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Corporate climbers

What a depressing time – falling markets, layoffs everywhere and a continuous diet of gloomy news. All this will lead to further falls in interest rates and I expect another cut in December with more to come later. I would not be surprised to see rates below 2 per cent by February.

This will clearly have an impact on deposit accounts, something the average investor has not realised yet. Investors still have 6 per cent at the front of their minds so it will come as a shock to many people when their bank account rate halves early next year.

The last time interest rates were 3 per cent was in the mid-1950s. Even during the Great Depression they were only 2 per cent. The Bank of England has been around for more than three centuries and not once has the interest rate been below 2 per cent. This truly is an unprecedented situation.

What can savers do? Those spooked by falling stockmarkets who will only hold money in cash will simply have to accept a lower return. Rates will eventually rise again but I suspect there will not be significant increases until at least 2010.

However, those who feel they can take on some risk should consider corporate bond funds.

Now these are like any investment and can fall in value and this year they have done exactly that – but yields have risen correspondingly. One fund worth looking at is the Jupiter corporate bond fund run by John Hamilton.

Since the middle of last year, Hamilton has been gradually increasing the risk on the fund by reducing exposure to government bonds and AAA-rated securities from around 25 per cent to 8 per cent of the portfolio. This was switched into banks, utilities and telecoms.

Why has he increased the risk? Hamilton now believes he is being paid to take the risk, in other words, the bonds look great value for money.

Investment-grade bonds are currently pricing in a five-year default rate of about 25 per cent – this assumes that one in four companies issuing investment-grade bonds will go bust over the next five years. This is not impossible but seems massively unlikely, even during a severe recession.

Mr Hamilton has made a point of investing in companies with low levels of debt and the flexibility to manage their business through a tough period.

He is also realistic enough to expect there will be some defaults, given the current downturn, but remember that even if a firm does default on their debt, investors usually get some of their money back so it is not a total write-off.

The current yield on the fund is 5.4 per cent, with a gross redemption yield of 7.5 per cent. In other words, the fund should see some capital appreciation as well as the income. These yields appear low compared with other corporate bond funds. However, one factor to remember is that Hamilton’s annual management charge comes out of income whereas many other fund managers take it out of capital.

This year has been the first period for ages that I have been recommending corporate bond funds. A yield in the region of 5 per cent might look incredibly unexciting right now but next year when you are getting only 2 per cent in the bank it will be far more enticing.

The security of cash is crucial and everyone should have some of their assets in instant-access accounts but if you are seeking a better return on your money (and are prepared to take some risk to achieve it) then a fund such as Jupiter corporate bond is worth considering.

Mark Dampier is head of research at Hargreaves Lansdown


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