Stocks were severely punished in 2008, but perhaps more surprising was the hit that corporate bonds took. Yet late in the year, bonds started to show some life, and there are some strong arguments why returns may continue their upward trends in the New Year.

The iShares GS $InvesTop Corp Bond (NYSE:LQD) is an option for investors who seek the safety of corporate bonds and are willing to take on the risk/return potential of a substantial stake in financial holdings. Like many investments, the fund was down for most of 2008, but almost managed to eke out a positive return near the end of the year.

Fund specifics
The iShares Corporate fund tracks a Goldman Sachs corporate bond index. It holds about 100 bonds, with 75%-80% of its holdings rated A or better, giving it a solid investment-grade foundation.

Fund facts

  • 2008 return: (0.4%)
  • Expense ratio: 0.15%
  • Assets: $6.9 billion
  • Top 5 holdings: IBM (NYSE:IBM), PepsiCo (NYSE:PEP), Johnson & Johnson (NYSE:JNJ), Abbott Labs (NYSE:ABT), Wal-Mart (NYSE:WMT).

Source: Morningstar.

Fund prospects and risks
The iShares Corporate fund is very liquid, trading on average over 1.1 million shares a day. With nearly 40% of its portfolio in bonds of banks and financial services firms, the fund will benefit if financials find a way out of their doldrums. Despite economic concerns across corporate America, the high grade of most of the fund's holdings may also provide a bulwark of relative safety in these volatile times.

Treasury bond yields plunged in 2008 as investors fled any whiff of risk and sought safety. At the same time, the spread between corporate bonds and Treasuries also widened, another indication of risk, and approached levels last seen during the Great Depression.

Such a bearish viewpoint may well be appropriate. But with the U.S. and other nations doing whatever they can to alleviate the credit crisis, market prices may be based more on fear than on reality. Should the numerous attempts to stimulate global economies succeed in 2009, bond yields and spreads may revert to more normal levels, which could in turn bump up the price of corporate bonds and give investors some solid capital gains.

Portfolio fit?
Investors spooked by the declines in the stock market may want to look beyond the slim yields of Treasuries to corporate bonds for their fixed income allocations. In addition to diversifying your portfolio, bonds offer investors the advantage of being higher on the capital structure than stocks. That preference would help if defaults or bankruptcies become even more widespread.

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Fool contributor Zoe Van Schyndel lives in the Seattle area, where she enjoys the coffee and natural wonders. She does not own any of the funds or securities mentioned in this article. PepsiCo and Johnson & Johnson are Motley Fool Income Investor picks. Wal-Mart Stores is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.