Funds can include unit trusts, investment trusts and the new-fangled open-ended investment companies (Oeics). Unit trusts, by far the most popular PEP investment, simply divide their assets into units of equal size, which are bought by investors. Investment trusts are listed companies and are prone to be more volatile than unit trusts, although growth can be more dramatic.
You can quickly cut through the 1,000-plus funds that are eligible for PEP investment by deciding whether you want to invest to receive a regular income or to lock your money away, leaving it to grow. Funds can offer either or both. Growth investors can choose from funds investing in big "blue chip" companies, and smaller company funds that are generally more volatile but have more potential for rapid share price growth. While index- tracking funds following the FT-SE 100 index have led the way recently, smaller companies may come to the fore now investors feel that many blue chip stocks are looking overpriced.
PEP investors have tended to stick to the UK but continental Europe can account for your full pounds 6,000 general PEP allowance if you wish. The region has been providing some of the best returns to PEP investors.
In What PEP magazine's latest analysis, six of the top 10 PEP unit trusts were European funds. Keiran Gallagher, manager of the Newton European Fund, says the good returns are because European companies are coming round to the idea of shareholder value and are tightening up their operations in preparation for European Monetary Union. "Europe is undergoing the same process of change that the UK experienced under Margaret Thatcher in the 1980s," he says.
Investors wanting to go further up the risk ladder can invest up to pounds 1,500 of their general PEP overseas, for example in America, Japan or the Far East funds.
Roddy Kohn of Kohn Cougar, independent financial advisers, believes Asia is a good home for some PEP money, even given the economic turmoil. "You have to be fairly gutsy and accept that there will continue to be a lot of volatility for some time to come. But provided money is left for the long term, now is a good time to invest."
Mr Kohn points out that Far Eastern funds produce little or no income, so investors worried about the pounds 50,000 threshold proposed for Individual Savings Accounts can leave them outside their ISA in 1999 and have fewer tax consequences to worry about. "You can set the growth you do make against your annual capital gains allowance."
Income-seeking investors should stick to UK-invested funds, as few foreign markets can match the dividends that UK companies pay on their shares.
Mr Kohn champions investment trusts for income-seekers, for example the split-capital Geared Income & Growth trust managed by Henderson Investors. The trust's ordinary shares are trading at a 13.5 per cent discount to the trust's net asset value (NAV), which means new investors are in effect getting income on a pounds 1 worth of assets but only paying 86.5p for them. Geared Income & Growth is due to wind up in 2003, at which point ordinary shareholders could be due a further cut of the trust's assets.
Split investment trusts can offer income of as much as 13 per cent if they are highly geared, but you need to know how they work and the risks to capital.
Income-seekers who do not want these risks and complexities should look to corporate bond unit trusts. These invest in debt issued by companies. Investors give the company their capital to borrow, receiving annual interest on it until the capital is returned at some specified future date. The typical advertised yield for a corporate bond fund is 7 per cent a year. Funds with higher yields should be inspected closely as they are usually either investing in higher-risk bonds or tapping into capital to increase returns.
Once you know the type of fund you want, you can start sifting out the good ones. Comprehensive performance tables, which divide funds by their objective or geographical exposure, are given in monthly magazines like What Investment and Money Management. Performance should be studied over a number of time periods to be sure that a fund's good showing in one period is not a fluke.
Familiarise yourself with the names of the management houses constantly at the top of the league tables. A group that has good performance across its fund range indicates a successful house approach rather than a single star manager who could leave at any time.
q Juliet Oxborrow is editor of 'What Pep' magazine.