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Index-linked gilts should shine through

THE record highs hit by the stock market are seen as a pointer by nervous investors that now may be the time for a break from direct equity investment.

If so, gilts could offer some protection against the potential correction expected by many experts. For increasing numbers of advisers they are the safe option demanded by clients.

David Brennan, of Swire Fraser, the financial advisers, says: "We are certainly seeing more interest from clients in gilts, mainly from those aged between 45 and 65 who want security.

"If you do not want to be in equities but want something more than a building society offers then a gilt investment is worth looking at. The returns are not as great as on stocks but they have a lower risk rating. A guarantee is only as good as the guarantor and I think the promise of repayment by the Treasury is the best one out there."

A gilt offers a twice-yearly fixed income and a promised return of capital at the end of the day, all guaranteed by the Treasury. It has a fixed life but before coming up for redemption it can be traded in the market. The price depends, as with equities, on supply and demand. If the price of a gilt falls, because the income stream is fixed, the actual return on the gilt goes up.

Andrew Roberts, bond analyst at UBS, says: "Investors should not be fooled by the fact that a gilt is a government security. The price can be volatile, even more so than with equities."

The one big factor that can undermine real returns is inflation. Cheap gilts are those that the markets believe will be heavily affected by inflation, and vice versa for expensive gilts.

Kevin Adams, a gilts analyst at BZW, says: "The UK economy is doing well so we think inflation and interest rates will be going up next year. There are also other market conditions which can affect the future for gilt investors. If a Labour government is elected there could be fears of a rise in inflation.

Mr Brennan recommends investors buy gilts that cannot be undermined by inflation. Called index-linked gilts, they promise to pay a fixed amount above inflation, both on the income stream and the capital repayment at the end of the term.

He believes that gilts, like equities, are for the long term: "Gilts are not short-term investments to switch in and out of quickly. We would advocate holding them for around eight years." While interest payment from gilts are subject to income tax, the capital repayment does not incur capital gains tax.

q For details on gilts call National Savings helpline on 0865 645000.