Stapley, manager of the £305m JPM UK Higher Income fund, targets companies with a high and sustainable yield, which has become very challenging in recent months as strong share price performance has pushed both valuations and dividends to extreme levels. This view was recently expressed by FE Alpha Manager Neil Woodford, who warned that equity income investors should not expect to do as well in the next three years as in the last.
Popular sectors such as consumer goods and tobacco have seen their yields come in significantly, but Stapley says it is still possible to find good entry points for anyone who is willing to look further afield – even at companies that are not yet paying a dividend.
"It’s important to make sure you aren’t paying too much for UK equity income, with valuations of some stocks looking increasingly stretched," he explained.
"We have recently added exposure to BHP and Rio Tinto, each of which is yielding about 4 per cent. They are reducing capital expenditure and focusing on high-margin volume growth, creating better dividend cover from cash-flows."
Stapley has bought these stocks not only for his UK Higher Income portfolio, but also the JPM UK Strategic Equity Income and JPM UK Strategic Growth funds, which although they sit in the UK All Companies sector, still target a competitive yield.
He is not the only UK Equity Income manager with a significant exposure to Rio at the moment: FE data shows that 23 funds in the sector hold the FTSE 100 company in their top-10, including Adrian Frost’s £6.3bn Artemis Income portfolio.
Cazenove UK Equity Income, Rathbone Income and Aviva Inv UK Equity Income also have a big stake in the business.
BHP Billiton is slightly less popular, appearing in the top-10 holdings of 17 UK Equity Income funds overall.
"We have also moved to overweight diversified financials, preferring insurance companies and asset managers, but I’ve also added to my position in Lloyds," continued Stapley.
The manager says he likes banks because of their exposure to the recovering UK economy, as well as their improving capital position and slowing loan losses.
Their potential for capital growth is the main draw at the moment, given that the likes of Lloyds and Barclays are not yet paying a dividend; however, he says this will change in the future.
"They have sufficient capital to resume dividends in the first quarter of 2014, pending Government approval," he explained. "The market is expecting a 5 per cent dividend yield by 2015."
He is also buying insurance companies, including Legal & General, which is yielding a little over 4 per cent, and Amlin and Beazley, which are yielding closer to 5.5 per cent.
"They have had to focus on improving profitability in the low interest rate environment and are paying dividends well in excess of the market average," he added.
The third standout sector for value is UK retailers. While there has been improving sentiment in the high street in the last 12 months or so, the manager says valuations remain cheap, pointing out that some companies also offer an attractive source of income.
"I’m adding to Halfords as a turnaround story," he said. "They have just significantly beaten analyst expectations with high organic growth, helped by the success of their cycling business."
Stapley also likes Next: "The retailer has been the poster child of share buybacks, using them as a powerful tool. They’ve retired over 40 per cent of share capital in the last five years as part of a massive de-equitisation and delivered over 500 per cent total return in that time period."
Performance of stock and index over 5yrs
Source: FE Analytics
The JPM UK Higher Income fund is currently yielding 3.62 per cent, which is just above average for the sector.
On a total return basis, it has performed in line with its FTSE All Share benchmark since Stapley started running it in July last year, but has fallen short of its IMA UK Equity Income sector average.
The manager’s JPM UK Strategic Growth and UK Strategic Equity Income funds have been more successful, however.
Our data shows that both have beaten their FTSE All Share benchmark and UK All Companies sector average over one and three years.
Performance of funds, sector and index over 3yrs
Source: FE Analytics
Aside from targeting undervalued sectors, another way Stapley says he is propping up his income is by scoping out companies that actively manage their dividend strategy.
"Another strategy for hunting equity income is to look for companies doing buybacks and paying special dividends," he explained.
"easyJet would be a recent example of a major special dividend payout. They have a well-capitalised business, are growing their top-line and increasing margins."
"Other examples include ITV, which recently did a special dividend to give back cash-flow to shareholders."
"BP in the energy space is another example. Its liabilities are fading and the third quarter dividend was 6 per cent, ahead of market expectations and the $10bn that it pledged to give back to shareholders."
Stapley is generally optimistic about the future of the UK corporate sector, even though valuations are stretched in certain areas.
He says the volume of IPOs this year is a good barometer of the overall market health and level of investor risk appetite.
"In 2013, we’ve seen 30 companies raising more than £5.3bn. A specific example I have bought is Foxtons, which has an expected dividend yield of 6.5 per cent."