent seven years managing a fixed-income portfolio for a regional municipality.

AGF’s principal manager, Tristan Sones, is currently a co-manager of all AGF domestic and global fixed-income mandates. With 13 years’ experience, he joined AGF’s investment-management group in 1996. Before that, he developed a personal financial risk modelling application for AGF.

Taking a quantitative approach, LeClair uses macroeconomic analysis to select currencies that are trading outside their long-term ranges and to assess their direction compared with the C$. Not wanting to take much credit risk, his focus is on high-quality issues backed by both Canadian and foreign governments, as well those issued by supranational agencies such as the World Bank.

Believing currency exposure is what really drives returns, LeClair avoids making big bets in duration relative to the benchmark, the S&P/Citigroup world government bond index.

Duration, in simple terms, is a measure of a bond fund’s sensitivity to interest rate changes. The higher the duration, the more sensitive the fund. For example, a duration of 4.0 means that a 1% rise in interest rates causes about a 4% drop in the fund.

Right now, the AIC fund has a duration of roughly 5.1, lower than most of its peers. The weighted average time to maturity of the bonds in the portfolio is 7.4 years.

Earlier this year, when the C$ hit record highs, LeClair trimmed the AIC fund’s exposure, boosting exposure to the euro, the British pound and the U.S. dollar.

AGF’s Sones is also interested in risk reduction when building his portfolio, using interest rate anticipation and currency movements as his principal tools. Value is added through multiple sources, with a primary emphasis on country allocation as well as quality positioning, yield-curve positioning and individual security selection.

@page_break@In the AGF fund’s case, average maturity is 6.9 years, with an overall duration of 5.6. He has also reduced exposure to the C$ recently, tilting instead toward the yen, the euro and the Swedish krona.

The AGF fund is the more volatile of the two. For the five years ended Sept. 30, it has had a standard deviation of 7.3, whereas the AIC fund has had standard deviation of 6.4, which is substantially lower than that of the benchmark and of the majority of its peers.

Nonetheless, respective Sharpe ratios of negative 0.02 for the AGF fund and positive 0.07 for the AIC fund indicate neither fund has had much to offer over the same five-year period.

The uninspiring returns of both of these funds over the past few years do not make a very compelling case for owning any fund in this category. But, as an asset class, global bonds are not closely correlated to North American markets. And when added to the investment universe, they drive the efficient frontier up and/or to the left, providing higher returns and/or lower risk.

In addition, only 35% of fund managers now believe that global bond markets are overvalued, down substantially from 53% last quarter, according to Merrill Lynch & Co. Inc. ’s latest monthly survey. And an increasing number now think these markets are actually undervalued.

With the shrinking probability of further increases in the C$, it makes sense to at least consider diversifying away from Canada. And with management expense ratios that are slightly lower than the category median, either of these funds could do the job for fixed-income investors. IE