How do they work?

When you buy company bonds you're lending money directly to the company. As part of the deal, you get regular "interest" (coupon) payments - and your principal comes back to you at a pre-set date when the bond matures. Some of these bonds are "subordinated", which means there are other creditors (those with "senior" debt) who will rank ahead of you in the creditors' queue if the company defaults.

If you don't want to hold the bonds until they mature, you can sell most of them on a secondary market to another investor. But that will be at the market price for those bonds at the time you want to sell (assuming there's someone who wants the bonds).

The investment bankers who create the bonds for their corporate clients are happy to point out the positives of DIY bond investing - "safe" names, higher returns than you'd get from term deposits, and no fee-taking fund managers.

But it isn't as straightforward as that, as we explain in what to watch out for.

Alternatives to DIY bonds

Buying directly is not the only way to invest in company bonds. You could also purchase units in a retail collective investment scheme that specialises in bonds. The AMP Capital NZ Fixed Interest Fund is the biggest, at around $600 million.

Here you're investing in a professionally managed diversified pool of bonds (including government and non-retail bonds) for a fee of 0.55 percent of the value of your investment each year plus expenses and entry and exit fees. Anthony Edmonds from AMP Capital Investors believes that large fixed-interest funds receive better deals on bonds than DIY investors (which may result in higher yields) by avoiding the significant brokerage fees DIY investors have to pay.

Unlike DIY bonds, units in a collective investment scheme have no set term of investment and you can't lock into a return. When you want to cash up, you sell the units back; what you get for them depends on what the pool of bonds is currently valued at. So you'll always be exposed to the risk that the units end up being worth less than you paid for them.

There's also a risk your money may be frozen if the fund gets into trouble. This can happen if investors want more money back from the fund than the fund is able to repay by selling bonds - for example, if the bonds are in default or can't be sold. This has happened to a number of mortgage funds in the past year.