PEPS: Take the fear out of staking your funds

Caution may not be the sexiest word in the language but when it comes to investing it can pay, particularly with stock markets flying so high.

If you have never invested in a PEP before, you should be sure you know what you are buying. A personal equity plan - to be replaced by the individual savings account (ISA) next month - is a stock market investment. Usually you buy shares, and there's a manager in place to select and buy the shares he or she thinks will do well. Younger investors can afford to approach PEPs and ISAs with a greater sense of bravado as they will have plenty of time to make good any losses. Older investors who are new to investment may wish to tread more carefully.

Whatever your age, attitude to risk is personal. So how do you know if you are a cautious investor? There are several telltale signs, says financial adviser Philippa Gee, of Gee & Company. "Do you actively worry about an investment once you have set it up? Some of my clients worry about very small holdings, even if they are performing well. They even check their value on a daily basis. That is daft, as this is what you pay the fund manager to do."

However, Ms Gee says that if you are a natural worrier and stock market swings will keep you awake at night, it might be better to ignore the current PEP hype and steer clear of the stock market altogether.

There are several types of PEP that specifically target the cautious investor. Your eye may have been caught by protected PEPs. These allow you to take some of the rewards of in-vesting in the stock market while limiting the losses you can suffer in a slump. This sounds simple, but Ms Gee does not like them. She does not believe they should exist.

"You are protected from losses but there is a downside in that you gain less when the market rises. If you are that worried about equity investments you should not be in the market in the first place."

The big noise in the safe investment game in recent months has been corporate- bond PEPs. With interest rates falling and the stock market volatile, these have attracted investors - particularly those looking for a high level of income. Many see them as a handy compromise between safe but dull savings accounts and the riskier stock market.

As with other PEPs, corporate-bond PEPs protect your gains from income and capital gains tax, but instead of investing in shares they invest in fixed-interest securities. These are loans issued by private companies to raise capital and they pay a fixed rate of interest while promising to repay your capital on a set date.

If the issuing company goes to the wall you could lose your investment, but since the majority of corporate bonds are in established blue-chip companies, most are secure. Furthermore, corporate-bond PEPs invest in a wide range of companies, spreading the risk.

Patrick Connelly, of Chartwell Investment Management, warns that some corporate bonds are riskier than others.

"Some pay yields of more than 8 per cent, but you can't do that without a degree of risk. That comes from investing in smaller, weaker companies' bonds which offer higher rates to compensate.

"Stronger, more secure bonds will offer a yield of around 5 to 6 per cent, which will appeal to investors wanting secure income. This is a good rate considering that interest rates on savings accounts have fallen and are likely to fall further."

For cautious investors, he recommends the M&G Corporate Bond fund.

Mr Connelly says investors can combine the security of corporate bonds with the greater growth potential of equities by buying into different funds through the same investment house.

"Most PEP providers will let you mix and match with a range of funds," he says. "For example, you could put a certain amount in Perpetual's UK Growth PEP and the remainder in its corporate bond."

Jamie Ware, managing director of Churchill Investments, says corporate bond PEPs have been slightly "over-egged" in recent months. "Everybody has been saying the market is turbulent and you should look for a corporate bond, but then shares have just risen by 10 per cent."

Broker Hargreaves Lansdown picks out four favourite corporate-bond PEPs: Aberdeen Fixed Interest Fund; CGU PPT Monthly Income Plus; Credit Suisse Corporate Bond Monthly Income Fund; and M&G High Yield Corporate Bond Fund.

The final option for the cautious investor is lower-risk equity funds. These might, for example, be funds that invest in major blue-chip companies and are looking for solid, consistent performance rather than rapid and possibly more precarious growth.

The risk is dramatically reduced if you can leave the money invested for many years. The figures bear this argument out. Despite the harrowing plunge in share values in the early Nineties, if you had invested pounds 1,000 in a typical PEP in January 1989, it would now be worth pounds 3,368. Placed in a building society deposit account it would have grown to just pounds 1,622.

Ms Gee recommends two relatively low-risk equity funds for the cautious: Perpetual UK Growth and Newton Income.

Jonathan Fry, director of Premier Fund Managers, says it is important to put risk in perspective: "PEPs are not a dodgy deal. It is not as if PEP companies are going to nick your money, and investors are backed by compensation schemes anyway."

He produces a series of tables that weigh up the growth prospects of a range of investments against the risk involved. These tables, which list the top 10 unit trusts in each sector, most of them PEPable, are available free to readers (see below).

n Contacts: Hargreaves Lansdown, 0117 900 9000; HSBC Capital Protected Income PEP, 0800 289505; M&G, 01245 390390; Midland Capital Protected Growth PEP, 0800 299299; Scottish Widows SafetyPlus PEP, 0845 845 0088.

Reader offer: for a free copy of the Chartwell corporate bond guide, call 01225 321710.

Premier Fund Managers risk tables, 0800 212577.