Government bond funds invest primarily in US Treasury Bonds. They may also invest in government agency bonds. Basically, they hold the safest debt instruments on the planet. Relative to other types of bond funds, the probability that a Government Bond Fund will suffer from an issuer defaulting is tiny. That does not mean that you cannot lose money in these types of funds however. If you invest in a government bond fund, you may lose a significant amount of your initial investment if interest rates go higher.
Right now (June 2012), interest rates on treasury bonds are near all time lows. The 10 year Treasury Bond is yielding 1.64%. Five years ago, it yield 5.0%. Twenty years ago, it yielded 7.5%, and 30 years ago the ten year treasury yielded almost 15%. The point is simple, current interest rates are very, very low. Even if interest rates on the 10 year treasury were to double from their current levels, they would still be very low when measured against the last 30 years.
The difference in maturity dates explains why there are still major differences in the performance of different types of funds, and even within the same category of fund. For example, an intermediate fund can hold bonds with maturities from 4 to 10 years. A fund with an average maturity of 4 years will produce very different returns than a fund with an average maturity of 9 years, even though both would be categorized as intermediate term government bond funds.
There are some government bond funds that only include strips. “Strips” are bonds that have been stripped of their coupon payment. If you had two identical bonds, except one is stripped and the other is not, the one which has been stripped will be more reactive to chagnes in interesr rates.
Want to know more about bond mutual funds and ETFs? Visit the Bond Funds section of Learn Bonds.