Corporate bond PEPs aim to provide a reasonably high income stream. If a company wants to raise capital at a fixed cost it will offer bonds paying a higher rate of interest than a savings account.
Fund managers aim to pick bonds which offer a combination of high income with minimal risk. They generally argue that corporate bonds are low-risk.
WHAT YOU SHOULD WATCH OUT FOR: Corporate bond PEPs may have both an "income" yield or a "redemption" yield. The former gives an indication of the income that you might receive at current yield rates. The latter is a measure of the total possible return, taking into account both income payments and the capital repayment at maturity of the bonds held in the portfolio.
If the redemption yield is higher than the income yield, that's OK. If it is significantly lower, it means that some of the income you receive may lead to losses .
Also, watch out for interest rate risk. If interest rates rise, bond prices will fall. This means you might get back less than you invested.
Tracker funds are almost always a type of unit trust PEP which aims to match the performance of a given stockmarket. This approach distinguishes trackers from managed PEPs.
While there are some excellent fund managers, most fail to beat the index most of the time, which is what makes trackers attractive for novice investors.
WHAT YOU SHOULD WATCH OUT FOR: Most trackers will deliver similar performance relative to others in their sector. A key factor therefore is cost. The lower the management fee and initial charges the better. Also, while trackers will deliver above-average performance (because the average fund under- performs the index) putting all your money in trackers means accepting market risk.
Equity/income growth PEPs offer a mixture of income and growth, where investors trade a lower income initially for a higher eventual yield. Yield on income funds will typically be about 1 per cent greater than that available on shares generally. That suggests that a yield of about 3 to 4 per cent is about right if you want the opportunity of capital growth.
THINGS TO WATCH OUT FOR: Income may fall in difficult years as struggling companies cut their dividends. Ones that quote the highest immediate yield may offer few opportunities for either capital growth or future income rises.
This may be because they have invested in lower-quality companies or because a higher proportion of your money is invested in preference shares or gilts to boost immediate income.
With a managed fund, once you have decided on the investment objective, a fund manager takes over. When choosing, good independent advice is generally crucial.
THINGS TO WATCH OUT FOR: Because managed funds vary widely, it is easy to make a mistake. You should always compare performance over several distinct time periods.
`The Independent' has published a free `Guide to PEPs', written by Nic Cicutti, the personal finance editor. The guide, sponsored by Scottish Widows, explains many of the commonest questions and offers tips on how to find the best PEP. For your copy, call 0345 678910Reuse content