Inflation is still low. Is it time to head for corporate bonds?

Liam Robb offers a guide for investors looking to for a better performance

Over the past few years, while inflation has been low, bonds have actually given a higher return than equities and the Chancellor's decision last summer to allow corporate bonds to be pepable was seen by the investment industry as a godsend.

There are two types of corporate bond PEPs. The vast majority - there are currently about 50 - are pooled unit trusts which invest in a range of fixed-interest securities with varying redemption dates. The problem is that as bond prices go up, their yields drift down and income flows and redemption prices from pooled vehicles can only be predicted - not guaranteed.

One alternative is Sun Alliance, which has recently launched the Daisy PEP. For a 5 per cent initial charge, the manager will guarantee repayment of capital if the fund is held for six years.

However, an increasing number of single corporate bond PEPs are arriving on the market. These offer the opportunity to invest in a single fixed- interest stock with a known redemption date and price (providing the bond is held until maturity) and a known yield which will be paid irrespective of prevailing interest rates.

General Accident, for example, has packaged National Grid debt in a corporate bond growth PEP which pays no dividend but promises a tax free return on the original investment plus 50 per cent growth at August 2002 (offer closes 26th March). Some companies have marketed their own debt - Legal & General was the most successful, raising pounds 130m in a guaranteed bond plan which offered 7.0 per cent fixed 5.5 years or 45 per cent growth. This issue is now closed although further issues are being considered.

Corporate bonds offered by building societies or banks are not eligible for inclusion in PEPs. However, Johnson Fry has packaged various building society securities within its Chip 5 fund offering a guarantee of capital repayment after five years. The yield is 6.3 per cent (equivalent annual return for basic rate tax payers of 7.88 per cent). The offer closes 18 March.

However, seduced by low interest rates at the bank, most companies are not particularly hungry for debt at the moment and the administrative difficulties of marketing their own debt within a PEP scheme ensures that such vehicles are rare.

It is possible for private investors to pick their own corporate bond and transfer it to a self-select PEP scheme. There is no shortage of choice with Eurosterling bonds available from most of the large quoted companies like Tesco, ICI or PowerGen. However, it is not necessarily possible for a broker to buy the bond in exactly the denominations a client needs. In addition, many domestic UK bonds do not have credit ratings so it can be difficult for private investors to assess the risk they are taking on.

Hargreaves Lansdown Asset Management has overcome some of the problems by buying single corporate bonds in bulk - normally those which are trading at or under par - and then packaging them in denominations which suit potential PEP buyers. There are savings to be made because of the economies of scale and the bonds on offer vary from week to week.

The company is currently promoting two: Eastern Electricity, which has a very long 30-year redemption date but which nonetheless offers an impressive gross redemption yield of 9.4 per cent, and Glaxo, which yields 8.77 per cent. The yields are guaranteed and are considerably higher than most of the pooled unit trusts. Perpetual's PEP bond fund, for example, which was voted top investment product for 1995 by independent financial advises, is currently yielding 7.3 per cent.

Many management companies believed that the natural market for corporate bond PEPs would be those who were in, or nearing, retirement. In fact, as Peter Hargreaves, chairman of Hargreaves Lansdown has discovered, the products are attracting investors of all ages. However, as Amanda Crowley of Allenbridge Group explained, a high yield should not be the only consideration. "The yields on single corporate bonds and the capital repayment at the end of the term are only guaranteed while the company is still in business," she said. "The reason they are yielding more is simply because they are much riskier vehicles."

Graham Hooper of independent financial advisers Chase de Vere also urged caution. "We would want to look at each issue on its merits and certainly wouldn't advocate investors going into single corporate bonds for the sole reason that they are yielding more," he said. "The collapse of Barings has shown that having all your eggs in one basket is not necessarily a good idea. For the less risk-averse investor however, certain single corporate bonds may well be worth considering."

Johnson Fry 0171-451 1000

Hargreaves Lansdown

0800-850 661

Sun Alliance 0500-100 333

General Accident

0500-100 200

Best Investment 0171-321 0100

Chase de Vere 0800-526 091

Allenbridge 0500-55 1000