(MONEY Magazine) – Given the explosive nature of international fixed-income markets over the past nine months, it wouldn't necessarily be a typo if this story were titled ''Investing in Foreign Bomb Funds.'' Indeed, the collapse last fall of Europe's once stable currency rates sent professional managers and individual investors alike running for cover: In just the last three months of 1992, total assets in global bond funds fell 12% to $28 billion as the funds themselves lost 1.5% on average. Still, there are reasons for you to consider investing between a tenth and a third of your fixed-income portfolio overseas. The first is diversification. Just as in equities (see page 66), international diversification in bonds can actually reduce your risk and enhance long-term gains. That's because the U.S. and foreign bond markets rarely move in unison; when one is down, the other is often on the rise. Beyond the timeless virtues of diversification, today might also be the right time for overseas bonds -- not because of the currently sexy if dicey yields of up to 12% but rather the possibility of a longer-term annual total return of 6% to 8%. Many experts believe that over the next few years the world's best bond returns -- averaging 8% -- will be found in countries like Germany, France and Spain. Why? For one thing, their bonds yield about 1 1/2 to seven percentage points above comparable U.S. securities: Short-term German government issues now pay 6.1%, for example, vs. 3.8% for comparable U.S. Treasuries. For another, analysts believe that Germany and other European countries will continue to lower their interest rates to spur their anemic economies, thereby giving bondholders a capital-gains bonus of anywhere from 4% to 10% in the next year. Says Larry E. Jeddeloh, editor of the Institutional Strategist financial journal: ''Germany has waited too long to kick-start its economy, so the Bundesbank has no choice but to dramatically lower rates. And when that happens, other countries will follow like dominoes.'' Remember, however, that foreign bond funds face the same currency risks discussed in the international stock story: When you invest in foreign securities of any kind you run the risk that a rising dollar will shrink their value. For the 12 months to March 1, for instance, a seemingly savvy investment in Italian government bonds would have returned 11.4% in lire but, when converted back to dollars, actually lost 13.8%. Reason: Over the same period, the lira fell 22.6% vs. the greenback. Most international bond funds try to minimize such risks by using sophisticated hedging techniques in the foreign exchange markets. The most common is dollar hedging, in which the global fund trades futures and options in non-U.S. currencies to reduce the impact of currency moves vis-a-vis the dollar. If the dollar rises, dropping the value of your foreign bondholdings, the futures or options contracts theoretically rise in value to offset those decreases. The second form of currency defense is cross hedging, in which funds buy offsetting positions in different foreign currencies to soften the effect of fluctuations. Neither form of hedging is an unmitigated plus. For one thing, buying options or protective positions can be expensive, shaving your fund's profits by as much as 5%. For another, fund managers can guess wrong about the trajectory of world exchange rates. Many investors will recall, some painfully, last year's experience with the heavily promoted global short-term income funds. STIFs, to use their acerbic and well-earned acronym, turned out to be a lot riskier than the CDs and money markets they were touted to replace. In last year's turbulent second half, all but six of the 32 STIFs that were rushed to market over the preceding three years lost money, according to Morningstar -- despite the fact that all had actively hedged. Considering their volatility and the dearth of STIFs with even three-year track records, most experts advise you to just say no. MONEY's best list (below) contains only long-term overseas funds, buying government or corporate bonds that typically mature in three to 10 years. Investors with time frames of a decade or longer can ride out currency swings, which tend to equalize over periods of five to 10 years. Don't, though, get carried away by the current yields of these funds and allot them disproportionately in your fixed-income portfolio. Because of the funds' volatility and currency risk, Ronald Yolles, a Southfield, Mich. money manager, urges clients to view foreign bonds rather as ''long-term, total- return investments,'' capable of producing average annual gains of two to three percentage points more than domestic bonds. There are now about 50 or so long-term global bond funds available. You will recall from the foreign equities story that global means that the manager has discretion to invest anywhere on earth, including the U.S. Among the MONEY 10, Yolles favors the purer foreign plays, notably Scudder International Bond and T. Rowe Price International Bond, which consistently maintain at least 65% of assets in non-U.S. issues. In general, he prefers funds with more than 50% of their portfolios in Western Europe, including Britain; he figures yields there are too high to last, and capital gains of 4% to 10% could be in the offing if, as he believes, interest rates drop by one to 1 1/2 percentage points in the next year. Says Yolles: ''The falling rates and rising bond prices we saw here are sure to repeat themselves overseas. Investors shouldn't miss out on that.''

CHART: NOT AVAILABLE CREDIT: Sources: Lipper Analytical Services, Morningstar Inc., fund companies CAPTION: THE 10 BEST OVERSEAS BOND FUNDS Don't be blinded -- or blindsided -- by seemingly ir resistible yields. These funds are ranked by total return, and that is what investors should consider them for, not current income.