Despite the lowering of yield requirements last year, the IA UK Equity Income sector is continuing to see high profile members leave, with several large income-focused funds now sitting alongside more generalist UK equity funds in the IA UK All Companies sector.
Last year, the Investment Association (IA) announced that the IA UK Equity Income sector’s yield hurdle would be lowered from 110 per cent of the FTSE All Share index over a rolling three-year period to 100 per cent.
However, the new yield target has remained difficult for some managers to attain with HC Charteris Premium Income fund moving from the sector in January.
The latest fund to be caught out by the yield requirement is FE Alpha Manager Neil Woodford’s flagship £6.6bn LF Woodford Equity Income fund, which is to join the larger IA UK All Companies sector, home to several other peers.
As LF Woodford Equity Income falls out of the sector to sit alongside several of the industry’s largest equity income funds, some questions have to be asked whether the peer group is appropriate for investors.
The IA UK Equity Income is still home to 87 funds with £62.5bn under management and is the fifth biggest sector after UK All Companies, Global, Targeted Absolute Return and Sterling Corporate Bond.
However, Woodford’s flagship offering joins his two previous funds – the £4.5bn Invesco Perpetual Income and £9.2bn Invesco Perpetual High Income funds, now managed by Mark Barnett - in the IA UK All Companies sector.
Other high-profile funds in this sector include the five FE Crown-rated £2bn Evenlode Income fund managed by FE Alpha Manager Hugh Yarrow and Ben Peters, Richard Colwell’s Threadneedle UK Growth & Income fund, and the £899.1m HSBC UK Growth & Income fund.
IA UK Equity Income sector weightings
Source: FE Analytics
The yield requirements have raised questions over whether managers should stick by their investment processes or chase yield in order to remain in the sector.
Indeed, concentration risk has become a greater concern to investors as managers seek out the best income stocks in a narrow field.
Patrick Connolly, head of communications at Chase de Vere, said the removal of the Woodford fund raises important issues that need answering over whether income managers should be allowed to invest as they see fit.
“What you'll find is some perfectly good-quality equity income funds kicked out of the sector and you need to go looking elsewhere to try to find them,” he explained. “It is an issue and I think that more consensus is needed in terms deciding what sectors funds should stay in.”
Connolly said is sensible that there are some criteria for inclusion in the IA UK Equity Income sector, because otherwise it could become home to funds that return very little in the way of income. However, he added that some consideration needs to be taken of longer-term record and the aims and objectives of individual funds.
He added: “The alternative is whether we want fund managers investing in stocks they don't like simply to boost their yield: that's the trade-off for managers.
“Really the best solution is to have some discretion and some leeway in terms of funds in the sector and not kick them out if they're not hitting a certain number by a certain time.”
Yield figures for the UK Equity Income sector
Source: IA
Currently several funds have been flagged by the IA for failing to meet the sector’s three-year yield criteria, as shown above. Only one, Old Mutual Woodford Equity Income – a separate mandate run by Woodford for Old Mutual Global Investors – has been struck out for failing to meet the more stringent 90 per cent target over one year.
The £2.4bn four FE Crown-rated Jupiter Income Trust, managed by Ben Whitmore, is one such fund as it has failed to meet yield requirements for two successive years.
Other funds failing to meet the three-year target include Investec UK Equity Income, TB Guinness UK Equity Income, UBS UK Equity Income and VT Odd Real Income.
However, income funds in the IA UK All Companies sector also face significant competition from new-found peers.
Indeed, the fund with the highest historic yield in the IA UK All Companies sector is the VT Munro Smart-Beta UK fund at 4.19 per cent, according to data from FE Analytics.
The smart beta strategy is overseen by Rob Davies and aims to replicate the performance of the Freedom Smart-Beta UK Dividend index, a market capitalisation-based index comprising 300 of the largest dividend-paying stocks and reweighted based on expected payouts.
Annual distribution of fund over 5yrs
Source: FE Analytics
Conversely, the fund with the lowest yield in the sector, according to FE Analytics, is the Investec UK Equity Income fund, managed by Blake Hutchins, with a yield of just 2.72 per cent.
So far the fund has been flagged by the IA for not meeting yield requirements in one year (2016) since joining the sector in 2015.
Despite the removal of several high-profile funds from the sector there have also been a number of readmissions. Last year Henderson UK Equity Income & Growth, Invesco Perpetual Income & Growth, Rathbone Income and Schroder income all rejoined the IA UK Equity Income sector.
One other notable readmission to the sector was the £407.2m five FE Crown-rated Man GLG UK Income fund, overseen by FE Alpha Manager Henry Dixon, which moved back to the sector after leaving in 2014 having failed the stricter 110 per cent yield requirement.
Ultimately, investors should not pay too much attention to which sector a fund is located, however. As noted above, strong income payers and good income managers can be found in the UK All Companies sector.
“Fund sectors should only be seen as a rough guide to what a fund does and are no shortcut for looking under the bonnet to get an idea of how the manager goes about his business,” said Hargreaves Lansdown senior analyst Laith Khalaf.
Chase de Vere’s Connolly said while the IA UK Equity Income sector “is very much relevant” to investors seeking an UK income strategy for their portfolio, it would not recommend selling out of a fund just because it had fallen out of the sector.
He added: “The funds we hold we know why we're holding them if they’re not meeting yield criteria we know why that's happened. From our perspective we would still use funds for income even if they're not in the equity income sector.”