Bond funds have an advantage over stocks

But with double-digit stock market losses so widespread in the three months ended Sept. 30, the bond market's red ink seemed much easier to bear.

That story line has continued in spades in the fourth quarter, just 12 days old. Many bond funds again are in the red, but far less so than stocks, which have been brutalized by relentless selling.

In both markets, the central issue remains investors' desperate desire to reduce risk and focus on safety of principal, amid severe worries about the financial system and economy.

For a few days at the end of the last quarter, even a classic risk-reduction move -- shifting savings to money market mutual funds -- appeared to be fraught with peril after a large money fund lost principal value on IOUs of bankrupt brokerage Lehman Bros. Holdings Inc.

The revelation triggered a run on many other funds, until the U.S. Treasury stepped in with a temporary insurance plan to guarantee money fund investors' principal. With the global credit crunch worsening, the last thing Wall Street needed was a sustained run on the $3.3-trillion money fund business.

The credit crunch also has had a direct effect on investors' perceptions of bond values, of course. Junk bonds, for example, have plunged in value because investors assume that it will only get more difficult for debt-heavy companies to fund themselves. That boosts the risk of default on junk issues.

Overall, though, the advantage bond funds have over stock funds in dicey periods like this is that the interest income bonds provide is a cushion against loss of principal value. That makes bonds a relative haven in a diversified investment portfolio.

Here's a look at how various bond fund categories fared in the third quarter:

Government bond funds

The government category was the only winner in the quarter, as investors worldwide hoarded Treasuries as a safety play.

The average fund that owns longer-term government bonds rose 1.4% in the three months through Sept. 30, according to Morningstar Inc. That's a "total return," meaning interest earnings plus or minus principal change.

The yield on the 30-year Treasury bond slid from 4.52% at the end of June to 4.31% at the end of September, boosting the value of older bonds issued at higher yields.