But charges and performance can vary significantly. Although they may have received high income, some investors have seen the underlying value of their money fall. Choosing the best is not straightforward.
Corporate-bond PEPs were one of the last brainwaves of the Conservative government. Introduced by Ken Clarke, then the Chancellor of the Exchequer, they involved the relaxation of rules which required investments into PEPs to go directly into equities.
To meet the rules for PEP status, a corporate-bond fund must have at least half its value invested into UK or EC-qualifying stocks. The rest of the fund can go into gilts, other government-backed securities and cash.
These qualifying stocks are issued by companies with shares traded on the Stock Exchange. They are issued as a cheaper and more convenient way of borrowing money. Bonds pay a fixed rate of interest and return the issue price (the amount paid for them) at a future specified date. Some carry a conversion option, which means they can be turned into shares or cash at the redemption date.
Two types of risk attach to corporate bonds. First, the company issuing them might fail. Bondholders will rank behind trade creditors, but above ordinary shareholders in any wind-up. This makes company's credit rating important in selecting bonds.
A second type of risk comes from what happens to interest rates once a bond has been issued. They can be traded like any other share, and if interest rates fall, they may be sold at a capital gain. But if interest rates rise, they may be sold at a loss. This is because the amount of interest payable on a bond determines its worth: if an investment gives you poorer returns, it will be worth less.
Of course, when you buy a corporate-bond PEP, you are paying a fund manager to manage this risk - choosing the right bond to invest in - as well as any commission due to your financial adviser. The amount and way in which these charges are made on your investment will affect performance.
Because you are buying into a unit trust, which in turn invests in these bonds, there may be a bid-offer spread on the fund, sometimes referred to as an initial charge. This is the difference between the price at which you buy units and the price at which you can sell them back to the fund manager. These can vary from 1 per cent to 6 per cent.
Annual management charges can be made on income from the fund, its underlying value, or both. These charges range between 0.5 per cent and 1.5 per cent. The basis on which they are charged in an issue of key importance. If charged on the fund value rather than the income, the investor may be trading income now for future capital losses.
For example, Fidelity makes no initial charge, with an annual management charge of 0.7 per cent out of income. Sun Life of Canada, by contrast, is much more expensive, with an initial charge of 6 per cent and annual management charge of 1.5 per cent.
Charges are not everything, however. The crucial equation for fund managers lies in maximising income while controlling risk. Compare the approach of Fidelity's Ian Spreadbury with M&G's Theodora Zemek.
Mr Spreadbury is clear: "We don't take interest rate bets in this fund. History shows how often we can be wrong about these. Our approach is one of targeted active management. Targeting means pre-selecting types of security which will allow the fund to hold its value if interest rates change." Research is based on the credit ratings of companies issuing bonds, and highly quantitive. Instead of looking on the management of a company, they will look at the stocks in terms of where they stand on market averages.
This may reduce the fund yield but he adds: "The majority of our corporate- bond PEP owners are over 60 and do not want to lose the money."
Ms Zemek's approach has a different emphasis: "We control risk in three ways. Credit ratings are a selection sieve, but not gospel. A double A- rate company can go to non-investment grade in seven days. In-house research on a company is vital. We have a 3 per cent ceiling on exposure to any one bond. If it fails, the world will not come to an end."
M&G does not ignore interest rates, but "stock picking is what we're good at. Hidden value can move a company credit rating from nothing to triple-A. We like to buy before this happens."
Both agree on one point. Their objective is to give high income and a return of the capital invested. This should be the minimum benchmark for performance used by investors. Ms Zemek says: "Too many funds dress up poor performance as non-risk taking."
As our performance table shows, the charges and returns on corporate- bond PEPs can vary widely. Over the same period, the sector's worst-performing fund from ABN Amro produced returns of just pounds 1016. M&G has occupied first or second place in the sector since corporate-bond PEPs were launched.
The Association of Unit Trusts and Investment Funds publishes a corporate- bond PEP factsheet. Ring 0181-207 1361 for a free copy.Reuse content