David Prosser: A chance to expose the bond funds

Outlook There are plenty of reasons to applaud the London Stock Exchange's launch of a marketplace for corporate bonds. It will give investors access to securities that offer higher yields than bank or building society accounts, often for not much greater risk.

Hopefully, the long-term bonus will be an erosion of the corporate bond fund racket. Billions of pounds worth of these packaged products have been sold over the years, both direct to the investing public and through independent financial advisers who should know better. The funds are sold as low-risk alternatives to stock market vehicles, or as high-yield alternatives to savings accounts. In practice, investors rarely understand what they have bought.

Corporate bonds are, indeed, less risky securities. Hold the bond until maturity and – assuming no default by the issuer – you know exactly what you'll get back. The very nature of a fund, however, undermines this whole premise.

At best, corporate bond funds expose investors to additional risk simply by trading in and out of bonds in search of short-term returns. At a stroke, that means investors can no longer be sure what capital return they will get. In the worst cases, managers build portfolios that include much greater exposure to riskier bonds than investors realise. The pay-off can be better returns, but the downside is much greater volatility, which is what investors were trying to avoid.

These funds often don't come cheap (and in cases where charges are taken from capital rather than income, the risk of loss of starting investment is even higher). And despite what the marketing blurb claims, the returns they produce are often not too cheerful.