How to pep up investments with tracker funds and corporate bonds

Low-cost tax-free personal equity plans investing in a mix of shares chosen to "track" the UK stock market are leading the fight to challenge the new Tessas. They are targeted at people who think fixed- rate Tessas with heavy penalties for changing your mind are a bit off and variable rates are unexciting, and at investors who have reached their tax-free limit of pounds 9,000 in a Tessa and need to reinvest their accumulated interest and future savings elsewhere.

Just six months ago, most experts thought that Tessa investors would turn to Peps investing in corporate bonds (ie fixed-interest loan stocks issued by UK companies).

Figures compiled by Baronworth currently quotes tax-free running yields (excluding any gains and losses on maturing bonds) of anything from 7.5 per cent to 8.5 per cent net of charges. But on average, corporate bond Peps offer perhaps 1 per cent more than a new-style Tessa.

They are invested in a range of bonds, so that the risk of a company going bust and defaulting is reduced to an acceptable minimum. The main risk to the capital will come only if interest rates generally start to rise significantly, so that the fixed interest coupons payable on most corporate bonds start to look unattractive and prices fall.

But the sharp rise in share prices on the London stock market has significantly increased the attractions of investments in shares, unit trusts, investment trusts and especially in tax-free Peps. Morgan Grenfell estimates that demand for Peps has risen 25 per cent over the past year, and 450,000 investors will actually take out a Pep between now and the end of the tax year. According to analysts Mintel, 10 per cent of them will be using the money from maturing Tessas.

The interest in Peps is being actively encouraged by signs of a price war on charges. This week Fidelity Investments - the aggressive American- based fund managers - threw down the gauntlet by offering MoneyBuilder Index, a Pep investing in a range of shares selected to match the movements of the top 100 UK shares. Trackers are cheap to manage and there are no entry charges, the full-amount subscribed is invested, there are no exit charges to take the money out (and, unlike Tessas, the tax-free status is not lost if the money is withdrawn), and the annual management charge including any fee for creating the Pep is just 0.5 per cent a year. On a maximum investment of pounds 6,000 the total charges are just pounds 30 a year.

It undercuts the previous cheapest Pep, a tracker fund based on the All-share index introduced by Legal & General last year, which charged 0.5 per cent plus pounds 25 plus VAT - a total of pounds 59 a year to manage a pounds 6,000 investment. It also undercuts the other market leaders, Gartmore, HSBC, Kleinwort Benson and Virgin, all of whom charge 1 per cent on similar products.

L&G immediately abolished their pounds 25 fee to match Fidelity and other providers are expected to introduce low-cost Peps shortly. Between them they should generate attractive low-cost competition for investors if share prices continue to rise.

Weekly corporate bond pep tables are available from Baronsworth, 0181- 518 1218

CG