The HD5850 1GB when at the same clockspeeds as the HD5870 1GB is very similar in performance. AFAIK, both the HD5850 1GB and HD5870 1GB can be overclocked a similar amount. The HD5870 1GB does consume more power than an HD5850 1GB with the same die area so it will need better cooling during overclocking than an HD5850 1GB. Even if you got an HD5850 1GB for £250 and an HD5870 for £300 at the same clockspeeds the HD5870 1GB would not be 20% faster from what I have read.
However, I have seen the HD5870 1GB sometimes below £300 so it might be worth looking around for cheaper one unless of course you want a version which has fancy cooling.
With regards to water cooling the GPU I cannot say whether it would be worth the effort TBH.
Have you considered a water cooling system such as the Corsair H50 or something similar?? For the sort of smaller overclocks you are thinking about such a system would do the trick IMHO.