Tax-Free savings: Do bonds have more fun?

Corporate bond ISAs seem to yield good returns, but be aware of the risks, writes Tony Lyons

If you're thinking of investing in a corporate bond fund ISA, watch out. Some fund managers have a trick or two up their sleeves.

A number, including Perpetual, Schroders and Barclays BGI, make charges against the capital rather than the income. This means they can boost the headline yield.

Most corporate bond funds have annual management charges of up to 1 per cent. When values are rising, it does not much matter how charges are taken. Come a setback, it is your capital that is at risk, as these groups will still be taking their fees.

Funds that invest overseas also pose a higher risk. An investment in Russian bonds, for example, would have produced disastrous returns after the country defaulted on its loans last summer. So corporate bond funds are not risk-free. They invest in loan stock, debentures, Euro-bonds, preference shares and convertibles issued by companies raising money and pay a fixed rate of interest until they are redeemed at a set date. So don't expect a rising income over time as with an ordinary income fund.

When looking at a fund, look at redemption yields as well as running yields. The running yield shows only the annual income you will receive from the bonds as a percentage of the money you invest, the redemption yield also includes any capital gains or losses if you hold the bonds until they are redeemed.

Any loan stock is only as good as the company issuing it. So you can expect the yield on BT or Glaxo-Wellcome's loan stock to be lower than that of a small engineer.

The big fear is that a company may go into default, that is, not pay the interest. Tessa Murray, of M&G, says: "Over the long term, 20 years or so, around 3 per cent of companies default each year. But this doesn't mean that you lose all your money, even if they go bust. As a bond holder, you stand much higher up in the pecking order."

While most of the funds invest in companies with top credit ratings, a number offer much higher yields of 7 or even 8 per cent by investing in so-called junk or sub-investment grade bonds.

"There can be higher risks," admits Ms Murray, "but there are often complicated reasons why a company can have a low credit rating. Many new companies and those expanding rapidly, such as the telecoms, have bonds with high yields. For example, Orange - the mobile phone company - is yielding 8.6 per cent, while HMV Media, the record stores, Coral, the betting shops, and Welcome Break, the motel chain, also have yields over 8 per cent."

Others are not so sanguine about these funds. "They're OK so long as the investor is aware of the risks," says Hugh Everitt, manager of CGU's fixed interest funds. "Higher yields are generally offered by highly geared and immature companies. At the moment, the economic environment is friendly towards them. If it changes, the market in these bonds can turn very volatile. While you can always buy them, you can't always sell them."

You can put up to pounds 7,000 into a corporate bond fund this year, falling to pounds 5,000 next year, through a maxi ISA, or pounds 3,000 in a mini ISA, with all the income and any capital gains free from tax. The income they earn is from interest payments, so is not subject to the advanced corporation tax that companies pay on dividends.

You can buy a corporate bond ISA directly from the managers, through independent financial advisers, or by using an execution only discount broker.

While you get no advice from the latter, you can make significant savings as most funds levy an initial charge of anything up to 5 per cent. A discount broker will return most if not all of this.

News
people'It can last and it's terrifying'
Sport
Radamel Falcao
footballManchester United agree loan deal for Monaco striker Falcao
Sport
Louis van Gaal, Radamel Falcao, Arturo Vidal, Mats Hummels and Javier Hernandez
footballFalcao, Hernandez, Welbeck and every deal live as it happens
Sport
footballFeaturing Bart Simpson
PROMOTED VIDEO
News
peopleA spokesperson said the support group was 'extremely disappointed'
Voices
A man shoots at targets depicting a portrait of Russian President Vladimir Putin, in a shooting range in the center of the western Ukrainian city of Lviv
voicesIt's cowardice to pretend this is anything other than an invasion
News
i100
Arts and Entertainment
Alex Kapranos of Franz Ferdinand performs live
music Pro-independence show to take place four days before vote
News
news Video - hailed as 'most original' since Benedict Cumberbatch's
Arts and Entertainment
booksNovelist takes aim at Orwell's rules for writing plain English
News
ebooksAn unforgettable anthology of contemporary reportage
Arts and Entertainment
The eyes have it: Kate Bush
music
News
i100
Life and Style
tech

Apple agrees deal with Visa on contactless payments

Life and Style
techIf those brochure kitchens look a little too perfect to be true, well, that’s probably because they are
News
i100
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Technical Software Consultant (Excel, VBA, SQL, JAVA, Oracle)

£40000 - £50000 per annum: Harrington Starr: You will not be expected to hav...

SQL DBA/Developer

£500 per day: Harrington Starr: SQL DBA/Developer SQL, C#, VBA, Data Warehousi...

.NET Developer

£650 per day: Harrington Starr: .NET Developer C#, Win Forms, WPF, WCF, MVVM,...

Java/C++ Developer

£350 - £375 per day: Harrington Starr: Looking for a Java/C++ Developer to wor...

Day In a Page

Alexander Fury: The designer names to look for at fashion week this season

The big names to look for this fashion week

This week, designers begin to show their spring 2015 collections in New York
Will Self: 'I like Orwell's writing as much as the next talented mediocrity'

'I like Orwell's writing as much as the next talented mediocrity'

Will Self takes aim at Orwell's rules for writing plain English
Meet Afghanistan's middle-class paint-ballers

Meet Afghanistan's middle-class paint-ballers

Toy guns proving a popular diversion in a country flooded with the real thing
Al Pacino wows Venice

Al Pacino wows Venice

Ham among the brilliance as actor premieres two films at festival
Neil Lawson Baker interview: ‘I’ve gained so much from art. It’s only right to give something back’.

Neil Lawson Baker interview

‘I’ve gained so much from art. It’s only right to give something back’.
The other Mugabe who is lining up for the Zimbabwean presidency

The other Mugabe who is lining up for the Zimbabwean presidency

Wife of President Robert Mugabe appears to have her sights set on succeeding her husband
The model of a gadget launch: Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed

The model for a gadget launch

Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed
Alice Roberts: She's done pretty well, for a boffin without a beard

She's done pretty well, for a boffin without a beard

Alice Roberts talks about her new book on evolution - and why her early TV work drew flak from (mostly male) colleagues
Get well soon, Joan Rivers - an inspiration, whether she likes it or not

Get well soon, Joan Rivers

She is awful. But she's also wonderful, not in spite of but because of the fact she's forever saying appalling things, argues Ellen E Jones
Doctor Who Into the Dalek review: A classic sci-fi adventure with all the spectacle of a blockbuster

A fresh take on an old foe

Doctor Who Into the Dalek more than compensated for last week's nonsensical offering
Fashion walks away from the celebrity runway show

Fashion walks away from the celebrity runway show

As the collections start, fashion editor Alexander Fury finds video and the internet are proving more attractive
Meet the stars of TV's Wolf Hall... and it's not the cast of the Tudor trilogy

Meet the stars of TV's Wolf Hall...

... and it's not the cast of the Tudor trilogy
Weekend at the Asylum: Europe's biggest steampunk convention heads to Lincoln

Europe's biggest steampunk convention

Jake Wallis Simons discovers how Victorian ray guns and the martial art of biscuit dunking are precisely what the 21st century needs
Don't swallow the tripe – a user's guide to weasel words

Don't swallow the tripe – a user's guide to weasel words

Lying is dangerous and unnecessary. A new book explains the strategies needed to avoid it. John Rentoul on the art of 'uncommunication'
Daddy, who was Richard Attenborough? Was the beloved thespian the last of the cross-generation stars?

Daddy, who was Richard Attenborough?

The atomisation of culture means that few of those we regard as stars are universally loved any more, says DJ Taylor