High income in an instant

PEPES AND TESSAS
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The Independent Online
IF YOUR first priority is getting an immediate high income from your savings, corporate bond PEPs may be the answer.

These plans, introduced in July last year, invest in the bonds which companies issue as a way to borrow money. They aim to provide an immediate high income for investors, typically 7 per cent to 9 per cent a year, but offer little or no capital growth. Most aim, but do not guarantee, to return the original investment when the PEP is encashed.

As with share-based PEPs, you can invest up to pounds 6,000 a year, at least half of which must go into EU-based companies. All income and any capital gains aretax free.

The average corporate bond has a life of about eight years, and pays fixed interest on a quarterly, half yearly or annual basis. Like shares they can be bought and sold, and their prices vary according to movements in interest rates, the outlook for inflation, and according to how long each bond has left to run.

On the whole, bonds are less volatile than equities. This makes them attractive to investors who are looking for a halfway house between the safety and low returns offered by deposit accounts and the higher potential returns and greater risk of shares.

Peter Hargreaves, managing director of Bristol-based independent financial adviser Hargreaves Lansdown, says: "If you went to any good investment adviser, he would offer you three elements in your portfolio: deposit, fixed interest and equities. Corporate bond PEPs are for anyone who wants some element of their portfolio to be in fixed interest."

At the end of their life, individual corporate bonds guarantee to repay the investor a fixed sum - the par value. The value of this guarantee depends on the financial security of the company which has issued the bond. Weak companies have to offer more interest to persuade investors to part with their money. Most corporate-bond PEP funds are based on unit trusts investing in a wide range of bonds issued by different businesses. This dilutes the risk of any one company collapsing.

Rather than investing in a unit trust, Hargreaves Lansdown's own corporate bond PEP buys directly into bonds issued by blue-chip companies such as Glaxo and British Gas. It pays an annual yield of 7.75 per cent in return for a flat-rate initial charge of pounds 15, and an annual administration charge of pounds 30. Many unit trust based schemes will levy an initial charge of perhaps 3 per cent and an annual management charge of perhaps 1 per cent.

Some corporate bond PEP portfolios contain a substantial proportion of more esoteric investments, such as preference shares and convertibles. These securities may offer higher yields but can raise the risk of fluctuations in the value of the investor's original capital.

Other PEP managers, including GT and Abtrust, may aim to maximise the level of income available to be paid out by deducting charges from the investor's capital rather than the interest on the bonds. But, warns Graham Hooper, investment director of independent financial adviser Chase de Vere, this practice not only erodes the investor's capital over time, but tends to encourage the fund manager to invest in slightly riskier securities in an attempt to make up the loss to capital.

Part of the idea of introducing corporate bond PEPs was to give companies a wider choice of sources from which they could borrow money. Banks and financial companies are barred from using their own bonds in a PEP, but last year Legal & General launched a plan which simply puts a PEP wrapper round the company's own corporate bonds.

This allowed Legal & General to guarantee a 7 per cent income, plus return of the investor's original capital sum, providing that money stays within the plan for five years. Savers warmed to this idea and ploughed pounds 130m into the plan.

Independent advisers name

their favourite bond PEPs

Lucinda Hines, Sedgwick Noble Lowndes

Name: M&G Corporate Bond PEP

Running yield: 7.5%

Redemption yield (taking into account expected capital losses if bonds are held to maturity): 7.3%

Charges: No initial charges, 1.25% a year, withdrawal charge of 4.5% (yr 1), 4% (yr 2), 3%(yr 3), 2%(yr 4), 1%(yr 5).

Comments: "The M&G PEP, unlike most others, is based on an existing unit trust, and so has a performance track record. M&G has a large number of funds to choose from should a switch be required. The main disadvantage is the withdrawal fee."

Paul Boni, Berry Birch & Noble

Name: Commercial Union Corporate Bond PEP

Running yield: 8.6%

Redemption yield: 8.3%

Charges: 4% initial, 1.5% annual

Comments: "People tend to be seeking high income with the prospect of maintaining capital value, and CU's PEP is one that has achieved that. It's also invested in the Monthly Income Plus unit trust, which is a very broad-based fund."

Graham Hooper, Chase de Vere Investments

Name: Sun Alliance Guaranteed Corporate Bond PEP

Running yield: 6.8%

Redemption yield: 6.8%

Charges: No initial charge, 1% annual, cost of optional guarantee of return of original investment on sixth anniversary - 5%

Comments: "If you want security of capital, which most corporate bond PEP holders do, this is a reasonable alternative to the building society. I think the extra cost of the guarantee is worth while."

Haydn Green, The PEP Shop

Name: Fidelity Moneybuilder Income PEP

Running yield: 7.83%

Redemption yield: 7.08%

Charges: No initial charge, 0.7% annual

Comments: "Corporate bond PEPs require so little input in terms of investment management that prospective investors should decide solely with reference to comparative charges. Fidelity wins that argument."

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