Last week Invesco Perpetual announced that FE Alpha Manager Mark Barnett’s £13.5bn fund is moving sector as it is unwilling to meet the yield requirement of 110 per cent of the FTSE All Share’s yield over three years. Barnett’s income fund joins that of FE Alpha Manager James Henderson in the IMA UK All Companies sector.
Dampier (pictured), says that the sector rules are effectively penalising funds for focusing on total returns rather than simply on yield, and the latter approach will harm investors in the long run. “It’s a situation that penalises a fund for strong capital growth,” he said. “That’s nuts. And it is likely that in a year or two the fund will be back in the sector.”
“It’s always been true that groups like Invesco Perpetual in particular run their funds with a total return approach, which is the correct one. Those that run it for dividends only are the ones that blow up.”
IMA sector rules require a fund to achieve a yield in excess of 110 per cent of the FTSE All Share at the year end. The IMA averages the yield over a three year rolling period using those year-end figures and funds which don’t beat the 110 per cent figure are ejected.
Dampier says that averaging year-end figures is a mistake, and the industry body should look at a fund’s yield over the whole period.
However, the main issue, he explains, is that the IMA seem to be repeating the mistakes of the past and could be pressuring funds into taking undue risks.
Dampier notes that the equity income sector was split into two a few years ago to divide higher from lower yielding portfolios.
The Invesco funds, run then by FE Alpha Manager Neil Woodford as they were until earlier this month, were at the centre of the storm at the time, with some criticizing them for delivering an insufficient yield.
Dampier says that the decision to split the sectors was really an “anti-Woodford” move, with the manager’s critics describing it as a “stealth growth fund”.
Fund groups such as Newton and Liontrust were in favour of the move, he explains, which backfired when they were forced to cut their yield.
“There was a deep irony in that two of the fund groups that went on about it were two that cut their dividends,” he said.
With equity markets having risen sharply over five years managers are finding it harder to find yielding stocks that fit their quality criteria.
Performance of indices over 5yrs
Source: FE Analytics
James Henderson is one to have warned that many of the high-yielding stocks on the market are “value traps” and managers are better off looking at more cyclical parts of the industry with lower yields and greater dividend growth.
Dampier says that by encouraging funds to focus on yield rather than total return the IMA is pushing them down a risky route which makes sense from a marketing perspective but not from the perspective of the owner of a fund.
“We took Newton Higher Income off the Wealth 150 list because we said its yield was unsustainable and were criticised for it and a few months later the dividend was cut,” he added. “Liontrust under Jeremy Laing did the same thing.”
“Marketing departments like a straight line of dividend increases, but that can be unsustainable, so that’s a crazy situation.”
“I have always said to equity income managers don’t worry about income but protect capital and you will get higher income in years to come. It’s nice to have rising dividend yield. I don’t think it matters if you protect capital.”
“Fund managers have to stand up to marketing departments,” he added.
FE Alpha Manager Guy Bowles, who has a 7.6 per cent weighting to Invesco Perpetual High Income in his Ingenious Global Growth portfolio, says the fund’s sector move is of little importance to him.
“From an investment point of view I don’t particularly care – the fund will be run in exactly the same way,” he said. “Its investment process will be exactly the same, and if anything the sector change reflects more accurately what this fund is.”
“I would question how many people hold this fund purely for the yield target anyway. The possible concern would be outflows as a result of the move, but I would be shocked if 99 per cent of the investors who hold it don’t understand that this is a growth and income fund.”
Performance of fund vs sector over 3yrs
Source: FE Analytics
Dampier adds that the IMA UK All Companies sector will become even more of a mess following the entrance of equity income portfolios.
It currently holds index trackers, small and mid cap funds, and ethical funds as well as blue-chip large cap portfolios. Fidelity Special Situations, one of the best-known and most successful funds in the sector was really a small and mid cap fund, he notes.
“There are 2000 funds in the UK All Companies sector and you could subdivide them into six divisions,” Dampier said.
However, he says that the IMA have an impossible job in subdividing these portfolios rationally. Investors should ignore the classifications and focus on strategy and how well a fund hits its own benchmarks, he says.
“The truth of the matter is I don’t care about sectors really,” he said. “On the whole they are only there because the groups want to show themselves to be the best: it’s all about marketing.”
“You have to look under the bonnet of the funds all the time and see does that fund suit you. I want funds run in the best way for clients not for the sectors.”
