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Investing For Income: Why clear aims matter more than high yields

THE LAST few weeks of the financial year will see a rush for corporate bond PEPs, the most popular investment for above average income.

Corporate bond PEPs appeal to those nervous about equity prices heading down or sideways, or to those who have made significant profits elsewhere and want to park them in a secure, lower-risk home.

But some experts believe investors could be making a mistake in the long run. Corporate bonds do offer a high and reasonably risk-free level of income, but this is unlikely to rise much. And they show little prospect of high capital growth.

Over five years or more, equities have almost always outperformedconventional investments, including gilts and company loan stocks.

"If you want a sensible level of income that will grow year on year, then you should consider income funds," says John Irons, of SG Asset Management. "Corporate bond funds are fine if all you want is immediate income. But investors should stop being drawn by the advertised high yields and think about their real aims and objectives."

SG Asset Management has recently launched the SocGen UK Income unit trust, its first to be directly run by Nicola Horlick. She heads the investment arm and is one of the best-known fund managers in the country.

"We aim to yield between 10 and 20 per cent more than the FTSE All Share, the most widely based stock market index," says John Irons. "We aim to grow this every year while showing a better rate of capital growth than the index."

The new fund will have an initial yield of around 3.2 per cent, much lower than that available with corporate bonds. Here, the mainstream funds that buy investment rated company loan stocks issued by the UK's leading companies are yielding around 6 or 7 per cent.

Some PEPs with high income rates of more than 7 per cent are also on offer but they invest in sub-investment grade stock. These are issued by companies seen to be higher risk and need to pay higher rates to attract money. Their prospects may improve, but there is always a fear that one may default.

Corporate bonds are investing in fixed-interest stock. They usually have portfolios of various types of corporate loans and, sometimes, government- issued gilt-edged stock. If a company issues stock to be repaid in 2025 with a coupon of 7 per cent, it will pay holders pounds 7 for every pounds 100 they invest until it repays the loan. If inflation falls, the value of this fixed interest stock is more attractive and its trading price is likely to go up. If inflation rises, the price is likely to fall. At current inflation levels, the prospects are low for any significant capital growth.

In equities, the value of a company's ordinary shares depends on several factors, the most important being its prospects. The better its prospects, the more demand there is for its shares and the higher they will rise. Income fund managers hope to increase their payouts by more than the rate of inflation. This is unlike the income from a corporate bond, which is relatively fixed and will therefore be reduced in value by the rate of inflation.

Jason Hollands, of BESt Investment, a firm of independent financial advisers, says: "If you want to maximise your income, choose corporate bonds. But if you want a mixture of a rising income and capital growth, there is still a strong case for buying income funds that invest in good quality equities."

`The Independent" has published a free 28-page Guide to PEPs. The guide, sponsored by Scottish Widows, is available by calling 0345 678910.

The Best Income Funds

Mainstream Corporate Bond PEPs

CGU PPT Monthly Income Plus (tel: 0181-686 9818) min investment pounds 5,000, 4% initial charge, 1.25% annual charge;

Legal & General (01222 448412) min pounds 1,000, no initial charge, 0.5% annual charge; M&G Corporate Bond (01245 390390) - min pounds 1,000, no initial charge, 1% annual charge, exit fees

Corporate Bond Funds investing in sub-investment rated stock - higher risk

Fidelity Extra Income (tel 0800 414110) - min investment pounds 1,000, 3.25% initial charge, 1.25% annual charge; M&G High Yield Corporate Bond (01222 448412) - min pounds 1,000, no initial charge, 1.25% annual charge, exit fees if cashed in within five years

Equity and Income Funds

BWD Rensburg Equity Income (0113 245 4488) min investment pounds 500, 4.5% initial charge, 1.5% annual charge; Jupiter Income (0500 050098) min pounds 500, 5% initial charge, 1.5% annual charge;

Newton Income (0800 614330) min investment pounds 1,000, 6% initial charge, 1.25% annual charge; Soc Gen UK Income (0808 100 254368) - min pounds 1,000, 5.25% initial charge, 1.5% annual charge; Newton Income (0800 614330) - min investment pounds 1,000, 6% initial charge, 1.25% annual charge

Selected by the independent advisers BESt Investment (0171-321 0100); and Pretty Technical Services (0171-377 5754).