Bonds keep chaos at bay

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IF YOU want to use your last PEP allowance but are wary of stock market turbulence, you could consider a corporate bond PEP. Bonds may not offer the dramatic returns delivered by shares in recent years - many corporate bonds yield around 6 per cent - but they are less volatile and should shield you from sudden downturns.

A corporate bond is a loan to a company in return for a fixed rate of interest and a pledge to repay your capital on a set date. Corporate bond PEPs have only been available since July 1995 but there are now 56 funds. Although low risk they are not risk free, because if the company goes to the wall you could lose your investment. However, you will be higher up the list of creditors than ordinary shareholders.

As the vast majority of corporate bonds are in established blue-chip companies, your investment should be relatively secure. Furthermore, they invest in a wide range of companies, which spreads the risk.

Bought as a PEP they are also free of income and capital gains tax, and you can protect these benefits by paying into a bond fund as part of the new independent savings accounts (ISAs), which replace PEPs from April 1999.

Theodora Zemek, head of fixed income at M&G, says: "With equity markets everybody is deeply concerned, but corporate bonds are holding up. They are a reasonable investment in times of low inflation."

But she warns that investors should choose a fund carefully as some are "masquerading" as fixed-interest investments and are not as safe as they might seem. "Funds must invest a minimum 50 per cent in UK corporate bonds, including convertible bonds. The rest can be pretty much anything you want, including corporate and convertible bonds but also gilts, preference shares and even emerging markets, which hardly makes them low risk."

She adds: "Corporate bond PEPs can be as diverse as any equity fund and they should be cleaned up so people know what they are getting."

She also says investors should look carefully at the initial charges, as fees of up to 5 per cent take a hefty chunk out of an investment.

Another thing you should check when considering a bond is the yield: the amount it pays out in income. Yields may reflect risk, so a bond issued by a solid company like Sainsbury's may have a lower yield than one from a less-established company.

Matters are complicated by the fact that two yields are often quoted on a corporate bond PEP. The running yield - the income paid by the fund - is easier to understand but will not reflect whether your capital has fallen or risen in value in line with market conditions. The gross redemption yield will.

Ian Spreadbury, senior portfolio manager for Fidelity, says the total return on its MoneyBuilder Income corporate bond PEP has been around 14.5 per cent over the last year, half from income yields and the rest from rises in the value of capital. "Gross redemption yields have come down on bonds now and it is probably unreasonable to expect that scale of return in the future."

He says the fund has a mix of corporate bonds and other fixed-interest securities in-cluding gilts (government-issued bonds). He is reducing the proportion of gilts and increasing holdings of corporate bonds in more secure companies.

Mr Spreadbury says corporate bonds have particular appeal to older investors who may want more security in the run- up to retirement, but should form a part of any investment portfolio.

Corporate bond PEPs can be bought through a financial adviser if you have one, but you can also buy through discount houses such as Chelsea Financial Services, which is currently offering a 4 per cent discount on the Aberdeen Prolific and CGU corporate bond PEP, and a 3 per cent launch discount off the new M&G high-yield corporate bond PEP.

Contacts: M&G, 01245 39039; Fidelity, 0800 414161; Chelsea Financial Services, 0171-351 6022.

the top 10 performers

Leading corporate bond PEP performers over the last 12 months. Total return from income and capital

Corporate bond Total return %

1. Fidelity MoneyBuilder Income 14.54

2. Govett Corporate Bond 14.09

3. CGU PPT Monthly Income Plus 13.72

4. Guinness FI Sterling Bond 13.30

5. National Provident High Income Bond 11.77

6. Tilney High Yield 11.52

7. Standard Life Corporate Bond 11.43

8. Smith & Williamson Fixed Interest 11.23

9. Dresdner RCM Bond Income 11.15

10. Threadneedle UK Corporate Bond 1 11.00