Beware the jump into the junk yard

A little knowledge is dangerous for investors

A rash of new-style corporate bond funds spread across the market last year. The high-yield funds, which promise returns of up to nine per cent, were welcomed as the answer for investors struggling to maximise their investment income at a time of low interest rates.

A rash of new-style corporate bond funds spread across the market last year. The high-yield funds, which promise returns of up to nine per cent, were welcomed as the answer for investors struggling to maximise their investment income at a time of low interest rates.

But concerns have since grown that these high-yield corporate bond unit trusts are much riskier than they appear. But, according to the Association of Unit Trust and Investment Funds (AUTIF), gross sales of corporate bond unit trusts rose to £6.2bn last year from £3.7bn in 1998 - despite a fall in value over 12 months.

Like Government bonds, corporate bonds are basically interest-paying IOUs - issued by companies rather than the Government. While bonds are less risky than shares - they are higher in the pecking order if the company goes bust -- they are only as good as their issuer.

Bonds issued by well-established, blue-chip companies, are almost as safe as government bonds, but those issued by less financially solid companies can be risky in the extreme. Most corporate bond funds which describe themselves as "high-yield" hold a large proportion of their assets in sub-investment grade bonds - the infamous junk bonds of the 1980s.

Ratings agency Standard & Poor's assesses the creditworthiness of bond issuers. Its ratings range from AAA+ for the most financially solid concern down to D for default. A bond from an issuer with a rating above BBB - is considered investment grade, below this it is classed sub-investment grade.

Standard & Poor's says it is at this point that the incidence of the company defaulting on its bonds increases markedly. The daring new breed of high-yield corporate bond funds, has prompted AUTIF to split its UK General Bonds sector category of unit trusts from April. There will be UK Corporate Bond sector, which will include funds investing in investment-grade bonds, and UK Other Bond sector coveringfunds holding non-investment-grade paper.

"We began to realise that some funds were offering very high rates of interest and they weren't necessarily the same as funds with a conservative investment approach," explains Claire Arber of AUTIF. Providers of high-yield corporate bond funds include Perpetual, M&G and Gartmore.

Colin Jackson, of independent financial advisers Baronworth Investment Services, says corporate bond funds can be ideal for investors seeking a high level of income, but... "The problem is that people look only at the headline rate," he says. "What they don't realise is that the capital is not fixed and neither is the rate."

David Hanratty, of Nelson Money Managers, believes most people would be better off buying a selection of the underlying bonds instead. The charges for this would be far lower, he says.

"The advertisements stress the value of bonds, but by buying bonds in a collective investment you lose all the guarantees," says Mr Hanratty. The guarantee inherent in a bond that your capital will be returned at the end of the term only applies if the bond is not sold in the meantime.

He also sees a contradiction in the way these funds appear designed to attract the type of cautious investor who would normally save their money in a building society account, but in fact hold highly risky investments such as sub-investment grade bonds.

But a big attraction of a corporate bond fund is that it can be held within an Individual Savings Accounts, making the returns completely tax-free.

Schroders runs two corporate bond unit trusts, one high-yield fund and one which restricts itself to investment grade bonds. The high-yield fund is suitable for people looking for a high income, says Bernard Abrahamsen, director of fixed income at Schroders. "But I wouldn't regard it as a substitute for a bank or building society."

He says the investors are becoming attracted to corporate bond funds as they become more sophisticated and look for investments which diversify their equity holdings.

The corporate bond market is going to continue growing as fewer government bonds are issued, says Mr Abrahamsen. "One supportive factor is that government supply is quite low, so generally investors are looking to move down the credit curve," he says.

 

Nelson Money Managers: 01829 741331

Baronworth Investment Services, produces a free corporate bond survey: 0181 518 1218

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

PROMOTED VIDEO
News
Teeth should be brushed twice a day to prevent tooth decay
education
News
Bryan Cranston as Walter White, in the acclaimed series 'Breaking Bad'
news
Sport
footballChelsea 6 Maribor 0: Blues warm up for Premier League showdown with stroll in Champions League - but Mourinho is short of strikers
News
Those who were encouraged to walk in a happy manner remembered less negative words
science
Arts and Entertainment
Princess Olga in 'You Can't Get the Staff'
tvReview: The anachronistic aristocrats, it seemed, were just happy to have some attention
News
Renee Zellweger as Bridget Jones
i100
Life and Style
tech

Board creates magnetic field to achieve lift

News
There have been various incidents of social media users inadvertently flouting the law
news

Life and Style
Stack ‘em high?: quantity doesn’t always trump quality, as Friends of the Earth can testify
techThe proliferation of online petitions allows us to register our protests at the touch of a button. But do they change anything?
News
Bourgogne wine maker Laboure-Roi vice president Thibault Garin (L) offers the company's 2013 Beaujolais Nouveau wine to the guest in the wine spa at the Hakone Yunessun spa resort facilities in Hakone town, Kanagawa prefecture, some 100-kilometre west of Tokyo
i100
Sport
CSKA Moscow celebrate after equalising with a late penalty
footballCSKA Moscow 2 Manchester City 2: Premier League champions let two goal lead slip in Russia
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Helpdesk Analyst

    £23000 per annum + pension and 22 days holiday: Ashdown Group: An established ...

    Senior Helpdesk Analyst / Service Desk Co-ordinator

    £27000 per annum + pension, 22 days holiday: Ashdown Group: An established ind...

    Senior Pensions Administrator

    £23000 - £26000 Per Annum: Clearwater People Solutions Ltd: Our client is curr...

    Corporate Actions Administrator / Operations Administrator

    £25 - 30k: Guru Careers: A Corporate Actions Administrator / Operations Admini...

    Day In a Page

    Indiana serial killer? Man arrested for murdering teenage prostitute confesses to six other murders - and police fear there could be many more

    A new American serial killer?

    Police fear man arrested for murder of teen prostitute could be responsible for killing spree dating back 20 years
    Sweetie, the fake 10-year-old girl designed to catch online predators, claims her first scalp

    Sting to trap paedophiles may not carry weight in UK courts

    Computer image of ‘Sweetie’ represented entrapment, experts say
    Fukushima nuclear crisis: Evacuees still stuck in cramped emergency housing three years on - and may never return home

    Return to Fukushima – a land they will never call home again

    Evacuees still stuck in cramped emergency housing three years on from nuclear disaster
    Wildlife Photographer of the Year: Intimate image of resting lions claims top prize

    Wildlife Photographer of the Year

    Intimate image of resting lions claims top prize
    Online petitions: Sign here to change the world

    Want to change the world? Just sign here

    The proliferation of online petitions allows us to register our protests at the touch of a button. But do they change anything?
    Ed Sheeran hits back after being labelled too boring to headline festivals

    'You need me, I don’t need you'

    Ed Sheeran hits back after being labelled too boring to headline festivals
    How to Get Away with Murder: Shonda Rhimes reinvents the legal drama

    How to Get Away with Murder

    Shonda Rhimes reinvents the legal drama
    A cup of tea is every worker's right

    Hard to swallow

    Three hospitals in Leicester have banned their staff from drinking tea and coffee in public areas. Christopher Hirst explains why he thinks that a cuppa is every worker's right
    Which animals are nearly extinct?

    Which animals are nearly extinct?

    Conservationists in Kenya are in mourning after the death of a white northern rhino, which has left the species with a single male. These are the other species on the brink
    12 best children's shoes

    Perfect for leaf-kicking: 12 best children's shoes

    Find footwear perfect to keep kids' feet protected this autumn
    Anderlecht vs Arsenal: Gunners' ray of light Aaron Ramsey shines again

    Arsenal’s ray of light ready to shine again

    Aaron Ramsey’s injury record has prompted a club investigation. For now, the midfielder is just happy to be fit to face Anderlecht in the Champions League
    Comment: David Moyes' show of sensitivity thrown back in his face by former Manchester United manager Sir Alex Ferguson

    Moyes’ show of sensitivity thrown back in his face... by Ferguson

    Manchester United legend tramples on successor who resisted criticising his inheritance
    Two super-sized ships have cruised into British waters, but how big can these behemoths get?

    Super-sized ships: How big can they get?

    Two of the largest vessels in the world cruised into UK waters last week
    British doctors on brink of 'cure' for paralysis with spinal cord treatment

    British doctors on brink of cure for paralysis

    Sufferers can now be offered the possibility of cure thanks to a revolutionary implant of regenerative cells
    Ranked seventh in world’s best tourist cities - not London, or Edinburgh, but Salisbury

    Lonely Planet’s Best in Travel 2015

    UK city beats Vienna, Paris and New York to be ranked seventh in world’s best tourist destinations - but it's not London