Rate cuts rescue high-yield bonds

It is not just stock markets that have taken heart from the interest rate cuts. In Britain and the US, high yield corporate bonds - loans by companies - have also soared in value.

Threadneedle's High Yield Bond fund, for example, is up by 13 per cent since the new year. Yet this firm, like many other fund managers, still believes the sector could rise further.

A further rise would not be before time. These funds were all the rage two years ago, with a spate of heavily promoted launches. Predictably, that was the signal for the sector to turn sour, and they have mostly performed poorly ever since.

With hindsight, it is easy to see why. Corporate bonds are traded in a similar way to shares. Their price is determined by interest rates and the market's assessment of the chances that a company will be able to meet its interest and capital repayments.

Until last week, rates had been rising, and investors were gradually realising that some of the companies issuing the bonds - particularly in the telecoms sector - had very large debts.

They worried about the risk of defaults and scurried for the safer investment- grade bonds, issued by blue chip companies. High-yield corporate bonds fell by 13 per cent last year.

Now, however, interest rates are falling and, while there is still concern over the creditworthiness of some, there is a feeling that higher- rate corporate bonds could have fallen too far, too fast.

Certainly, yields - the traditional way in which they are measured - look attractive. The prices of some bonds have fallen so far that they are offering rates as high as 15 per cent, a huge premium over investment- grade bonds. Despite the spectacular performance so far this year, Threadneedle's High Yield Bond fund is still offering more than 10 per cent. Try getting that from your local building society.

This does not mean bonds are an alternative to the building society. While they are safer than shares - firms will pay their interest bills even if they have to cut their dividend - they are not guaranteed. The price of corpo rate bonds will fluctuate sharply, depending on investors' views of economic and corporate prospects. The higher the yield, the greater the risk.

Funds which invest only in top-rated corporate bonds from blue chips will offer around 5 per cent, half that on many high-yield bond funds.

Many commentators think the spread between investment-grade and high- yield bonds is now too great. Gary Marshall of Aberdeen Asset Management believes that, unless we end up with a 'hard landing', high-yield bonds offer good value.

Those with the appetite for some risk should consider a high-yield fund. Even if the price does not rise, the income is healthy. Sheltering it in an Isa makes it doubly attractive, as bond interest still carries a 20 per cent tax rebate, compared with 10 per cent for shares.

Funds worth considering include Threadneedle, Aberdeen's High Yield Bond, M&G's European High Yield Bond and Gartmore's Global Bond.