The yield sounds good, but are you a gambler?

A new-style corporate bond promises glittering rewards, reports Isabel Berwick

MOST OF the fresh ideas we see in the UK turn out to be American imports. The latest concept to cross the Atlantic is the chance to earn a projected 9 per cent a year, tax-free, in a PEP (or ISA). The returns come from a riskier breed of corporate bonds, issued to raise cash for large companies (see the article below for more on how the system works).

Until now, UK corporate bond funds have put investors' cash into bonds from companies with a very strong credit rating. Marks & Spencer has an AAA credit rating - the same as the Government's bonds. But American investors can buy bonds with a lower rating, generally BB and B (see box). These bonds carry increased risk, reflected in their interest rates of 10 per cent and above.

M&G's director of global fixed-interest funds, Dr Theo Zemek, is the first UK manager to put together a corporate bond PEP fund which gives investors here the chance to buy very high-yielding UK bonds. She says: "We are hoping to outperform our advertised 9.5 per cent return. Why is it so high? You get 14 per cent because there is a perceived risk of default, rightly or wrongly. Most people think default means you lose every penny. But in corporate bonds, in most cases, you'd get all or most of the money back. And the default rate on sub-investment grade [riskier] bonds in the USA over the last 20 years has been 2 to 3 per cent. You are over-rewarded for taking risks."

Dr Zemek and her team will approach bond selection in the same way as an equity fund manager, and will use M&G's equity research resources.

The M&G launch is the first of its kind but it believes other big management houses are likely to follow its example in the near future. Long-term interest rates are falling, which means savers get lousy rates, and world stock markets may well be entering a long bear run. Given these factors, a fund offering potentially double-digit returns is likely to have widespread appeal.

But other bond fund managers are cautious about recommending such high- yielding bonds to UK investors at a time when the UK economy is slowing down and there is talk of recession. John Kelly, investment director of BGI (Barclays) funds, says: "Ask yourself whether this is the right time to combine high risk with a relatively high interest rate scenario. Sensible investors will time their investments. Are the signals such that you want to take a risky position at a risky time?"

You will still get a good return in a traditional corporate bond fund. Commercial Union's Ruth Clarke says: "We run our fund to produce income for customers with a level of risk we are comfortable with. The capital performance has been staggering, up 20 per cent in the last year and delivering outstanding returns, currently 6.65 per cent."

That income level does not look great in 1998. But the European central bank is predicted to set its rates at 3.3 per cent, which will bring down UK interest rates even if we don't join the single currency. Acting now to lock yourself into a long-term annual return of 6.65 per cent, plus capital gains, is a prudent move.

Contacts: M&G High Yield Corporate Bond PEP, 0800 389 8601; BGI Gilt and Fixed Income PEP, 0181-522 4000; CU Monthly Income Plus PEP, 0181- 686 9818.

credit ratings

The risk-rating companies (the best known of which is Standard & Poor's) study the financial strength of governments and companies to come up with an "at a glance" rating from AAA downwards.

In the US, risk ratings are widely used and understood by investors but the concept is still new to individual investors over here.

The lower you move down the ratings, the higher the yield on these company bonds will be. But the risk isn't likely to be great if you select your company carefully; some of the lower-rating firms in the UK are household names.

So the skill is the same as it is in picking shares: you need to find an undervalued company with a good management and financial record. If you are lucky, your chosen companies will be re-rated upwards, giving you more security and making the bond's capital value rise.

If not, the rating will stay the same or even slip further downwards.

Rating Borrower Yield on the

bonds %

AAA 10 Year Gilts 5.3

(UK Treasury)

Marks & Spencer 5.6

AA Halifax 5.9

A British Gas 6.5

BBB London Electricity 7.0

Scottish Life 7.0

BB Orange 7.5-10

B William Hill 10-14

HMV 10-14

Colt Telecom 10-14

Source: M&G

Start your day with The Independent, sign up for daily news emails
ebooksA special investigation by Andy McSmith
Life and Style
Powdered colors are displayed for sale at a market ahead of the Holi festival in Bhopal, India
techHere's what you need to know about the riotous occasion
Arts and Entertainment
Larry David and Rosie Perez in ‘Fish in the Dark’
theatreReview: Had Fish in the Dark been penned by a civilian it would have barely got a reading, let alone £10m advance sales
Details of the self-cleaning coating were published last night in the journal Science
Approved Food sell products past their sell-by dates at discounted prices
Life-changing: Simone de Beauvoir in 1947, two years before she wrote 'The Second Sex', credited as the starting point of second wave feminism
peopleHer seminal feminist polemic, The Second Sex, has been published in short-form to mark International Women's Day
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

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

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Evening Administrator

£8 per hour: Recruitment Genius: This Pension Specialist was established early...

Guru Careers: Executive Assistant / PA

£30 - 35k + Bonus & Benefits: Guru Careers: We are seeking an Executive Assist...

Ashdown Group: Graduate Application Support Analyst

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Reach Volunteering: External Finance Trustee Needed!

Voluntary post, reasonable expenses reimbursed: Reach Volunteering: Would you ...

Day In a Page

Homeless Veterans campaign: Donations hit record-breaking £1m target after £300,000 gift from Lloyds Bank

Homeless Veterans campaign

Donations hit record-breaking £1m target after huge gift from Lloyds Bank
Flight MH370 a year on: Lost without a trace – but the search goes on

Lost without a trace

But, a year on, the search continues for Flight MH370
Germany's spymasters left red-faced after thieves break into brand new secret service HQ and steal taps

Germany's spy HQ springs a leak

Thieves break into new €1.5bn complex... to steal taps
International Women's Day 2015: Celebrating the whirlwind wit of Simone de Beauvoir

Whirlwind wit of Simone de Beauvoir

Simone de Beauvoir's seminal feminist polemic, 'The Second Sex', has been published in short-form for International Women's Day
Mark Zuckerberg’s hiring policy might suit him – but it wouldn’t work for me

Mark Zuckerberg’s hiring policy might suit him – but it wouldn’t work for me

Why would I want to employ someone I’d be happy to have as my boss, asks Simon Kelner
Confessions of a planespotter: With three Britons under arrest in the UAE, the perils have never been more apparent

Confessions of a planespotter

With three Britons under arrest in the UAE, the perils have never been more apparent. Sam Masters explains the appeal
Russia's gulag museum 'makes no mention' of Stalin's atrocities

Russia's gulag museum

Ministry of Culture-run site 'makes no mention' of Stalin's atrocities
The big fresh food con: Alarming truth behind the chocolate muffin that won't decay

The big fresh food con

Joanna Blythman reveals the alarming truth behind the chocolate muffin that won't decay
Virginia Ironside was my landlady: What is it like to live with an agony aunt on call 24/7?

Virginia Ironside was my landlady

Tim Willis reveals what it's like to live with an agony aunt on call 24/7
Paris Fashion Week 2015: The wit and wisdom of Manish Arora's exercise in high camp

Paris Fashion Week 2015

The wit and wisdom of Manish Arora's exercise in high camp
8 best workout DVDs

8 best workout DVDs

If your 'New Year new you' regime hasn’t lasted beyond February, why not try working out from home?
Paul Scholes column: I don't believe Jonny Evans was spitting at Papiss Cissé. It was a reflex. But what the Newcastle striker did next was horrible

Paul Scholes column

I don't believe Evans was spitting at Cissé. It was a reflex. But what the Newcastle striker did next was horrible
Miguel Layun interview: From the Azteca to Vicarage Road with a million followers

From the Azteca to Vicarage Road with a million followers

Miguel Layun is a star in Mexico where he was criticised for leaving to join Watford. But he says he sees the bigger picture
Frank Warren column: Amir Khan ready to meet winner of Floyd Mayweather v Manny Pacquiao

Khan ready to meet winner of Mayweather v Pacquiao

The Bolton fighter is unlikely to take on Kell Brook with two superstar opponents on the horizon, says Frank Warren
War with Isis: Iraq's government fights to win back Tikrit from militants - but then what?

Baghdad fights to win back Tikrit from Isis – but then what?

Patrick Cockburn reports from Kirkuk on a conflict which sectarianism has made intractable