Investors are being urged to look at beleaguered equity-income funds again as the yield on the FTSE 100 index of Britain’s leading companies is close to its highest level since the bear market in 2003.

Equity-income funds, which invest in shares with above-aver-age dividend yields, have had a torrid year because they have tended to invest in bank shares.

However, yields have spiked to such high levels as share prices have fallen that advisers suggest it could be a good time to get back in.

The yield on the FTSE 100, which shows the average dividend as a proportion of the price, spiked above 4% last month – the last time it did so was in March 2003 at the trough of the bear market, according to Fidelity International, the investment manager.

One in four companies in the FTSE 100 are yielding between 4.5% and 10%, it said.

Six of the above companies are banks, and there is concern that financial firms will be forced to cut their dividends to conserve cash.

Last week it was reported that Royal Bank of Scotland is considering a right issues to raise capital, and dividend cuts could be the next step.

It is not just banks feeling the pain. Retailers Kingfisher and Woolworths both announced recently they have been forced to cut their dividends because of the pain on the high street.

However, there are plenty of other shares with high dividends that are well covered. Dividend cover indicates the amount of capital a company has to fund its payout – if a company has cover of two, it could maintain its payout twice over.

For example, the housebuilder Persimmon is paying a 7.4% yield at present, and has cover of 2.69.

Old Mutual, Astra Zeneca, Aviva and Royal & Sun Alliance are all paying more than 5% with dividend cover of more than two.

Even if a company cuts its dividend, this could be a good signal to buy.

Analysis of 100 dividend cuts in the past 15 years by Morgan Stanley, the investment bank, shows the share price outperforms the market by around 14% in the year after the cut.

Analyst Graham Secker said: “The best subsequent performance comes from stocks that yield more than 8% prior to the dividend-cut announcement.

“Stocks that yielded 12% or more ahead of the cut outperformed by 57% over the next year,” Secker said.

“The best subsequent performance comes from stocks that cut their dividend the most. The median stock that cuts its dividend by 90% or more outperforms by 48% over the next two years and with a 73% probability of outperforming.

“So, unlike the average rights issue, the average dividend cut can be generally considered to be a positive influence on share prices in the medium-term.

“However, the best long-term returns in both scenarios come from buying into ‘distressed’ stocks – that is, those that are recapitalising the most.”

We asked analysts for their pick of the safest income shares for hard times – those with a high dividend yield but good cover.

And if you don’t want the risk of individual shares, Mark Dampier of adviser Hargreaves Lansdown suggests Invesco Perpetual Income or Higher Income, both yielding 3.3%, PSigma Income at 4.2%, or Artemis Income which is also paying 4.2%.

ASTRA ZENECA

Drugs stocks have historically been the perfect sector in a down-turn because people still need medicine even if the economy is performing poorly. However, the sector has not conformed to type this year with Astra’s shares off 27% over the past year.

Some analysts think this makes them a buy – especially as they are yielding a healthy 4.5% which is covered more than twice over.

AVIVA

The Norwich Union owner is yielding a tasty 5.1%, which is covered 2.44 times and is rated a strong buy by City analysts.

It has been hit hard by the turmoil in financial stocks, falling 20% over the past 12 months, but experts said it had been unfairly punished.

Graham Spooner of broker The Share Centre said: “Life insurers have a lot of competition in the UK but it has been growing strongly in Asia.”

BP

Shares in the oil giant have fallen 3% over the past year despite the fact that crude is trading at a record above $116. This has pushed the yield up to 4%, which is covered twice over.

Richard Hunter of Hargreaves Lansdown said: “Despite falling profits over both the fourth quarter and the full year, signs of improving prospects for 2008 are tangible.

“Oil production levels have finally begun to improve, cost savings from the group’s recently announced restructuring plan should begin coming through and a marked increase in the dividend helps to provide underlying support to the share price.

“Given a historically high oil price, significant room for operational improvement and strong cash attractions set against an uncertain economic backdrop, market consensus opinion is currently positive in tone.”

NEXT

You would have to be brave to buy a retailer in the current climate, but Next is yielding 4.8% and its dividend is covered more than three times over.

Spooner said: “All retailers have been hit hard, but for brave investors we would be happy to recommend that you hold on to your shares.”

PERSIMMON

The blue-chip housebuilder’s shares have slumped more than 50% to 687.5p over the past year as fears of a house-price crash have grown, pushing the yield to 7.4%.

However, analysts point out that this is covered 2.69 times and the share might even be a buy for contrarian investors.

Spooner said: “We took the contrarian decision to get back into Persimmon two to three months ago. We were too early, but our reasoning still stands.

We think the UK housing bubble will deflate rather than burst and we therefore think there is too much bad news in the share price.”

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