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Add corporate bonds to your ISA for income

WHEN the Bank of England introduced its £200bn emergency quantitative easing (QE) programme last year, the expectation in the markets was that benchmark 10-year gilt yields would fall as the Bank soaked up the billions of pounds worth of debt that the government was issuing. In fact, yields are today much where they were a year ago and remained stubbornly still when the Bank announced it would be pausing its asset purchases.

But there are plenty of reasons to think that gilt yields could still rise (and therefore lower the price of the gilt) – for example the political uncertainty surrounding the upcoming general election, and the outlook for the UK credit rating and the £225bn of debt issuance in 2010-11 that the Debt Management Office needs to find a buyer for. So although purchasing gilts has been a traditionally popular and inherently safe way for individuals to invest, this is no longer the case and the yields still aren’t that attractive.

Corporate bonds are a much better option for individuals to include in their ISAs, says Adrian Lowcock, senior investment adviser at BestInvest, an independent financial advisory firm. But he says that it is very difficult for investors, even those with plenty of market experience, to identify appropriate corporate bonds that are eligible to include in an ISA.

For example, if you buy a share in a company you know what you are buying. But a large company may issue thousands of debt lines so you would have to pick the right corporate bonds. “There are risks involved in picking the right one and it is much better to appoint a bond manager who has the resources to do just that,” says Lowcock, adding that bond funds are the simplest way for individuals to gain exposure to fixed income through their stocks and shares ISA.

He adds: “What you are looking for is a strategic or tactical bond fund that can invest anywhere in the corporate bond sector from triple-A to junk. Considering the economic climate, these funds give you the greatest flexibility to achieve both income and growth.”

He recommends looking at the M&G optimal income fund for your ISA as a good bond fund for income, while investors seeking growth could investigate the recently-launched Invesco Perpetual tactical bond fund.

But how much exposure should you have to corporate bonds? Lowcock advises that the general investor, who tends to be after growth and prepared to take on a moderate level of risk, should have around 22 per cent (and up to 25 per cent) of their portfolio in corporate bonds. However, as you get older you should increase your portfolio’s bond exposure and shift your focus towards income and away from growth. As soon as you start looking towards your retirement, you need to concentrate on investing in funds that will give you regular income rather than focus on growing the size of your capital.