The half-century linker

This is the longest-dated index-linked gilt yet to be launched, and will no doubt find a ready home with life insurance companies and other organisations who have an insatiable appetite for such assets in order to match long-term inflation-linked liabilities. For private investors, the bond may be somewhat too long for a buy and hold approach, but as with any new issue, it's useful to kick the tyres and have a look. No doubt at some point they will make a useful addition to a portfolio.

The point of issue is the easiest time to get to grips with an index-linked bond, since at inception, the coupon will be as stated and the redemption proceeds will be the RPI-adjusted amount of par. Thus, holders buying the bond at par and holding to maturity will enjoy a "real return" (that is, a return over and above the rate of inflation) simply equivalent to the coupon.

So if we assume that inflation runs at the Bank of England's guideline of 2 per cent per annum, that means that coupon rate will gradually increase; this year 0.375 per cent, next year 0.3825 per cent and so on. After ten years the coupon will have edged up to 0.46 per cent. As for the redemption proceeds, over 50 years, even a modest 2 per cent has a powerful compounding effect. £100 invested at par will pay £269 on maturity. If inflation continues at the current rate of 5.6 per cent, the outcome will be considerably higher. The chart below shows the coupon appreciation at 2 per cent (the target rate), 5.6 per cent (the current rate) and 3.8 per cent (the mid-point of the two). Note how the curve of the chart picks up - compounding in action!

* All gilts can be bought in penny lots, although few investors ever do!

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