- Find the right Cash ISAs
- Cash ISAs or not?
- Which ISA for you

With UK interest rates down to 1%, there is not much for UK savers to get excited about. As the Bank of England lowers rates, so in turn do the high street banks and building societies. This might be good news for those on variable rate or tracker mortgages but it is anything but good news for those with cash in deposit accounts.

Those in cash ISAs may have the benefit of a tax-free wrapper but in most cases returns are going to be pretty paltry. Sure cash is a safe option but for ISA investors who want better returns and are prepared to take a little more risk to achieve that, there is a growing temptation to look at corporate bond ISAs.

IFA Hargreaves Lansdown has noted a 10-fold increase in people leaving cash ISAs and instead shifting into corporate bonds via a stocks and shares ISA. Meera Patel at Hargreaves believes corporate bonds are offering good returns at a relatively low risk and are a good way to make your money work for you without going back into direct shares or equity funds.

Andy Merricks, an IFA with Skerritt Consultants, reckons 2009 is the most important ISA season ever and he too believes that investors looking to generate income should consider corporate bonds now as the first port of call. “I am getting regular calls from people, mostly retired, who are genuinely struggling to cope with interest rates down to 1%. I know that everyone is banging on about corporate bond funds at the moment, but they really do look like the answer this ISA season. Sometimes if it looks like a duck, sounds like a duck and walks like a duck, it is a duck!.”

Martin Bamford, IFA with Informed Choice believes investment grade bonds (see box) are the way to go. “Investment grade bonds appear to be the most attractive, and it is important to diversify through a collective investment fund in case defaults do begin to materialise. Our preferred corporate bond funds at the moment are M&G Corporate Bond and Standard Life AAA Income bond. Both funds invest in the higher quality end of the bond market and have a good track record. The Standard Life fund should represent a more secure option for investors, but the M&G fund has a good level of diversification with over 400 individual holdings.” Arthur Childs, IFA with Arch Financial Planning sees corporate bonds as a viable alternative to cash ISAs too. “Provided investors are prepared to take the risk involved, investing up to £7,200 into one or two of the better corporate bond funds would seem a good option for your 2009 ISA. Current yields on these funds are relatively attractive in the current market, for example, Investec Sterling Bond (5.4%), Jupiter Corporate Bond (5.1%), and M&G Corporate Bond (4.9%). A number of corporate bond funds have current yields well in excess of 5% but this is generally a reflection of the fact that they are holding a noticeable proportion of debt which is sub-investment grade, and would expose an investor’s capital to a significantly higher risk of loss. I think it is too early in the economic cycle to recommend these funds.”

But even if ISA investors dismiss some of the riskier, higher yield bonds, the returns from high quality, investment grade bonds outshines the best currently offered on Cash ISAs. Compare 5.4% from the Investec Sterling Bond fund with the best rates on cash ISAs such as 3.6% from First Save or 3.3% from Saffron Building Society. Some of these rates may fall further and there are already plenty of banks offering as little as 2% or below.

Neil Mumford, IFA with Milestone Wealth Management sees corporate bonds offering good opportunities over the next 2-3 years. “It is a good entry point for corporate bonds as you are buying investment grade quality when assets are trading below par. Investors are getting a good income stream but also good potential of capital growth too.”

Corporate bonds are not without risk but they are considerably less risky than equity funds. When you invest into a corporate bond fund, instead of 'lending' money to a bank - which is effectively what happens when you place money on deposit – you are effectively lending your money to companies who agree to pay an amount of interest over a certain period of time.

Bonds are split into categories - investment grade (for companies deemed to be low risk) and sub-investment grade (companies deemed to be higher risk). Typically sub-investment grade companies will provide higher income for the additional risk taken on by the investor. However with many riskier bonds there is a risk of default and this is one of the reasons that most IFAs are wary of this end of the market.