As yield becomes harder to find in the overfished traditional dividend-paying sectors, investors are increasingly turning to the unloved areas of the market that look ripe for a dividend increase.
Economic headwinds such as the regulatory pressures on the tobacco and banking sectors, along with weakness in demand for commodities and retailers have revealed opportunities for bold investors.
‘Complacent UK equity income investors could find themselves missing diverse income opportunities in non-traditional sectors,’ said Citywire AA-rated JPM UK Higher Income fund manager Thomas Buckingham.
His £313.2 million fund is yielding 3.6% and its biggest play is an 8.8% overweight to financials. Within that sector, Buckingham is excited about UK banks.
‘From an income investor’s perspective, UK domestic banks can once again be seen flashing on the radar screen,’ he said.
While the banking sector has taken a sustained break from dividend payments, the manager argued that ‘this picture is changing,’ as some take positive steps toward improving their balance sheets.
In particular, Buckingham is positive on Barclays and Lloyds because they have made good progress in their asset reduction programmes, with the former disposing of its stake in BlackRock and the latter selling Scottish Widows Investment Partnership.
‘With vast improvements in capital positioning and balance sheet strength, both companies seem destined to improve their dividend paying attractions in the short to medium term,’ he said.
Barclays, in particular looks set to ramp up its pay outs soon, with the market expecting a yield of close to 4% this year, rising to 5.5% in 2015, Buckingham added.
‘It has become more difficult to find that many good-quality companies with a good yield,’ he said, adding that the fund is ‘looking for situations where value, growth or cashflow is mispriced’.
‘HSBC is trading on a cheaper valuation than Lloyds and with better structural growth,’ he said. Gergel is reassured by the fact that the company has a history of conservative management.
Unlike Buckingham, he is not tempted by other banks because of governmental pressure to meet capital requirements.
Like Buckingham, Gergel is also adding stocks from the troubled commodity sector, but within that he favours oil companies over miners, as he believes the mining companies are subject to too much uncertainty.
‘The oil majors BP and Shell look very solid to us as cashflows are improving and they are not spending so much money without getting a decent return,’ he said.
But Gergel is mindful that China’s shift away from infrastructure towards a consumption-led economy is not going away.
‘Mining is a bit harder to be confident on because you are more dependent on iron ore and copper, and it is much more dependent on China,’ he said.
‘We are nervous about where the iron ore price might settle in the long run, whereas oil is growing steadily in the Middle East and emerging markets. We are more relaxed about the outlook for these companies.’
Elsewhere, managers are returning to the tobacco sector.
Richard Colwell, the Citywire AAA-rated co-manager of the £2.7 billion Threadneedle UK Equity Income fund, has been buying Imperial Tobacco over the past six months on the back of what he deems its attractive valuation.
‘It had been weak because operationally it has been struggling because a third of its market is now illicit trade, so volumes have been declining quite strongly. Nevertheless, cashflows have been good and supportive of dividends,’ he explained.