Here's some good news. You can get an income of 4.4 per cent a year - a percentage point better than most ISAs. And it's guaranteed for life, however long you live.
There must be a catch, right? Of course there is. I'm referring to the 3.5 per cent War Loan, a gilt which will never mature and just pay an income in perpetuity. The catch is that the attractive income comes at the price of putting your capital at risk.
For example, during the last 10 years the volatility of monthly price changes in War Loan has been twice that of a shorter-dated gilt, the 9 per cent 2011 stock. This suggests that there's a one-in-eight chance that War Loan will lose you 10 per cent or more over a six month period, compared to just a 1 per cent chance for medium-dated gilts.
The reason for this greater volatility is simple. It arises from the fact that the price of a gilt is merely the discounted present value of all future payments you get from it. When interest rates go up, these future payments are discounted more heavily. And the further in the future the payments come, the bigger is the increase in the discount. Because War Loan pays out in the further future than other gilts - perpetuity is a long time - so it falls more in price when interest rates rise. It's brute maths.
There's a simple measure of this effect - modified duration. The modified duration of War Loan is 22.4. That means a one percentage point rise in its yield cuts its price by 22.4 per cent. By contrast, the modified duration of gilts maturing before 2012 is less than three, implying that a percentage point rise in yield cuts their prices by less than 3 per cent.
So, why not buy a shorter-dated gilt? The 9% 2011 issue, pays an income of 7.7 per cent.
Simple. On this gilt, you are guaranteed to lose money - almost 15 per cent if you hold it to maturity. The total return on it - income plus the capital loss is a mere 1.3 per cent annualized.
If you want decent income without a certain capital loss, therefore, you have to take some risk. So what are the risks that might cause a fall in War Loan prices? Most of the dangers are global ones, not just UK ones. This is because gilts are a close substitute for European or US government bonds, so if the latter sell off, so will gilts. There are, at least, four such risks:
1.A deterioration in governments' creditworthiness, as a result of the increased borrowing to bail out banks and to pull economies out of recession.
2. Higher inflation, perhaps as a result of UK and US governments printing money, or - more likely - because the economic recovery leads to expectations of rising prices.
3. An end to the Asian savings glut that has caused big demand for western bonds in recent years.
4. A flight out of safe assets a global investors rediscover their appetite for risk, probably as a result of them anticipating economic recovery.
How likely are these? I've put them in increasing order of my subjective probability, ranging from "unlikely" to "odds on sometime in the next 12 months."
But my subjective probabilities are worth as much as the next man's - nothing. The key point is that professional Yorkshiremen are right - you don't get owt for nowt. High income on any asset - bonds or shares - is only a reward for taking some kind of risk.
