Top performers in the risk-free zone

SECTOR WATCH FIXED-INTEREST FUNDS

The most popular home for personal equity plans in this, the last- ever season for PEPs, is corporate bond funds. They are listed under a peculiarly named sector: Other UK Fixed Interest.

This is to differentiate the corporate bond funds from those investing solely in government bonds (gilts), although a number of funds in this sector do have large holdings in government issued loan stock.

Most of these funds yield 6 to 7 per cent a year, tax free in a PEP. They invest in various kinds of loan stocks issued by the leading UK and European companies. There is now a range of higher-income bond funds, typically yielding well over 7 per cent. But even the first of these, the M&G High Yield Corporate Bond fund launched last year, is too recent to enter our performance charts.

Unit trusts investing in various types of company loan stocks and convertibles have been around for more than a decade, providing a home for risk-averse investors and those seeking to maximise income.

One of the most consistent performers, CGU PPT Preference Share, is unusual in being one of the few unit trusts to specialise in preference shares. It currently yields 5.9 per cent and is valued at around pounds 42m. "We are a major player in this particular market," says Mark Roxburgh of CGU. "We account for some 10 to 11 per cent of the trading in preference shares."

A convertible pays a fixed rate of interest and gives the holder the right to swap it into ordinary shares at a set price at some future date. Many of these shares were issued when interest rates were much higher. Now rates are lower, companies may want to buy their high-coupon stock - that is, preference shares paying a high rate of fixed interest.

"In these cases, we can negotiate a good deal on behalf of our investors," says Mr Roxburgh. "If, say, a stock has a value of pounds 100, we may argue for a price of pounds 130 to redeem it. When we sell the stock, we get a big capital boost which we then reinvest in the market."

CGU also has one of the most popular and consistently performing corporate bonds, the CGU PPT Monthly Income Plus fund. Now valued at over pounds 1bn, it is one of the very few funds that will pay a monthly income to investors. Most funds only pay out quarterly or half yearly.

Good long-term performance depends on how a fund manager mixes different types of loan stock in its funds. "You would think that a fund that invests in just company loan stock will be more volatile than one that invests in gilts," says Andrew Jenkins, head of fixed interest with Fidelity. "But if you have a very widely diversified portfolio, research shows this will reduce the volatility, and it will not move between the extremes that gilts do."

Fidelity's team has to visit every company before it considers buying its bonds. "We went to look at several motorway restaurants before deciding whether to invest in their loan stock," Mr Jenkins says.

"We look for asset-backed investments with strong cash flow that are well managed and that we think are cheap. As the company is seen to improve, its rating goes up."

Many investors aren't looking for income and reinvest their income and gains to buy more units. Fixed-income funds offer protection against market and interest-rate falls.