Index-linked gilts were the success-story of 2011 as inflation rose to a level almost unimaginable four years ago. Back then, in early 2008, Bank of England (BoE) still had a leveller in the interest rate. And only the sad Cassandras of the world — along with regulatory-wise obliged pensions funds — would be holding something as boring as gilts. Be they index-linked or not.

How things have changed.

Some time during the sun-deprived summer of 2011, the true seriousness of the eurozone crisis became clear and those not yet in gilts made sure that the BoE had buyers for every last issue it could print.

Come September, the consumer prices index (CPI) peaked at 5.2% and as the inflation was unmatched by increases in wages, index-linking seemed to be the only way to safeguard savings and invested income. Accordingly, index-linked bonds took off and yields plummeted. Spectacularly.

In fact, the demand for index-linked gilts is such that the real yield of the new £700m issue of 2047 index-linked gilts is negative. -0.116% to be exact.

We have a situation where investors are paying for the privilege of lending to the British government.

In this topsy-turvey financial climate, what should be the cautious adviser’s advice?

While index-linked gilts were clearly a brilliant hedge against inflation in 2011, not to mention a great investment, this all hinged on the fear of continued inflation.

However, inflation is falling rather quickly at the moment, as predicted by the BoE. Already down to 4.2% in December, the CPI is predicted to drop to 2% by the end of 2012.

If this is a lasting trend, and inflation does indeed keep falling, there is little incentive to hold large amounts of index-linked gilts in a portfolio for the long term. This is especially if wages begin to catch up with the new and lower inflation.

Eventually, the price of anything index-linked will almost certainly begin to fall.

A double whammy that will be for the faithful index-linked investor is that, with a lower coupon comes a lower price. Real yields may go up, but this means nothing to an investor who bought within the last six months and who is bound to see the value of the investment fall.

Even if the price of index-linked gilts stays put, the meagre coupon is no match for the opportunity cost of not investing the money somewhere with at little more risk and potential reward.

That is, of course, if inflation does fall. And, of course, the BoE may be wrong.

So the question for each adviser is how much the clients are willing to pay to hedge against inflation. The answer might just be somewhat less than three months ago.