INVESTORS are rediscovering bonds as yields have soared to their highest level for five years.

The yields on some bonds issued by banks, which show the income you earn as a proportion of their price, are higher than the returns on their best savings accounts.

You can get a yield of 8.2% from an HSBC bond, for example, compared with just 6% on its cash Isa, while Halifax bonds are paying 8.35%, compared with its cash Isa rate of 6.2%.

Yields are so high because prices have been hit by the credit crunch, as investors fear banks could default on their bonds following the collapse of both Northern Rock, the mortgage bank, and Bear Stearns, the US investment bank.

When prices fall, yields rise, and vice versa. However, some analysts think that the risk of another bank going bust has been overplayed and that some bonds now offer great value.

Nigel Parsons, investment manager at Bestinvest, an adviser, said: “Investors should ask themselves the question, if I am happy to lend Abbey money at 6.25% via their Isa, why would I not buy corporate debt from them which yields me 7.88%?”

Ben Yearsley at Hargreaves Lansdown, an adviser, agrees. He said: “I never thought I’d buy into bonds, but a couple of weeks ago I bought three funds - the Invesco Perpetual Monthly Income Plus, the Henderson Strategic and New Star Extra High Yield – and put them into my Isa.

“The opportunity just looked too good. On the New Star fund, you’re getting an 11% yield, Invesco about 7.8% and Henderson about 6%.”

Corporate bonds are basically loans to companies. The company pays a fixed income to the investor, which is the equivalent of the interest on a loan.

If you hold a bond to maturity, you get your capital back in full – as long as the company doesn’t go bust.

Once issued, bonds are traded on the stock market, so their prices go up and down depending on demand. If you sell a bond before maturity, therefore, you could get back less than what you paid. However, bonds are not generally as volatile as shares.

Many corporate bonds are currently trading below the issue price as a result of the credit crunch. Every £100 worth of Barclays bonds, for example, costs £96, giving you a 4% capital gain if you held the bond until maturity.

At issue, each £100 bond was yielding 6.875%. That £6.88 is now equivalent to a yield of 7.16% given that the price has fallen.

Payments on corporate bonds also take priority over dividends and equities so you are more likely to be paid in a crisis anyway.

Northern Rock bondholders with the most senior tier of debt are likely to get their money back in full as a result of the nationalisation of the bank, although those investors with lower-grade debt will only get limited compensation.

You can invest in a corporate bond directly by buying individual stocks through your broker although you will need to invest at least £10,000 to do so. Alternatively, you can buy through an investment fund.

Bestinvest likes the New Star Sterling Bond fund, managed by Philip Roantree, which is up 66% over the past 10 years.

The fund holds bonds issued by Bradford & Bingley, the Bank of Ireland and Alliance & Leicester.

All have been hit hard by the Northern Rock crisis, but that could present an opportunity for brave investors.

Alternatively, the Invesco Perpetual Corporate Bond fund run by Paul Causer and Paul Read has been a more stable performer, although its yield is lower at 3.5%.

You can invest more into a corporate bond fund via a stocks and shares Isa than you can in a straightforward cash Isa – £7,200 versus £3,600.

Bond income is classed as interest, so outside an Isa 20% tax is deducted at source and higher-rate taxpayers must paya further 20% through their tax return. Inside an Isa, the income would be tax free.

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