Corporate bonds or corporate bond funds are being offered as an alternative to investors who want income-producing investments but are unhappy with interest rates available on deposit-type products.
Corporate bonds are effectively loans to companies, where the company pays relatively high interest over the life of the loan and repays the investors capital in a lump sum at the end of an agreed term. They offer higher yields because often the firms seeking the funds cannot raise funds in any other way.
While returns can be well ahead of rates on deposit accounts, corporate bonds are high-risk investments. There are two distinct risks - that the company or fund will not be able to pay the interest/coupon offered and/or repay the capital sum. Bonds with the highest default risks will offer the highest returns.
Investors need to assess these products carefully. With individual bonds they should look at the credit ratings given to the bond by agencies such as Standard & Poor's or Moody's - these range from AAA for relatively safe companies to D, where a company cannot repay.
Investors should get a breakdown of the investment allocation by credit rating - what proportion of the fund is invested in sub-investment grade bonds and the credit risk assessment of the bond promoter. Funds have the advantage over individual bonds of spreading the risk. But investors need to examine the entry and ongoing management charges to assess the prospects of a return sufficient to compensate for the risk involved.
