Take, for example, the sales pitch that promises: "We pay a higher interest rate than the others." All things being equal, a higher rate is achieved at the price of a higher risk. Provided it is clearly signposted, this is fair enough. It is when the essential information gets lost in the thicket of small print that investors should start to worry.
Yesterday the Inland Revenue called a halt to the period of consultation about its proposed rules for corporate bond PEPs. In late June or early July the new PEP regulations will be cleared for launch.
At this point another sales ploy will kick in. "First is best." But it ain't necessarily so. There will be many new bond launches and they will vary. Investors need not be hustled into buying the first products they see.
The thing to bear in mind about a PEP is that it is only a tax-free zone. Whether a PEP is good value or not depends on the performance of the investment within it - after charges have been deducted. If the company that issued a corporate bond became insolvent, you could lose much of your investment. (Remember Polly Peck).
Rather than rushing to buy the first PEP with a beguiling advertisement, cool-headed investors will ask themselves a number of questions.
One key question is: "Do I want to make my own investment decisions, albeit with some help, or do I prefer to have my investments managed for me?"
If you want to hand over the responsibility of selecting the investments, you have the choice of a managed PEP or a unit trust PEP. With a managed PEP your money is simply entrusted to the PEP provider, who makes all the investment decisions. However, you pay for management and administration costs.
With a unit trust PEP, instead of buying shares for you in a relatively small number of companies, the unit trust provider pools your money with that of other investors to create a fund investing in a wider range of companies. You receive "units" rather than shares and again the administration expense is a consideration.
Many investors prefer the personal involvement of owning shares directly. Some would like to go a stage further and choose for themselves the companies in which to invest. This is called a self-select PEP.
The self-select route involves no management charges as you in effect manage your own PEP. The charges involved are only for share dealing and administration. Self-select PEPs can be used to shelter existing as well as new qualifying investments and you can also change the bonds or shares within your PEP as frequently or as infrequently as you like.
Self-select allows you to combine the guaranteed return of capital and fixed income offered by a corporate bond with the tax-free benefits of a PEP. You can, if you wish, re-invest the income to provide a larger tax-free income when you need it - for example, when you retire. This allows you to tailor your investments more precisely for your own needs.
Corporate bonds are not the only new PEP qualifier. A couple of similar investments also now qualify - convertibles and preference shares.
Their different characteristics will suit different investors. Corporate bonds are certificates issued by companies stating they will pay a fixed rate of interest and repay the capital at the end of a specified term.
Convertibles are similar except that at the time of maturity you can either have your investment returned or converted into shares in the company issuing the bond.
Preference shares usually pay a fixed dividend income independent of the profits made by the issuing company. If the company went bust the preference shareholders would get their money back before the others.
The author is director of business planning at Barclays Stockbrokers.Reuse content