It has a strong record of consistent dividend growth as well, returning significantly more in dividends alone than a £10,000 initial investment made 20 years ago.
Mark Barnett’s fund, formerly run by Neil Woodford (pictured), was kicked out of the IMA UK Equity Income sector earlier this year. Why? Because it failed to generate a yield in excess of 110 per cent of the FTSE All Share yield over a three year rolling period, as outlined in the IMA’s sector definition.
The question is: has a technicality that’s led to such a high profile fund being excluded from one of the UK’s bestselling sectors done more harm than good to the industry, and more importantly, the end investor?
I would have to say it has the potential of doing much more harm than good.
Firstly, let’s look at whether the fund deserves to be kicked out of the sector. Many UK Equity Income funds that are struggling to hit the 110 per cent yield target at the moment are doing so because the stocks they are invested in have seen their share prices rally to such an extent.
Income earned from an initial £10,000 investment 20yrs ago
Source: FE Analytics
This has particularly been the case for those with a mid-cap focus, which prompted Fidelity’s Michael Clark to declare that all of those in this bracket will have to leave the sector in the coming months, as it is becoming nigh-on impossible to find high yields in the FTSE 250. This problem directly resulted in James Henderson’s Henderson UK Equity Income & Growth fund leaving the sector in 2013.
While yield is a useful measure when it comes to measuring income, it can be hugely misleading. Just because these funds have seen their yields compress, it doesn’t mean they have slashed their dividend; indeed, in many cases they have raised it.
“We’re at a stage that UK Equity Income funds run the risk of being kicked out of a sector, and they’ve grown their dividend,” said one high-profile fund manager who wished to remain anonymous.
“I think it’s unhealthy. If you chase yield, you run the risk of then sacrificing capital growth.”
“The mistake that is being made here is that the rigid yield targets are not in line with what the underlying investor wants. In many ways, funds are being penalised for investing in stocks whose share prices have risen. Is this right?”
The manager in question adds that the fact Barnett’s Invesco Perpetual Income fund, which has an almost identical portfolio, performance record and yield to High Income, is still in the UK Equity Income sector shows there is something fundamentally wrong with the current system.
After all, the primary objective of IMA sectors is to make it easier for investors to compare like-for-like products. Is it fair, or worse, is it potentially harmful, not to include a fund with the dividend and total return record of Invesco Perpetual High Income in the hunting ground for dividend-focused UK equity vehicles?
“You’ve got a fund that was number-one in the sector over 10 years, and now it’s been removed for not hitting a yield target. There has to be some recognition that capital growth lowers yield,” the manager said.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
Invesco Perpetual and Henderson were both prepared to move their funds into the UK All Companies sector. Both have an excellent reputation and performance record and as a result are unlikely to suffer from a marketing perspective.
However, funds with a lower profile don’t necessarily have this luxury.
“We all know what happens when managers chase yield, and it isn’t usually a good thing,” said Mark Dampier, head of research at Hargreaves Lansdown.
“Look at what happened to Tineke Frikkee [former manager of the Newton Higher Income fund] and Jeremy Lang [former manager of Liontrust Global Income]. There’s a whole host of managers over the past 30 years who have chased yield, and usually it doesn’t end well.” “Not only did you see Newton Higher Income get clobbered from a capital growth perspective, but the fund had to slash its dividend as well.”
Dampier (pictured) says that the majority of investors in equity income funds reinvest their dividends, and for that reason believes it is in their interest that managers prioritise total return.
He says that small dividend cuts are acceptable if they mean that the fund performs better overall, but agrees that cuts of 30 or 40 per cent are not appropriate, given that some investors do rely on an equity income funds for dividends.
Dampier points out that a UK Equity Income & Growth sector was launched in late 2008 to cater for funds that struggled to hit the yield target, but says it would be disastrous if this happened again, given that so few fund groups showed interest in it first time around.
From the point of view of savvy investors, he says he sees no problem with funds moving into IMA UK All Companies, but acknowledges that beginners may overlook certain vehicles that aren’t included in the IMA UK Equity Income sector.
Dampier and the unnamed manager both argue that a less rigid UK Equity Income sector definition is in the interest of fund groups and investors.
“Yield isn’t what’s important – it’s the total return and the income record that is important,” said Dampier.
“I think we need to go back to the old days when capital and income were both outlined so that the investor can see exactly what they’re getting. A percentage doesn’t work.”
“I think that funds in the IMA UK Equity Income sector should have an income objective and then be judged on how good they are at delivering it.”
It’s interesting to note that the IMA Targeted Absolute Return sector has a similarly vague definition. While funds in the sector must attempt to achieve an absolute return in all market conditions, they are not forcibly removed if they don’t achieve the feat.
UK All Companies funds aren’t booted out of their sector for not delivering decent capital growth; should it be any different for income funds?
If a UK Equity Income fund isn’t producing an income, investors won’t buy it – pure and simple.
I agree with these experts – the definition at the moment is too strict and could see funds sacrifice performance in order to meet an arbitrary yield target. A more flexible sector definition would prevent this conversation being had every time the market rallies and yields get harder to find.
We’d be very interested to hear what you think – leave a comment below or email us at editorial@financialexpress.net
