Is it time to quit corporate bonds?


Investors in corporate bond funds have discovered that they can lose money.

These funds, aimed at income seekers, have had a rough ride over the past 18 months.

Climbing interest rates have made the interest paid by bonds look less attractive, so prices have fallen. Many investors are now sitting on a capital loss - although they are still earning their income.

With a typical minimum investment of £1,000, these pooled funds give private investors an entry into an area dominated by institutional investors such as pension funds and insurance companies.

You often need tens of thousands of pounds to buy just one bond and, unlike shares, the prices are not widely quoted. Bond funds pool together money from private investors, and the manager spreads the money widely over numerous corporate bonds.

But the market is starting to open up for those who prefer to hold individual bonds tailored to their needs. Chester-based Nelson Money Managers, which specialises in advising those near or in retirement, allows you to invest directly in corporate bonds rather than going through a fund.

This, it claims, takes away an extra layer of risk that comes with pooled funds - the market risk. It recommends this route for 'ultra-cautious' investors.

Corporate bonds work like gilts - or British Government Securities - but instead of being issued by the Government, they are issued by companies as a means of financing their business. They run for a fixed term and pay a fixed rate of interest during that term. At their 'maturity' date, you get your capital back.

The price of the bond will fluctuate between when it is issued and when it matures, but this only adds risk if you intend to trade in bonds. If you hold the bond from issue to maturity, the only risk to your money is if the company goes bust.

You will earn less interest with a bond issued by a solid well-known company than a smaller one where the risk of defaulting on the repayment is higher. Gilts offer lower returns than corporate bonds because the Government is deemed to be a better guarantor than any company.

During its life, a bond can be bought and sold on the stock market, and the price depends on the level of general interest rates. Bond prices will rise if interest rates come down, or fall when rates rise. Corporate bond funds do not hold bonds to maturity but buy and sell depending on where they see value in the market - so the capital value of your investment can go up and down and you are not guaranteed to get your money back.

David Cassidy, chairman at Nelson, says: 'Direct investment in bonds offers a fixed income for a fixed period with a return of capital on a known date. They are ideal investments for ultra-cautious investors who want to earn more than with a building society.'

Nelson spreads your money over several bonds to reduce the risk and over several time periods so that you have a series of bonds maturing at different times. It favours bonds issued by strong companies such as Commercial Union, Glaxo, Lloyds-TSB, Tesco, Halifax and BG Transco.

With an average yield of around 6.5%, it is not as good as the 8%-plus you can earn on some corporate bonds funds. But this is what you give up by sticking to secure companies.

Peter Bickley, director at Liverpool-based Tilney Investment Management, says: 'We have discouraged clients from buying corporate bonds rather than gilts in the past, but we are now revisiting the issue.'

But David Kauders, at Kauders Portfolio Management, believes investors should stick to gilts, where they sidestep the default risk altogether.

Tim Cockerill, at independent financial advisers CCK, prefers bond funds. He says: 'If you invest directly in just one or two corporate bonds, you are exposed to the default problem. Bond funds take this away by spreading your money around 80 or so bonds.'

He picks M & G Corporate Bond and Norwich Union Corporate Bond funds as being among the least risky.

John and Betty Jackson (pictured) from Hertfordshire have a wide range of investments providing an income, including building society bonds, guaranteed income bonds, gilts and corporate bonds, and shares for capital growth.

Retired John says: 'I have part of my money in safe corporate bonds, which give a guaranteed income and pay my capital back when they mature. Some are wrapped up in an Isa. They are phased to mature at different times, which keeps my investments flexible.'

Is it time to quit corporate bonds?

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