With instability in global equity markets many investors are running for cover. The main destination they are headed is into corporate bonds. More than $1 trillion have moved into corporate and government bonds since August.

While bonds and fixed interest securities represent the largest asset class in the world, most private investors hold little if any allocation in their portfolio.

There are two main reasons for this: Firstly many investors and financial advisors don’t understand bonds. Secondly bonds are dull. They don’t catch the headlines in the way the equities or commodities do.

However with institutional funds returning 7%+ per annum over 10 years they are an asset class that should appeal to many people, especially investors looking for low risk consistent returns or a better paying alternative to fixed deposits.

A corporate bond is a debt which has been securitised and is tradable on the stock market. Large companies often issue corporate bonds to finance new infrastructure or to pay for corporate takeovers. A corporate bond pays an interest payment typically every six months. At the end of the term the company who borrowed the money pays it back to the investor.

As the interest rate of the bond is fixed at the start of the term it will become more or less attractive to the market depending on a number of external factors:

If the market interest rate falls then the higher interest rate offered by older bonds becomes more attractive. This causes the market price of the bond to rise. Similarly if the demand for corporate bonds increases the price of the bond will rise. If a company’s credit worthiness declines then investors will demand a higher interest rate to hold that debt. This results in a decline in the price of the bond.

As a bond has a capital guarantee at the end of the term and the price and interest rate yield move in opposite directions, it is generally considered to be a safer investment than an equity.

Bond fund managers hold a number of different bonds from governments to failing companies. They use interest rate differentials and credit worthiness strategies to maximise returns on their funds.

The best bond funds on the market are typically institutional funds. Two of the best used by Farringdon are shown below:

INVESCO Perpetual Corporate Bond

Morningstar Rating *****

Inception 1999

Growth Since Inception 7.44%pa

The fund has only had one down year in 2008 with a loss of 8.51%

M&G Strategic Corporate Bond

Morningstar Rating *****

Inception 2005

Growth Since Inception 7.76%pa

The fund has only ever made a loss once - in 2006 losing 0.23%

The additional funds that have moved into bonds in the last two months probably mean that returns will be limited in the short term. However with interest rates likely to remain low and credit markets frozen, the medium to long term outlook for corporate bonds is very positive. Investors should consider corporate bonds to bring stability into their portfolios and for gaining better returns on cash balances.