Bonds beat banks

By NEIL SIMPSON
Updated: 19:00 EST, 25 February 2002

BONDS are back in fashion for investors with spare cash who are worried about volatile and depressed stock markets.

The latest annual investment report from Barclays Capital shows bonds produced a six% average return in 2001 after inflation, against 4.8% for cash deposits and a 13.8% drop for shares.

In the past decade, the average annual return from bonds beat shares by one%, confounding pundits who say the stock market is the only place to go for real growth.

Corporate bonds are effectively IOUs issued by companies in return for loans from investors. Bond holders are paid interest on the loan and can sell their bonds to other investors at any time.

Bond funds accept investments of as little as £500 and tend to pay more interest than building societies, without the volatility of shares.

This appealed to computer project manager Adam Cockburn, who picked a bond fund when he had spare cash to invest last year. Alan, 33, says: 'I plan to use the money as a deposit on a buytolet flat.

'I didn't want it at the mercy of stock markets where its value could crash overnight, but I was hoping for better returns than I could expect from a deposit savings account.'

Adam picked the relatively new Extra Income fund from Royal & SunAlliance. This invests half of its money in corporate bonds issued by the UK's biggest, most stable companies, and half in higher-paying bonds from smaller, less secure firms, with the intention of providing above-average returns without exposure to big risks.

Adam says: 'I've left the money in the fund while I try to find the right property. I am reinvesting the income.'

This is an increasingly popular strategy for growth investors who don't want their fortunes to be tied too closely to the performance of shares. And buying a bond fund through a tax-free Isa also allows bond investors to take advantage of a tax break which is not open to stock market investors.

Income tax of 20% is taken from dividends paid by shares held in Isas. While half of this may now be reclaimed from the Revenue, that concession ends in April 2004. But no tax is taken from income paid by corporate bonds held in Isas.

The difference may be small, but it is seen as the icing on the cake for investors who have already decided that a bond fund is for them.

So which bond funds should investors look at? The number of funds has soared since 1996, when Inland Revenue rules changed to allow them to be held in tax-free Peps. Many fund managers have launched funds since then to win over Pep and now Isa savers in search of solid income or steady growth.

But performance and potential varies widely. The David Aaron Partnership, an independent financial adviser in Woburn Sands, Buckinghamshire, has produced a detailed report on the bond market. It says that conservative investors wanting to stick to blue chip bonds from secure big-name companies should consider Aberdeen Sterling Bond, Norwich Corporate Bond, M&G Corporate Bond, Legal & General Fixed Interest and Fidelity MoneyBuilder Income.

It says funds from many High Street banks have underperformed over the past five years and should be avoided.

Financial adviser WiseUp, based in Leeds, has a portfolio of four bond funds it recommends to investors prepared to take slightly more risks in return for higher potential returns.

It suggests investors spread their money between Aberdeen Fixed Interest, Britannic Corporate Bond, Old Mutual Corporate Bond and Credit Suisse Monthly Income.

Whichever fund an investor picks, it is important to realise that the value of the capital is not guaranteed.