Mark Dampier: Where can savers turn as rates fall?

A few weeks ago, I suggested that interest rates would fall quite sharply. However, even I didn't anticipate that they were going to come down a full 1.5 percentage points. And now we learn that the Bank of England considered a 2 percentage-point cut.

It is unprecedented for interest rates to be slashed by a third in one go. The Bank of England's Monetary Policy Committee meets again on 4 December, and I would not be surprised to see at least another half-point come off interest rates then.

If the Christmas shopping season turns out to be as bad as the media are suggesting, then further cuts in January and February are not out of the question. Rates below 1 per cent (a level never seen in the Bank of England's 314-year history) early next year are a real possibility.

Mortgages rates will come down sharply as a result – but what about the savers? There are far more savers than there are borrowers, and many of them rely on those savings for an income. If base rates fall to record lows, then surely instant-access bank accounts are likely to be yielding only between 2 and 3 per cent gross. I think that many people have still not realised this. The best-buy tables are still displaying rates of 6 per cent – but not for much longer.

So what can savers do? Well, those who are spooked by falling stock markets and will only hold money in cash will simply have to accept a lower return. Of course rates will eventually rise again, but I suspect there will not be significant increases until at least 2010. However, those who feel they can take some risk should consider corporate bond funds. Now, these are like any investment and can fall in value, and this year they have done exactly that – but yields have risen correspondingly. One fund worth looking at is the Jupiter Corporate Bond Fund run by John Hamilton.

Since the middle of last year, Mr Hamilton has been gradually increasing the risk on the fund by reducing exposure to government bonds and AAA-rated securities from around 25 per cent to 8 per cent of the portfolio. This was switched into banks, utilities and telecoms.

Why has he increased the risk? Well, he now believes he is being paid to take the risk; in other words, the bonds look great value for money. Investment-grade bonds are currently pricing in a five-year default rate of more than 25 per cent – this assumes that more than one in four companies issuing investment-grade bonds will go bust over the next five years. This is not impossible, but it seems massively unlikely, even during a severe recession.

Mr Hamilton has made a point of investing in companies with low levels of debt and the flexibility to manage their business through a tough period. He is also realistic enough to expect some defaults, given the current downturn, but remember that even if a firm does default on its debt, investors usually get some of their money back, so it's not a total write-off.

The current yield on the fund is 5.4 per cent, and the fund should see some capital appreciation in addition to the income. This yield appears low compared to other corporate bond funds, but one factor to remember is that Mr Hamilton's annual management charge comes out of income, whereas many other fund managers take it out of capital.

This year has been the first period for ages that I have been recommending corporate bond funds. A yield in the region of 5 per cent might look incredibly unexciting right now, but next year, when you are getting only 2 per cent in the bank, it will be far more enticing.

Of course, the security of cash is crucial and everyone should have some of their assets in instant-access accounts, but if you are seeking a better return on your money (and are prepared to take some risk to achieve it) a fund such as Jupiter Corporate Bond is worth considering.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent