Other fixed-interest investments

CORPORATE bond PEPs often invest in two other fixed-interest investments: convertibles and preference shares. Both of these carry more risk than gilts or corporate bonds. If you are worried, check the breakdown of the holdings in a corporate bond PEP fund before you invest. There are some funds that specialise in preference shares: these are listed within the corporate bond sector. You can spot them by their names: for instance, the Henderson Preference and Bond Fund (0800 832832) and the Dresdner RCM Preference Trust (0870 601 6117).

If you are looking for a higher income rate than you would get from an ordinary corporate bond fund, a preference fund is worth investigating.The extra income signals that you are buying a more volatile investment.

Convertibles are also bonds issued by large companies. A convertible is like a straightforward corporate bond in that you pay a fixed price (typically pounds 100, known as "par") at issue and then receive a regular income. But the twist is that a convertible has an "added extra" in the form of an option giving you the right to convert the bond into ordinary shares in the issuing company.

James Gledhill, at M&G, says the success of equities in recent years made convertible funds more attractive: "They have a price at which you are allowed to convert, and because equities have gone up so much, they are a long way above that price. So that right to convert is worth a lot," he points out.

A convertible pays a lower rate of interest than an ordinary corporate bond, because of the potentially valuable extra option contract. As markets drop, convertibles become less attractive. However, investors still have the regular income stream from the bond.

Preference shares are the most volatile investment held in gilt and fixed-interest funds. On the risk scale they fit between corporate bonds and normal equity shares in a company. Again, investors are paid a fixed (and occasionally rising) income, called a dividend, because it is income from shares rather than bonds. All dividends have to be paid to preference shareholders before equity shareholders can get any money. If a company is wound up, preference shareholders are paid out before the ordinary shareholders.

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