Time for a gilt complex?: Government securities look a safe bet, but it isn't as simple as all that, says Andrew Bibby

INVESTORS weary of low building society interest rates may feel an unfamiliar surge of excitement if they turn to check the current prices and yields on government securities.

Prices in the international bond markets have been tumbling since February, when the US government unexpectedly increased interest rates. British government stocks, or gilts, fell particularly dramatically, by as much as 20 per cent in some cases. As prices have fallen, yields have risen. The gross yield on long-dated gilts is now about 8 per cent.

There was a time when stockbrokers would almost automatically suggest that clients held part of their portfolio in gilts. The years of high inflation and high returns on equities changed all that, but smaller investors may now feel tempted to look again at the gilts market.

Superficially, gilts seem a reassuringly safe and straightforward investment. They are backed by the Government and generally carry both a fixed rate of interest and a set redemption date.

In practice the simplicity is more apparent than real. The set interest rate (the 'coupon') is calculated on the eventual redemption price of pounds 100, but the actual purchase price at any time depends on market forces. As the past few months have shown, you may be in for a roller- coaster ride and - unless you intend to hold your stock until the redemption date - will have to accept the possibility of capital losses as well as gains.

Kean Seager, of the Bristol financial advisers Whitechurch Securities, argues that the market has taken gilt prices to an unsustainably low level and anyone buying gilts now could benefit both from immediate high yields and the prospect of capital gains. 'In the past few months the gilts market has fallen significantly more than the equity market,' he says. 'High yields are not going to last for ever. Either inflation will pick up or the price of gilts will go up considerably.'

Recent days have in fact seen gilts prices edge slightly higher, a process unaffected by Tuesday's further rise in US interest rates. Not everyone is convinced, however, that a long-term recovery in prices is under way.

'We are being a little cautious and are not saying 'Pile in now,' ' says Eric Hathorn, research director with the stockbrokers Henderson Crosthwaite. 'It is difficult to call the bottom of the market, although we are less fearful that we are going to see another nosedive.'

Gerry Loughrey, economic strategist with Albert E Sharp, also suggests a cautious approach. 'Technically, the market is due for a bit of a bounce, but gilts are likely to be sensitive to political moves and expectations,' he says. Any longer- term return to higher inflation levels and higher interest rates would make gilts once again an unattractive proposition.

As a gilt approaches its redemption date its price moves closer to the par value of pounds 100. Conversely, the longer- dated the stock the more the price varies. As Mr Seager explains, the most volatile are those that are undated, such as War Loan and Consols, and with low coupon value. 'I think that's where we'll see some good gains,' he says.

Mr Loughrey is rather more conservative, suggesting that the most appropriate gilts for many investors may be those with about 10 years to redemption. He adds that this does not mean the stock should be held that long. 'People do buy gilts and sit on them but that is ridiculous,' he says, arguing that a more active investment strategy allows for changes in economic and political circumstances.

Capital gains on gilts are exempt from tax. Interest on gilts purchased through the National Savings stock register is paid gross of income tax, though payments are subject to tax and must be declared to the Inland Revenue.

Investors have to pick up a form from a Post Office to deal by post through the register, generally an easier and cheaper method than going through a broker.

(Photograph and graph omitted)