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ISA picks for 2006: 27 April 2006
Fixed income ISA picks for 2006.
    

The newspapers are full of suggestions for holdings for the 2006 ISA allowance, but why limit this valuable tax break to equities and managed funds? Long term investors know that real growth comes through the re-investment of dividends, not through short-term capital gains and in this aspect, corporate bonds offer some genuine advantage over equities, with bond coupons paid out of revenue before the imposition of corporation tax. What is more, the ISA structure lends itself well to this type of investment, avoiding the 40% income tax that might otherwise be paid by investors.

Bond
Price
Yield
Credit Rating
Marks & Spencer 6.375% 2011
104.95
5.3%
BBB
Cable & Wireless 8.75% Aug 2012
104.05
7.96%
B
Wal Mart
4.75% Jan 2013
99.75
4.8%
AA
Next 5.25%
30 Sept 20013
98.90
5.38%
BBB
Kingfisher
5.625% Dec 2014
99.25
5.68%
BBB
At present, the UK fixed income market is not ideally positioned for the longer-term private investors. Investors are expecting UK rates to fall in the longer term and the yield curve shows rates for medium and longer-term Gilts lower than that available for cash with 5 year issues at 4.4% and 10 year issues at a less than generous 4.3%.
 
In the world of corporate bonds, the picture is slightly more attractive, with spreads for the majority of issues some 50-100 bp (1/2 to 1%) over government bonds.
 
So what to buy? When buying a corporate bond for an ISA, the rules* state that the maturity must be greater than 5 years. We would add some additional criteria to this, namely that the issues should be under (or at least close to) par and that the issuer should be investment rated (BBB rating or equivalent and above).  Given that we are looking for a Sterling issue, this narrows the choice considerably, and looking through the list of closing prices we highlight some possibilities in the table above.
 
Of these, the Marks & Spencer looks to be a reasonable deal, paying 5.3% p/a YTM over around 5 years, but at 104.95%, the price is too far over par for my liking. The 8% yield on the Cable & Wireless is tempting, but with a single B credit rating, this bond is below our criteria. At the other end of the scale, Wal Mart (the owner of Asda) boasts an impressive AA rating, placing the company on a level footing with some of the banks in terms of creditworthiness. However, the 4.8% yield fails to tempt me. That leaves us with two other retailers, and I am plumping for the Kingfisher 5.625% Dec 2014 (click to view price history chart), priced under par and with a yield to maturity of just under 5.7%.
 
I will be reviewing these selections next year. Good luck for the year ahead!
 
Mark Glowrey, 27th April 2005
 
 *Bonds eligible to be held within an ISA fulfill two characteristics. Firstly, the bond must be either listed on a recognized exchange or be issued by a company, the shares of which are listed on a recognized stock exchange. Secondly, the bond must have a maturity of five years or more and without an early redemption option for the holder.