A PEP is simply the name of a way to shelter investments from the demands of income tax or capital gains tax. This is important to remember because there are many kinds of investment opportunities, and many kinds of PEPs.
A wise investor will choose the investment vehicle first, and then decide how to protect it from the Inland Revenue. The rules governing the types of investment allowed in a PEP are fairly broad, although specific when it comes to where you invest your cash.
It is permissible to invest in the UK, but not always all right to do so overseas. The investments you can hold in a PEP include individual company shares, pooled investments, such as unit trusts and investment trusts, and also fixed investments such as corporate bonds, preference shares and convertibles.
What they all have in common is that they represent some kind of risk, so deciding which kind of investment is right for you means assessing your attitude to risk.
The riskiest PEPable investment is to buy shares in an individual company. The price of shares can rise and fall minute by minute. It can be a roller-coaster ride and not one for the nervous, although if you already hold shares it may be worth putting them in a PEP to save paying tax on dividend income.
But the predominant investment in a PEP is a unit trust. This reduces the risk by spreading your cash among a wide number of shares and often other investments. Of the estimated pounds 35bn currently invested through PEPs, around pounds 25bn is in unit trusts. According to the Association of Unit Trusts and Investment Funds, only around half of the 1,500 unit trusts in existence are PEPable. This is because the PEP rules require the trusts to be at last 50 per cent invested in shares from the UK or the European Union.
Unit trusts come in a variety of formats, offering different levels of risk. Recent history shows that unit trusts that invest in smaller companies have offered best performance - Gartmore, Schroders and Hill Samuel are popular good performers - but these are high-risk funds, and anyone investing at the wrong time could easily lose out.
Increasingly popular these days are index-tracker PEPs. These are offered by the likes of Virgin Direct and Marks & Spencer on the basis of price and simplicity. With index-tracker funds there is no active investment management, as the aim is simply to replicate the performance of the FT- SE 100. But they can therefore limit your potential return. For the best performing funds you will have to pick a specialist unit trust. However, there is no way of knowing which funds will perform best and today's winners could be tomorrow's also-rans.
Novice investors used to the safer world of building society accounts could be better off investing in corporate-bond PEPs.
Corporate bonds effectively are fixed-interest loans to large corporations. As with any other type of loan the companies pay interest on the bonds and repay the capital at a pre-set date. Investors are therefore lending a company money for a fixed time and receiving interest on the loan until it is repaid.
Whatever your choice of PEP, expert advice will help guide you through this investment mine-field `The Independent' has produced a free 32-page guide to PEPs, written by Steve Lodge, Personal Finance Editor of our Sunday sister paper. The guide, sponsored by General Accident Life, is available by calling 0500 125888. Or fill in the coupon on page 19.Reuse content