The investment industry hoped that putting those products inside the tax-free wrapper of a PEP would attract investors looking for a higher return than they could get down at the building society, and who wanted a long-term investment that would help to pay off the mortgage or the school fees, but who didn't fancy the risk of investing in shares.
But the take-up of products launched so far has been patchy and the amount invested in corporate bond PEPs so far adds up to just pounds 1.3bn, compared to pounds 5.7bn in general PEPs in 1993-94, according to the trade body Autif. The average gross return on the corporate bond PEPs launched a year ago is 10-11 per cent net of tax - which means that even if they are taking income, most early investors have already covered their start-up costs which will have been 7-8 per cent of the investment on average. But performance has been overshadowed by equity-based PEPs.
"There is a growing awareness of corporate bond PEPs and they are growing in popularity, but they are still not as popular as the industry thought they would be," says Colin Jackson of the independent financial advisers Baronworth Investment Services. "They were hyped to start with and everybody had great expectations, but the reality is that clients have to like it."
Ian Millward of the independent advisers Chase de Vere says that bond PEPs have become more popular in recent months, but that the trend is short-term and mostly a result of the large amount of Tessa money slushing around the investment market.
"People have avoided going overboard on them," he says. "In the past when there has been a new investment vehicle, there has been a lot of shouting from the rooftops and people have invested without really understanding what is involved. It seems that with corporate bond PEPs, the industry and individual investors have been a bit more restrained. If you are looking for high income and no growth, that is fine, but if you are looking for capital growth or rising income, you are better off in an equity-based investment."
Colin Jackson says that the ideal bond PEP investor is in late middle- age, wants more than the building society can offer, knows that yields on bonds are not guaranteed and doesn't already have a regular equity PEP. "That's quite a tall order. Most older investors who are looking for income or yield want a guarantee and they want something very simple. One of the big problems is that investors see a headline rate of 8 or 9 per cent, and they assume that is the yield they are going to get. It is only when they discuss it with someone that they realise that, with a few exceptions, it is not a guaranteed yield. I think that really has put a lot of people off."
Mr Millward agrees that bond PEPs are suitable for some investors. "They do have their place, but they are not the big solution to every building society investor who are not happy with the return on their money." But he warns: "The fear is now that if interest rates start to rise - which is not really an issue now, but could well be over the next five years - that will have an adverse effect on the capital value of the bonds."
Investors considering a bond PEP need to consider what level of return can be expected, how much risk the PEP manager is taking to get that return, and what sort of track record the PEP manager has with company bonds, as opposed to equities - some have limited experience.
To complicate matters, the PEP providers can quote different rates of return. There is a key difference between the current or distribution yield, which is how much your PEP is likely to actually pay out, and the yield to redemption, which is the likely total return on your investment and includes any gain or loss on your initial capital. "Yield to redemption is the real figure; the rest of it can be manipulated," says one expert.
One particular factor that affects the yield is how the manager deducts the fees charged for setting up, and then looking after, the PEP. These can be charged against your annual income or your capital. With an income- producing investment such as a bond PEP, it is important to realise that charges taken from capital will gradually erode the base of your investment.
It is always important to consider all the different charges together. In general, you should expect to pay an initial charge totalling around 3 per cent of the money you invest and then an annual charge of about 1 per cent. If there is no initial charge, check whether there is a "back- end" penalty charge when you come to sell your PEP. On top of that, there will be commission to pay if you use an independent financial adviser to track down a PEP for you. A typical commission is 3 per cent, although some IFAs will give part of this back.
This week's highest-yielding bond PEP is from Abtrust Unit Trust Managers. Its investment strategy - graded medium risk by Baronworth Investment Services - generates a running yield of 9.24 per cent and a redemption yield of 10.1 per cent. PEPS with a lower yield but guaranteed return are also available - the Johnson Fry Secured Corporate Bond High Income PEP currently offers investors a guaranteed 6.75 per cent per annum together with guaranteed return of capital at the end of five years.Reuse content