Latest PEPs line up at the starting post

By this time next week you too could be a pioneering investor in corporate bond personal equity plans, the latest financial animal genetically engineered by a Conservative Chancellor in yet another effort to encourage UK small investors to put their money where industry can use it, rather than in that now discredited old standby, bricks and mortar.

Clerical Medical Unit Trust Managers already claims to have taken pounds 40m worth of applications for its Extra Income PEP, ready to invest in securities as soon as the whistle blows next Thursday. The quoted venture capital group 3i plans to launch a corporate bond PEP next Thursday and already has a savings plan up and running to feed investments into the PEP.

Norwich Union launches a PEP unit trust to invest in corporate bonds next Thursday. Natwest Bank and M&G will both launch on 24 July, while TSB and Britannia Building Society are waiting only until they are sure the tax treatment of the bond PEPS has been clarified beyond all doubt.

Some of the big investment managers who are expected to try to win a piece of the action, which could pull in as much as pounds 1bn before the end of the current tax year, are being more cautious. Save & Prosper has already advised investors to wait and see what choice of products is developed between now and the autumn before making any decision to invest.

Fidelity Investments is also advising caution until the tax rules are crystal-clear, but both S&P and Fidelity believe the potential is there for a successul new investment vehicle.

Until now PEPs have been invested only in shares in UK-based companies, and unit trusts, and although both dividend income and capital gains on the underlying shares are exempt from tax, the value of the PEPs, like the underlying shares, has gone down as well as up. Last year alone average share values fell almost 20 per cent between the high in February and the low last June, and they have still not fully recovered.

Small investors unaccustomed to risk may well not be ready for that, although the evidence shows that over any five-year period shares have outperformed investments in banks, building societies, National Savings and government stocks.

Investors averse to risks have been able to invest in unit trust and investment trust PEPs which in turn have been able to put up to half their money in fixed-interest securities, but there has still been a substantial exposure to fluctuating share values.

Corporate bond PEPs are intended to be high-income, medium-risk investments, with a touch of capital gains and attractive tax advantages, managed by experts and intended to appeal especially to better-off pensioners looking for income and to higher-rate taxpayers in search of tax-efficient investments.

In particular they can invest in corporate bonds, which are issued by companies with a specified rate of interest on the capital value and a fixed date of maturity, at which point the capital must be repaid in full. Because the rate is fixed at the time a bond is issued, it will become more attractive when rates elsewhere in the economy fall, and the market value of the bond will rise. But if interest rates generally rise the fixed return on the bond will look less attractive and its value will fall.

There is a modest risk that companies issuing bonds could go bust, so the yield or coupon on corporate bonds has to be higher, usually anything from 0.5 to 1.5 per cent higher than the yield the Government pays on a government stock or gilt maturing over the same period.

If ever a reminder was necessary, the fate of the pounds 100m worth of bonds issued by Barings, which became worthless overnight when the Singapore- based trader Nick Leeson famously bust the bank with his speculations, acts as a salutary reminder. But the point of a corporate bond PEP is that it will be a managed investment pooling the savings of many investors in a wide range of bonds chosen to combine high income with a spread of risks.

The high cost of issuing corporate bonds has limited the number of UK companies wanting to raise capital in this way. New share issues and even bank loans have usually been cheaper. Finally the Chancellor, Kenneth Clarke, has agreed to extend the tax advantages of PEPS to funds investment entirely in corporate bonds issued by UK and EU companies, in order to attract more money into bonds and bring down the return borrowers have to offer and allow smaller companies to raise capital at lower fixed interest rates, and at the same time give investors a new investment vehicle.

For practical purposes corporate bond PEPs will also be allowed to invest in debenture shares and preference shares issued by companies which offer fixed dividends, and in convertible bonds (convertibles). They start off life as bonds, paying a fixed rate of interest over a set period of years, but can be profitably converted into shares at predetermined prices if the company does well and its shares go up enough to exceed the conversion price.