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Yield marshal

The formidable equity income sector is soon to shrink as the IMA looks to tackle funds not conforming to its yield requirements – a measurement that has been difficult to do in the current climate. In recent weeks, the IMA has sent questionnaires to groups asking about the yield on their income funds and whether or not they believe them to be sustainable.

On December 31, equity income funds calculate their yield based on distributions declared over the previous 12 months as a percentage of mid-market unit price at any given date. At that time, it will be clear which funds are in compliance with the 110 per cent of the FTSE All-Share yield target and which would be consideration for removal from the equity income classification.

According to the IMA’s calculations, almost half of the funds in the 95-strong sector failed this measurement as of June. But that was before the difficult third and fourth quarters so the question will be how many will fail it when looking back over the entire past year? Will any pass such a test?

Suggested solutions to the debate around this sector have been that the IMA will either create a new sector, growth & income, it will hold off doing anything for now or it will put those funds not meeting the required yield target into the broader UK all companies sector. It is expected that a decision on which direction the IMA will take will likely be settled before the end of the year. The IMA had no comment.

Details of the suggested growth & income sector show it would have a lower yield requirement than the current 110 per cent of the FTSE All-Share yield used by managers in the equity income sector. If funds were to be moved into another sector for failing to meet yield targets, it is understood that their track records would remain intact.

Among the names expected to populate any such new sector or at the very least be among those kicked out of equity income for failing yield requirements would be Invesco Perpetual’s Neil Woodford, with both his giant billion-pound portfolios, Jupiter’s Tony Nutt, Bill Mott’s Psigma income and Standard Life Investment’s higher-income fund managed by Karen Robertson. The combination of just these five funds would amount to some £16bn in assets. Left behind would still be popular managers such as Adrian Frost on the £2.2bn Artemis income and Jeremy Lang of the £683m Liontrust first income.

The controversy has been running for several years as many complain that funds in the sector are not achieving the yield required by the sector’s definition. Instead, some argued that funds were getting returns from capital which, combined with their income streams, gave them a performance advantage over those funds investing solely for income. There are funds that achieve year in and year out rises in income such as Liontrust but on a total return basis, may fall further down the rankings compared with managers that seek out capital as well as income.

The suggested growth & income sector differs in that it would require funds to achieve a yield on the distributable income between 80 per cent and 110 per cent of the FTSE All-Share yield. This would enable funds to use a combination of growth and income to achieve its distribution.

The pros and cons of a new sector aside, the timing of any such introduction or the splitting of the popular equity income sector in any other way based on yield alone is considered foolhardy.

The FTSE All-Share currently has a yield just in excess of 5 per cent, meaning income funds would have to invest in companies with yields higher than this in order to achieve the goal of 110 per cent of All-Share. This at a time when the traditional providers of dividends – banks – have suspended payments and when corporate earnings and dividends are under pressure in almost every area of the market. Yes, there are sure to be firms that survive this environment and fund managers are seeking out those firms able to continue to reward shareholders but will it be enough to give a fund a yield surpassing 5 per cent? And if it did, would these be reliable companies? Stocks with the highest yields are often those that represent the greatest risk.

Equity income fund managers are by and large bullish on their market at the moment but they are selectively so. They says that opportunities exist for income but not across the board and quality of companies is vital.

Considering the December 31 deadline, activity over the past year is what will go into determining those deemed “income” funds by the IMA’s definition. Yet this past year has been anything but normal for any fund manager.

The average equity income fund, on a total return basis, is down by 35 per cent on a bid to bid basis over the 12 months to November 3, according to Morningstar data. Woodford’s high income fund, which is among those often accused of not seeking the 110 per cent goal, has dropped by 25.2 per cent over the same timeframe while Jupiter’s Tony Nutt has fallen by some 33 per cent. On the other hand, Liontrust First Income has fallen 40.7 per cent and New Star’s Toby Thompson has seen his New Star high income fund fall by 46.6 per cent.

The other concern that splitting of the equity income sector poses is, which part do groups want to fall into? Such as has been the popularity of Woodford’s funds that many could see advantages in being in a separate sector that includes him, preferring to be top quartile with such a strong competitor. Others say the clarity of which type of manager and income fund being sought by investors would be advantaged by such a divide, making it easier for investors to understand what they are buying.

However, considering the mish mash of funds in other sectors, especially the mammoth UK all companies, there is a question as to whether or not separating funds to allow for greater like-for-like comparisons should even be on the table at this time.

Rob Page, marketing director at Liontrust, says: “We are aware that the IMA is reviewing the equity income sector but we have not heard the final outcome. The IMA should be applauded for taking the lead here but any solution needs to ensure that it does not just move the problem to another sector. We fully endorse the principle of enforcing the qualification rule and removing funds if necessary, enabling investors to compare funds on a like-for-like basis.”


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