Better to come from plans investing in bonds

IGNORE the current rash of PEPs investing in bonds - they are going to get better, claim some. A big unit trust company is trying to engineer a PEP that might guarantee tax-free income of 7.5 per cent and your original money back. The move could spearhead a new generation of safer PEPs that will carry fewer risks than those currently available.

"If they offered this, they'd clean up," says John Holder, at independent adviser Chelsea Financial Services.

Meanwhile, for those tempted by the existing bond PEPs, a price war could well be on the cards. This is already well underway among PEPs investing in shares (see story above).

Bond PEPs are a new type of lower-risk, tax-free investment announced in the last Budget but which have yet to attract significant numbers of investors.

Unit trust and investment company Save & Prosper says it is trying to structure a bond PEP that would offer a fixed tax-free income of more than 7 per cent and guarantee investors' original money back after five years.

The idea is to offer an attractive investment to savers with Tax Exempt Special Savings Accounts (Tessas) maturing from next January. Millions of savers will have up to pounds 10,000 or more available from these Tessas from next year. Save & Prosper also wants to offer a more attractive option than the bond PEPs offered by unit trust companies at present and that might also sidestep the risks of investing in the bonds of just one company. Last week saw the launch of a PEP offering a 7 per cent fixed income from investing in specially issued bonds of a single industrial company - the brick and tile maker Redland.

Existing bond PEPs from unit trust companies, while offering tax-free incomes of 7 per cent or more, do not guarantee the level of income paid nor the original value of your investment. In addition, they have been criticised for high charges which mean investors' first income cheques could be cancelled out - or more than cancelled out - by the the reduction in the value of their original investment.

Four companies - Fidelity, M&G, Virgin Direct and Legal & General - now offer bond PEPs with no upfront charges. But others are believed to be looking at cutting prices for the new year to appeal to Tessa savers and to capture end-of-tax-year interest.

Discount brokers also report fair interest from savers based on the brokers' ability to reduce quoted charges. Chelsea Financial Services, for example, offers a cashback equivalent to 2 per cent of your investment in M&G's PEP.

Save & Prosper is one of the largest companies for guaranteed investments. One of the reasons suggested by some market commentators for Save & Prosper "holding fire" on a guaranteed bond PEP is its promotion of the fixed- rate Tessa offered b its sister company Fleming, which currently offers an attractive fixed rate of 7.5 per cent. This is available to savers now but the company also hopes to promote it to savers with maturing Tessas.