Skip to the content

What do you think the Investment Association should do with the UK Equity Income sector?

19 April 2016

The Investment Association is consulting on changing the yield requirement of the IA UK Equity Income sector following a number of high profile exits in recent years.

By Gary Jackson,

Editor, FE Trustnet

How do you solve a problem like the IA UK Equity Income sector? The requirement for its members to generate a yield that’s more than 110 per cent of the FTSE All Share’s is intended to make sure funds are delivering enough income but has led to several controversial ejections.

But the trade body is now launching a consultation on this rule, looking at whether it should amend the requirements to avoid more outcomes like this.

There are three options outlined in the consultation. The first is to change nothing; the second is to essentially lower the bar and say funds only need to yield more than the FTSE All Share to stay in the sector; and the third is for funds to publish more in-depth income statistics (such as absolute net income over five years and income growth) to allow investors to better judge the fund’s performance.

Current rules state that IA UK Equity Income funds have to yield 10 per cent more than the FTSE All Share over rolling three-year periods and they cannot yield less than 90 per cent of the index in any one year. Failure to meet the first requirement has seen several funds moving out of the sector.

One of the highest profile of these was when FE Alpha Manager Mark Barnett's Invesco Perpetual High Income fund – which was run by Neil Woodford for much of its track record – moved into the IA UK All Companies sector in 2014, closely followed by his Invesco Perpetual Income and UK Strategic Income funds.

In total, some £19bn of assets are now in the IA UK All Companies sector that would still be in the IA UK Equity Income sector had they not failed the yield requirement.

For example, Nick Kirrage and Kevin Murphy’s Schroder Income, Henry Dixon's Man GLG UK Income, James Henderson and Laura Foll's Henderson UK Equity Income & Growth and Ian Butler's JPM UK Strategic Equity Income funds are all former IA UK Equity Income portfolios that now reside in the growth sector.

Performance of funds vs sector and index over 5yrs

 

Source: FE Analytics

Today, it also emerged that Carl Stick’s £1.2bn Rathbone Income fund will leave the sector on 1 May after yielding less than 110 per cent of the index over the most recent period. As the graph on the following page shows, the fund has delivered on the actual income paid side of things, paying out more than £3,500 on an investment of £10,000 made 10 years ago.

It has also performed well from a total return point of view. Over 10 years, Rathbone Income has made 72.93 per cent compared with a 65.29 per cent gain made by its average peer and the 60.52 per cent rise in the benchmark.

Stick, who has run the fund since the start of 2000, said: “We have stated repeatedly that a principal aim of the Rathbone Income fund is to provide a real increase in distribution year on year, giving unitholders an ‘annual pay rise’, if you will. We have done this by investing in businesses that are best placed to grow their dividends organically, through internally generated cash flow.”

“Over the years, the yield on the fund has been a function of this process, rather than a specific aim. This has not hindered us from being one of the leading performers in the sector, in terms of dividend growth and total return.”

“We have every intention to be as helpful and constructive as we can in our contributions to the IA’s consultation process. However, we will not change the fund’s process or focus. The Rathbone Income fund is an income fund, irrespective of the sector to which it is assigned. We continue to seek to fulfil all of the income expectations of our investors.”


 

Income earned by Rathbone Income over 10yrs

 

Source: FE Analytics

The example of the Rathbone Income fund highlights the main problem that comes with just using yield to determine membership of the sector: some of the most respected UK equity income funds in the market can fall foul of the 100 per cent yield requirement.

Rathbone Income, for example, is a member of the FE Invest Approved list – which highlights the preferred funds of the FE Research team – and holds five FE Crowns. FE’s analysts like the fund because of Stick’s cautious approach and his dedication to providing a stable and growing income stream.

Laith Khalaf, senior analyst at Hargreaves Lansdown, says his firm views Rathbone Income as “one of the best funds in the sector”.

“The current IA UK Equity Income rules reward failure and punish success,” Khalaf added.

“They lead to the absurd situation where an income manager can get kicked out of the sector because they have done a good job in growing investors’ capital. It’s high time the IA UK Equity Income sector definition was reviewed to stop good funds being expelled from the sector on a technicality.”

The Investment Association’s consultation comes at a time when the UK market has endured a series of dividend cuts from high-profile names and some commentators expect more to be seen in the coming times.

We recently highlighted how difficult it could be for UK equity income funds to meet the sector’s yield requirement while avoiding the riskiest stocks in the market. Many equity income managers rightfully do not want to be pushed into stocks with dividend risk hanging over them just to meet a sector target.

Stick is one of the managers who thinks trying to run a portfolio to a set yield target in the current market environment could not be in the best interests of investors.

“As we are all well aware, the current yield offered by the FTSE All Share is distorted by the dividends paid by a number of mega-caps, yet we understand that many of these pay-outs are precarious. The market is distorted,” he said.

“If we were to use yield as our primary target, we would put both our own growth in distribution under some threat, and we would be taking on far too much risk for our clients.”

Here at FE Trustnet we have long been of the view that yield alone is a poor metric on which to judge the worth of an equity income fund.

As many have pointed out, a fund’s yield can rise because the value of the underlying holdings has fallen rather than the income going up and vice versa; if a high yield is seen as ‘attractive’, it could push investors into a fund with a weaker track record.


 

Indeed, we launched the FE Trustnet income campaign to highlight this issue. We want more fund groups to publish better income information – including but not limited to the amount of actual income paid – to allow their investors a greater understanding of their performance.

We had some initial success in this, with the Troy Trojan Income fund being one highly respected member of the sector to add income history to its factsheet. However, many other groups were reluctant to engage with the campaign and are content to only put yield on their factsheet – even though the problems of relying on this metric are well known.

It’s clear that the IA UK Equity Income sector’s yield requirement has led to some controversial changes to its membership but exactly how it should be amended is far from clear.

Most would agree that the option of doing nothing and leaving the 110 per cent requirement would be an unsatisfactory outcome, given how many high-quality funds have already left the peer group.

The second option of lowering the bar to just yielding more than the FTSE All Share doesn’t really address the problem that looking at yield alone isn’t a good way to analyse an income fund.

And option three of providing a lot more income information seems like it could create somewhat of a free-for-all and leave the investor with a bewildering range of data to examine to if a fund is living up to its promises.

Some have suggested alternative solutions. Hargreaves Lansdown, for example, says that calculating a fund’s yield based on its price at the start of the year, not at the end, creates a more accurate picture of how it has really delivered from an income point of view.

But about you, dear FE Trustnet reader? How do you think the Investment Association should decide on what a ‘real’ UK equity income fund should look like and what information do you need to assess these funds on your own? Post your answers in the comments section and we’ll look to use the best in the coming article.

ALT_TAG

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.