(FORTUNE Magazine) – This has been a tough time for holders of "risk-free" government paper. The total return for the benchmark 30-year Treasury bond in the first quarter was a dismal -7.17%. Even the less leveraged ten-year bond lost 3.19%. Somehow, the miracle of low inflation escaped the attention of the fixed-income world--or maybe they know something the rest of us don't. Practically the only U.S. paper that wasn't negative for the first three months of the year was Treasury inflation-protected securities (TIPS)--in which the principal is indexed to inflation--and even those bonds eked out a total return of just 0.41%.

So if you want high current income but don't want to lose principal, what kind of bonds should you look for? The answer is: You need to go further out on the risk curve. Both junk bonds and emerging-market bonds have done well so far this year, and the trend looks likely to continue. "Spread product" (what professionals call bonds that have a risk spread in their yields) is still recovering from the August-September crash that equities long ago left behind. That follows the historical pattern, since bond investors are more easily spooked and take longer to recover than equity holders do.

Let's start with domestic junk paper. In the first quarter, junk-bond yield spreads over Treasuries dropped faster than the T-bonds' prices. So even though interest rates rose, junk-bond prices went up faster. That meant that those bonds' total returns were positive, albeit barely--just 1.08% on the Merrill Lynch high-yield index. But you still get income while protecting your principal.

Although junk takes a lot of analysis, if you have the time and inclination you can cherry-pick a better yield than you'll get from a high-yield fund. I'd look at both value and growth. You may have to wait longer than you figured for the capital gains payoff. But fortunately, since we're talking bonds, you get paid to wait.

In the value category, my pick would be the shipping industry. The bad news is that it is overbuilt, its recovery is uncertain and distant, and everybody hates it. The good news is that the bad news is already factored into bond prices, and you have a pretty active market in buying and selling the underlying assets, namely the ships. Go for the most secure paper, such as first-mortgage notes. (These work the same way home mortgages do: As a mortgage holder, you and your co-investors can seize and sell the ships if the owners default.) "I've always done well with first-mortgage ship bonds," says Martin Whitman of the Third Avenue fund, a seasoned investor in undervalued properties. Keep in mind, though, that these are small issues--$150 million is common--so liquidity is thin, and dealer spreads between bid and asked prices are high. You should spread your purchases among a number of issues.

Any in particular? Consider Ultrapetrol, which operates both tankers in South America and oil-service boats. It has first-mortgage notes of 2008 selling at a 14.1% yield. Or try less risky Moran--you'll see its tugboats in New York harbor. Its first-mortgage paper of '04 yields 9.68%.

If you're more the growth type, take a look at Level 3 Communications (a darling of the stock market, thanks to a virtual cult around CEO James Crowe). Level 3 is building a nationwide fiber-optic network. This could well be the overcrowded industry of the future (see "Too Much Long Distance," March 15, in the Fortune.com archive), so projections about cash-flow coverage are probably just bad guesses.

But let's look at the numbers anyway: As of March 31, Level 3 had only $2.6 billion of bonds outstanding, plus $3.6 billion of paid-in equity from stock offerings and $4.86 billion in cash. Yes, it's spending the cash, but 80% will go to plant and equipment--that is, hard assets. Even if the industry takes years to fill all the new capacity and produce cash, and the stock crashes 90% in a long-distance price war, the assets would still be there to back up the 98% bond of 2008. That's 362 basis points over the seven-year point in the Treasury curve (the most comparable Treasury maturity). And if your dreams come true and some company like Bell Atlantic takes over Level 3 in the next couple of years, then there are another 15 points or so of profit as the bonds' price rises to investment-grade level.

Emerging-markets bonds did the best of any fixed-income category in the first quarter, with a total return of 5.06% on the J.P. Morgan Emerging Markets Bond Index Plus. True, that return already encompasses the recovery from last summer's crash. But even so, this is still probably the most value-laden sector in fixed income.

Take Pemex Finance 8 7/8% bonds of 2010, which pay about 370 basis points over Treasury ten-year paper. These are investment-grade bonds (rated Baa1/BBB by Moody's and Standard & Poor's, respectively) with a junk yield. Pemex (the Mexican government oil monopoly) sells oil to Gulf Coast refiners, which send their payments to Pemex Finance, a shell company in the Cayman Islands. Pemex has to maintain receivables in Pemex Finance equal to 3.5 times the annual debt service on the bonds. "These bonds would go into default [only] if Mexico stops selling oil to the U.S. and the U.S. stops paying for the oil it's bought," says Morgan bond analyst Scott McKee. If the world comes to that point, you'd better forget about bonds and stock up on canned food and ammunition.

How about discount Brady Bonds from Ecuador (named after former U.S. Treasury Secretary Nicholas Brady)? Traders call them "Dork Discos," and they are paying 13.95% at the recent offer price of $50.82. To a norteamericano newcomer, Ecuadorian paper might look like Confederate money: The country's finances are in really bad shape, the International Monetary Fund has been called in, the unions are in an uproar, Congress is mired in long debates about critical changes, El Nino passed through...you name it.

But there's more security here than you would think. Ecuador's prospects have improved as oil prices have risen. (It exports.) The government is going along with the IMF and wants to avoid default. Best of all for bondholders, the Discos are secured in part by collateral in the form of U.S. Treasuries. If they go into default tomorrow and Ecuador never pays another dime, you'll still get back your principal--and you'll earn a 3.145% yield to maturity. In my opinion, that's a better risk-reward ratio than you'll get from the U.S. equity market.

--John Dizard

JOHN DIZARD is a New York-based freelance writer (and a bond-market junkie).