Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Thomas Buckingham, fund manager, JP Morgan UK Higher Income Fund.
We continue to find good equity income opportunities within the UK financials sector. We've been particularly keen on insurance and asset-management companies throughout the year, and despite the strong performance of the sector, we still see attractive, sustainable yields.
We only invest in shares which yield more than the wider UK market, and where we also have strong confidence that the company will be able to pay the expected dividend.
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Examples include fund-management group Aberdeen Asset Management (LSE: ADN), which we have recently bought. It is expected to yield 3.9% in 2014, and the market expects this to grow significantly to more than 4.5% by 2015, and 5.4% in 2016.
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Brewin Dolphin (LSE: BRW) is another asset-management firm which is highly cash-generative, and has relatively low capital requirements, meaning it also has the ability to pay an attractive and growing dividend (the City expects 3.4% in 2014, rising to 5.9% by 2016).
In the insurance sector, Catlin (LSE: CGL) is one name that we are positive on. Like many of its peers, the company has had to focus heavily on cost control and underwriting profitability, in an environment of low bond yields. This has limited the investment returns that it is able to generate.
This focus on writing better-quality business and controlling costs reassures us of Catlin's ability to pay its dividend (the expected yield this year is around 5.3%), which is almost twice covered by earnings.
Outside the UK financial sector, there are a range of opportunities. One example, which doesn't initially look like a high-yielding name (the City expects a 2014 yield of 2.3%), is power-station operator Drax (LSE: DRX).
However, this month the company received confirmation that it will be awarded a subsidy to convert one of its power-generation units to run on environmentally-friendly biomass rather than coal. It is also eligible for subsidies relating to the conversion of two further units, which significantly reduces the risk in Drax's portfolio and improves the likelihood of it ultimately converting all six units.
These subsidies hugely improve the outlook for the company's free-cash-flow generation, and some analysts are now forecasting that the company could return between 50% and 100% of its market cap to shareholders by 2017-2020, without increasing its level of borrowing. This suggests that the dividend could be raised significantly in the medium term, which is why we think it fits the bill for those looking for income.
A final example is accountancy software publisher Sage (LSE: SGE). Once again, we favour its low capital intensity (it doesn't need to invest a huge amount) and high cash-flow generation (it has a lot of money coming in the door).The company makes around 70% of its revenues via existing users, so visibility is very good on both earnings and cash flow generation, through the subscription and service fees users pay.
As a result, Sage has been able to commit to buying back shares as well as paying ordinary and special dividends. This is a great example of a company where it is important to look beyond the ordinary dividend towards other returns.
In 2013, Sage will have returned 2.9% through an ordinary dividend, 4.8% through a special dividend and 6.0% through a share buyback giving a quasi-yield of 13.7%.
