Fixed-income funds and mortgage funds used to be boring. "Boring" because they produced steady, reliable income not much higher, after fees, than the cash rate.

However, new, aggressive funds with more marketable names such as "high-yield", "diversified credit" and "multi-strategy income" have appeared alongside the boring investments of old, whose mainstays were government bonds and highly rated corporate debt.

The new breeds of income funds have been investing in such things as collateralised debt obligations, asset-backed securities and mortgage-backed securities, as well as emerging market debt and non-investment grade corporate debt.

Investors stampeded into high-yield funds, such as those run by hedge fund managers Absolute Capital and Basis Capital, earning returns that investors would normally expect from shares but with much less risk.

Or so it seemed, until the US subprime mortgage meltdown triggered a worldwide credit crunch and the fund managers came a cropper.

The CDOs turned toxic as it emerged that the mortgages bundled up into them were "liar" loans, taken out by people with no hope of repaying them.

No doubt that will lead many investors who are sitting on losses, or have lost their savings, to question whether the risks of many income funds and their underlying securities were adequately described, either by the fund manager or their financial adviser.

Many investors have had to learn, once again, that higher returns always come with higher risk.

Mortgage fund managers, such as City Pacific's $1 billion First Mortgage Fund and Mirvac's AQUA mortgage funds, with $250 million in them, have stopped unit holders from getting their capital back.

The managers had little choice but to close the doors to redemptions temporarily, because a rush for the exits would have meant selling assets at the worst possible time. No one is suggesting that eventually investors in these funds will not receive most of their money back but it underlines the caution with which investors have to approach all investments, regardless of how much managers say they spread the risks.

Many higher-yielding funds have produced losses over the past year (see table). The BlackRock Monthly Income fund has lost more than 7 per cent. The fund paid income of almost 7 per cent to unit holders over the year. That implies that the value of the units is about 14 per cent lower than a year ago.

It is a similar story with most of the other big managers. Unit holders continue to receive regular income while sitting on capital losses.

The Vanguard International Credit Securities Index fund has bucked the trend somewhat. As an index manager, the fund mirrors the returns of the markets, rather than taking punts on riskier securities. It is an example of how a portfolio of investment-grade assets holds up well in tough times.

Over the year to August 31, the fund produced a total return of 7 per cent while delivering more than 12 per cent income. The value of the fund's units is about 5 per cent down on a year ago but that is much less than most of its actively managed competitors. The fund is fully hedged for currency, which added 3 or 4 percentage points to the income return.

Roger McIntosh, Vanguard's head of fixed interest, says about half the fund is invested in government bonds and bonds issued by government-related or government-backed agencies, with most of the rest of the fund invested in investment-grade corporate bonds.

"The portfolio is highly diversified [as to] credit rating, industry and geographic region and owns about 760 bonds [from] 400 issuers," he says.

No investor, especially those investing for income to live off, is happy to see the capital go backwards but the losses must be put into context. Anthony Serhan, Morningstar's head of research, says these funds have been paying attractive levels of income to unit holders.

Unit holders would be best off sticking with the funds until markets return to normal rather than realising capital losses now. With fixed-interest investments, the capital is repaid once the investment matures unless the borrower defaults or the company issuing the bond goes bust.

Roger Bridges, the head of fixed income at Tyndall/Suncorp Investment Management, says the fund managers' screening processes will help to insulate unit holders from defaults. He says the number of defaults should be relatively low in a well-diversified portfolio.

The higher the exposure of a fund to credit markets and the less to standard government and investment-grade corporate bonds, the longer the minimum time frame for investment in the fund should be. "That allows for when something goes wrong and gives investors time to get their money back," Bridges says.

INCOME HOLDS UP BUT UNIT PRICES DOWN                                                            
HIGH YIELD                              Return  Income  Return  Return  
                                        1yr %   rtn 1yr %       3yr %   5yr %   
Credit Suisse Syndicated Loan                   3.45    11.14   5.64    ???
AMP Capital Structured High Yield               11.92   15.43   10.83   10.55
Hastings Yield                          ???     ???     ???     ???
Principal Global Strategic Income               -5.81   9.27    0.58    ???
AMP Capital Structured High Yield A             11.69   15.22   10.93   ???
Portfolio Partners Prof High Yield              -3.09   5.7     2.17    ???
ING Diversified High Yield - Wholesale Units    -1.13   6.67    3.35    ???
Credit Suisse High Yield                        3.72    17.03   5.95    9.03
Enchanced Yield Alpha                   6.55    13.46   ???     ???
ANZ OA IP CSAM Syndicated Loan NE               0.95    9.4     ???     ???             
MULTI-STRATEGY INCOME                   Return  Income  Return  Return
                                        1yr %   rtn 1yr %       3yr %   5yr %
AMP Capital Enchanced Yield A                   6.84    11.85   7.73    8.45
Challenger Wholesale High Yield         -7.64   6.74    1.13    4.92
Credit Suisse Global Income                     -1.22   9.99    3.79    ???
Schroder Hybrid Securities                      -1.06   6.13    3.37    4.96
UBS Hybrib Income                               -4.13   3.88    1.45    3.58
Chifley Investment Absolute Return              ???     ???     ???     ???
Goldman Sachs JBWere Income Plus Wholesale      -0.49   6.14    4.94    6.48
Aberdeen Cash Plus                              0.54    4.56    4.06    4.81
Challenger Professional High Yield              -7.58   7.44    1.19    5
Goldman Sachs JBWere Enchanced Income Wholesale-7.14    7.85    1.65    4.08
DIVERSIFIED CREDIT*                     Return  Income  Return  Return
                                        1yr %   rtn 1yr %       3yr %   5yr %
BlackRock Monthly Income Class D                -7.19   6.96    1.41    ???
CFS WS Global Credit Income                     3.12    5.23    4.85    5.58
Vanguard Int Credit Securities Index (Hedged)   7.04    12.47   4.49    6.27
BlackRock Diversified Credit (Class D Units)    -2.39   3.06    3.14    ???
CFS WS Australian Corporate Debt                3.61    4.24    3.84    4.82
AMP Capital Core Plus Strategies                5.1     6.59    3.89    4.94
Macquarie - Fixed Interest Plus         4.64    NIL     3.92    4.8
Officium Income                         -1.36   1.51    2.11    3.73
Aberdeen Income                         1.14    6.37    4.25    ???
BT Wrap Essentials - BlackRock Monthly Income   -8.33   6       0.22    ???
* CORPRATE DEBTPERFORMANCE DATA TO AUGUST 31                                            
SOURCE: MORNINGSTAR