Personal Equity Plans: Big rush for bond PEPs

THIS is the year of the bond PEP. You may have seen adverts for a rash of new PEPs designed to cash in on this craze. M&G has attracted more than pounds 100m into its high-yield bond fund and similar funds from Fidelity, Schroders and Framlington have launched this month. Perpetual launches its high-yield fund next week and plans an estimated gross return of 8.5 per cent a year.

There is a good reason for all this excitement. Corporate bonds are issued by large companies to raise money and they pay a good level of income, tax-free. Bond investors will beat future interest rate cuts and effectively lock themselves into a good rate of return, even if they do not take an income. Interest on the bonds can be left to roll up in the fund.

The other big advantage of bonds over shares is an upcoming tax change. Neil Niven, marketing manager at HSBC-Midland says: "If you have a share with a dividend of pounds 1 you will only get 80p of that but it has a 20p tax credit, so in a PEP you get that 20p back. When we get to ISAs that 20p credit will be reduced to 10p. In a corporate bond fund you will still get the 20p tax credit repaid." This 10p rebate will be reduced to zero in 2004, making bonds even more attractive for the long term.

Most of the established bond PEP funds are aimed at older, conservative investors. They are made up of top-rated bonds from blue chip companies and government bonds (gilts). Two of the most popular are the CGU Monthly Income PEP, currently offering 6.67 per cent and Barclays' Global Investors Fund paying 6.10 per cent.

The new high-yield funds buy bonds from companies with a lower credit rating. M&G's established fund is paying 7.79 per cent at the moment and Framlington is aiming at 8 per cent. These funds are higher-risk but do not deserve a "junk bond" label: M&G says that even if the worst were to happen and a company went bust, its bondholders would typically get back 50 per cent of their investment. Ordinary shareholders would get nothing.

If you buy a bond PEP through an IFA or direct from the manager, you will pay initial charges including commission. Discount PEP brokers are much cheaper (see page 17).

Contacts: Barclays, 0181-522 4000; CGU, 0845 607 2439; Fidelity, 0800 414171; Framlington, 0345 775511; M&G, 0800 390390; Schroder, 0800 002000.