THIS must seem a particularly inauspicious time to pump cash into Britain’s beleaguered banks, but that is exactly what I am doing. Royal Bank of Scotland has just reported a first-half loss of £691m – better than feared, but still one of the biggest losses in UK corporate history. It follows Barclays’ announcement of a 33% fall in first-half profits to £2.75 billion the day before, and a poor show from HBOS, owner of Halifax, the previous week.

The best time to invest is often when most people feel gloomy, according to some of the country’s top stockpickers, so I am putting their theory to the test.

The UK has been all but forgotten by private investors in their rush to buy into Bric countries (Brazil, Russia, India and China) and hot commodities, despite a 20% fall in the price of crude oil over the past month to $116.

In Britain, banks have been one of the worst-performing sectors, with a fall of more than 30% over the past 12 months. So that is where my money is headed.

Half of my cash is going into bank bonds rather than shares. I looked at corporate bonds issued by banks in April, and while their yields (income as a proportion of price) at nearly 10% looked too good to miss, the interest-rate prognosis was not in their favour. Jean-Claude Trichet, president of the European Central Bank, warned he would fight inflation at all costs and interest-rate hike expectations soared. When interest rates are expected to go up, bond prices go down as their fixed interest no longer looks so enticing.

That has all changed as the oil price has come off and analysts are increasingly hopeful that inflation will peak at the end of this year or in early 2009. That would give the Bank of England scope to cut rates, with some traders pencilling in 4.5% by the end of next year.

Add to this the fact that bank bonds still look unbelievably cheap. Yields are more than 9%, compared with a more usual level of 6%. Higher yields reflect a higher risk of default, of course, but most people in the business think they have gone too far – at these levels, prices suggest 17% of investment-grade (high quality) bonds will default over the next five years, but the default rate has never been higher than 2.3% since the 1970s. You have to believe in financial Armageddon to think that bank bonds are expensive.

While there is certainly more pain to come, with repossessions and bad debts expected to rise further, the return you get more than compensates for the risk. One of RBS’s bonds redeemed in 2012, for example, is paying you a guaranteed 8.68% a year unless the bank goes bust – and as Northern Rock and Bear Stearns have shown, that is unlikely to happen.

So a £1,000 lump sum is going into the Henderson Strategic Bond fund managed by John Pattullo, which has half its portfolio in investment-grade bank bonds.

Banks look to me like telecoms after the crash of 2000. They had become too optimistic about their growth prospects in the 1990s, borrowed heavily to fund expansion, then fell back to earth as the bubble burst in 2000. BT responded with a rights issue and sold off assets – such as directory business Yell and mobile firm MMO2 – just as the banks are doing now.

And as telecoms firms became essentially utilities so, too, will banks. We all need a current account and a mortgage as much as we need a phone line. Phones are dull but the business throws off lots of cash and that is what investors want.

For the moment it is better to be a bondholder than a shareholder as rights issues have diluted the value of bank equities. But their time will come, too. The dividend yield on UK banks, at more than 9%, is already at its highest since 1973, according to figures from Mike Lenhoff at the broker Brewin Dolphin.

The price/earnings ratio, another measure of value, is at just five times earnings, back where it was in the mid1980s.

That is why I’m looking at an equity income fund with quite a bit in bank shares for my second investment. Top of my list is Standard Life UK High Income. Equity income has been one of the worst-performing sectors, down 15% over the past 12 months, even though it has tended to beat the market in previous downturns.

Tempting as it was to work the contrari-an theme to its logical conclusion and go for one of the worst performers in the sector, which would have taken me to New Star’s Toby Thompson, I decided it would be a step too far, so I am going for Karen Robertson at Standard Life instead. One of the most consistent managers in her field, she should be a good bet when the equity-income sector finally bounces back.

Kathryn Cooper is editor of the Money section

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