Top tips for income investing

Investors are pouring more cash into UK equity income funds than at any time in the past five years, with some £220m flowing into this sector in November. Experts say this reflects a change in investor sentiment away from safer havens such as bonds.

Stephen Message, manager of the Old Mutual Equity Income fund, gives Money Matters his five key themes for equity income investing in 2013.

1) Medium-sized companies offer opportunities:

A problem for many investors is that a significant amount of dividends are delivered from a handful of companies, so achieving diversity in income can be a challenge. There are a number of interesting income opportunities in medium-sized businesses, particularly in terms of dividend growth prospects. Examples include packaging business DS Smith, pub group Greene King, broadband provider TalkTalk, specialist lender Provident Financial and asset manager Aberdeen.

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2) Look for companies with excess cash:

Since the financial crisis, companies have typically been paying down debt, to the point where some are considering they have capital that is surplus to requirements and have rewarded shareholders with special dividends. These are one-off payments to shareholders in addition to regular dividends which further enhance investor income. Examples include plumbing merchant Wolseley, cruise line operator Carnival, chemicals company Johnson Matthey, hotels business InterContinental Hotels and speciality insurance group Lancashire. We think this feature will continue to be prominent in the coming year.

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3) Take advantage of rising consumer confidence:

Consumer confidence is beginning to stabilise and investors can take advantage of this. Examples of companies that could benefit include Carnival and US-focused jewellery retailer Signet. We would also not write off the prospects for a number of domestic companies because it is often in tough times that the strong get stronger, while the weaker fail. Well-managed, competitively positioned companies should be able to take market share and we are exploiting this theme through investments in cash-and-carry operator Booker Group, Greene King and budget airline easyJet.

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4) Consider bank shares:

We are not in the camp that considers bank shares are “uninvestable” and have holdings in Lloyds, Standard Chartered and HSBC as we feel that returns on equity can continue to improve in the coming years and there is still considerable investor pessimism towards the sector.

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5) Exercise caution on food retailers:

We are cautious about the outlook for the food retail sector as, despite offering premium dividend yields compared to the market, competition is intensifying after years of rampant space growth. In our view the prospects for dividend growth in this area are fairly muted.