Should you buy into corporate bonds?

"There's a bit of an opportunity in all this carnage in the markets," Hanif Mamdani of Phillips Hager and North Investment Management tells Globeandmail.com. He's not talking about battered stocks it's corporate bonds he likes. Gavin Hayes at Whitechurch Securities agrees. Chosen wisely, bonds offer "a good income and a lower risk-profile than equities". But is now the time to buy?

Corporate bonds are just IOUs issued by companies to raise cash. Most pay a regular income or 'coupons', fixed as a portion of their 'nominal value', often £100 for a sterling bond. So a 7% bond will pay a fixed £7 a year. Most bonds also have a fixed maturity, or 'redemption' date, when they are bought back by the issuer for the £100 nominal, or 'par' value. Meanwhile, the bond can be bought and sold, so its open-market price is down to supply and demand.

How safe are corporate bonds?

Bonds are safer than shares. That's because interest payments must be met from profits before dividends can be paid. But low risk isn't no risk. If a company goes bust, bondholders can expect to be repaid first, but there may well be insufficient funds to pay you back. And it's a risk worth bearing in mind data from the Government Insolvency Service show that liquidations are rising at their fastest pace in 18 years, recently topping 4,000 for the first time since 2002. The key to judging a bond's risk is its investment 'grade'. Professional agencies such as Standard & Poor's and Moody's rate bonds by looking at the quality (size, track record, etc) of the issuer and the relative safety of each type of bond it has issued. This largely reflects its ranking in the event of the issuer going bust. S&P rankings range from AAA effectively as safe as a gilt down to D, meaning the issuer has already defaulted, perhaps by missing an interest payment. A BBB-rating or above is 'investment grade'. Below that it's 'non-investment grade', or simply 'junk' but in return you can expect a higher yield.

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Corporate bond yields

The return from most corporate bonds is captured in two numbers. First is the 'flat', 'income' or 'running' yield, the coupon as a percentage of the bond's market price. So a 7% bond priced at £105 has a flat yield of 6.6% (7/105 x 100%). That can be compared to the dividend yield on riskier equities, or the return you could get from a safer bank deposit. For example, high-quality investment-grade bond-fund investors "should expect a running yield in the region of 5%", says Meera Patel at Hargreaves Landsdowne in Moneywise. That compares well to riskier equities the dividend yield on the FTSE 100 is around 5.2%.

For a high-yield, higher-risk fund, think "around 7% in the current climate". Bonds can also offer a capital gain if prices rise and yields fall, which seems likely as global interest rates tumble to ward off recession. That's broadly because as interest rates, and hence the return available on cash deposits, drops, the fixed income from, say, a 7% bond, gets more attractive. The resulting competition to buy the bond pushes its price up. Combine the flat yield with the capital gain (or loss) you would get if you held the bond to maturity and you get a 'redemption' yield, or total return. This is usually quoted before tax 'gross' and often shortened to GRY.

Is now the time to buy corporate bonds?

Corporate bonds: the best way in

Individual corporate bonds can be bought through most brokers. But "trying to cherry pick a single corporate bond could lead you into a minefield", says Harriet Mayer in Moneywise. You could lose all of your capital if the issuer goes bust, and also many require a large minimum investment. So a better bet is a managed fund or an exchange-traded fund (ETF). For the former, try the Threadneedle Absolute Return Bond Fund, up around 9% this year (also see Prudence will survive volatility when picking shares for another tip). Or, for a relatively low-risk ETF that tracks a portfolio of investment grade bonds, there's the iShares Corporate Bond Fund (LSE:SLXX), with an expense ratio of just 0.2% and a flat yield of 7.21%. For exposure to high yield, and consequently riskier, bonds, there's the iShares iBOXX High Yield Corporate Bonds Fund (AMEX:HYG).