However, domestic bonds bucked the trend to become the best-performing asset class for the first time since 1992.
According to Morningstar data, the Australian fixed interest index returned 14.95 per cent for 2008; a return that even outperformed hedged international bonds, which returned a respectable 9.21 per cent for the same period.
The top performers included Intech's Australian Bonds Trust, which returned 17.19 per cent for the year.
"This is a passive fund that has a government and semi-government mandate only, so there was absolutely no credit in that fund. That was why they managed to receive the return that they did," Morningstar consultant Sallyanne Cook said.
Suncorp-Metway's Australian Fixed Interest Funds and the UBS Australian Bond Fund both returned 15 per cent for the year.
Cook said funds that invested heavily in credit were the big losers in 2008 as investors became wary of anything deemed risky.
The worst-performing credit fund was the UBS Global High Yield, which lost 34.7 per cent for the year to 31 December 2008.
"All the credit-related funds had negative returns. It's all doom and gloom and you really don't want to hold listed property trusts and you don't want to hold Australian equities if we're going into a full-blown recession. In this sort of environment, a sovereign bond is the place to be," Cook said.
Perhaps capitalising on the interest in sovereign bonds is Vanguard Investments Australia with the recent launch of its Australian Government Bond Index Fund.
Vanguard principal and head of fixed interest Roger McIntosh said the fund featured zero exposure to non-government bonds and offered investors a high level of security.
And this trend is likely to continue into 2009 with the likelihood of further interest rate cuts by the Reserve Bank of Australia and a deepening of the financial crisis.
"Do you sit in cash which is going to give you 3 per cent or do you move out and pick up 50 to 100 basis points in a 10-year government bond? It's the safest place to be," Cook said.
