Steady bond market gives way to fear of rising interest rates. (Investments & Finance).

GOVERNMENT bonds have had an incredible run, and risk-wary investors who bought them when the stock market was still frenzied at the beginning of 2000 have outperformed stocks by nearly 26 percentage points. But as Newport Beach bond guru Bill Gross of Pacific Investment Management Co. puts it, "The salad days are over."

Despite a continuing global hangover from the bubble days, trade deficit imbalances and anemic demand from Europe and Japan, government yields worldwide "are close to rock bottom," Gross said in a speech at the end of March.

So what should bond investors do?

Gross recommends "coupon clipping," for now, and if inflation takes hold again, "price protection will be the order of tomorrow." (Bond prices fall as interest rates rise.)

Gross isn't the only local bond manager with an opinion, even if his are so influential they recently graced the pages of Barron's in a cover story. AIG Sun America, the Eli-Broad-founded unit of American International Group, has a few suggestions in a first quarter outlook issued by its financial desk. Though clearly concerned about rates, Sun America doesn't come out and predict they're going up.

Nevertheless, Sun has these suggestions for investors who buy into the conventional wisdom that interest rates will rise: Buy bonds with maturities less than three years; consider Treasury Inflation Protected Securities (TIPS), which are inflation adjusted; dabble in high yield or "junk" bonds, whose quality could improve with the economy, and look at income-generating alternatives to bonds.

But investors should be picky about which high-yield bonds they purchase, warns Los Angeles-based bond manager Payden & Rygel in its Quarterly Review. Bonds of so-called "fallen angels" -- companies that issued investment grade debt and then fell to junk status after hitting a rough patch -- don't offer the same protection to investors that bonds originally issued as high yield do.

For instance, companies agree to limit stock repurchases or dividends

when they issue high-yield debt. "Investors concerned by the lack of bondholder protection should consider waiting for the fallen angel to refinance in the high-yield market, when appropriate covenants will be added to the new bond indenture," Payden said.