The Investment Management Association’s (IMA) clampdown on the UK Equity Income sector has affected some of the biggest names in the industry. Stricter enforcement of yield targets led to 17 funds joining the newly created UK Equity Income & Growth sector in January. As Fund Strategy reported last week, notable entrants included Neil Woodford’s £7.9 billion Invesco High Income and £5.7 billion Income portfolios.
Tighter monitoring of UK Equity Income fund yields comes in response to longstanding criticism from some groups that the IMA has not been tough enough in applying its sector rules. UK Equity Income requires funds to generate a historic yield of more than 110% of the FTSE All-Share – the index yielded 4.49% in the year ending December 31, 2008, giving a target UK Equity Income yield of 4.94%.
According to Fundfact.com – a website launched by Liontrust, New Star and Newton early last year – Woodford’s funds top the five- and 10-year total return tables, but they also feature in the list of 10 lowest-yielding equity income portfolios. Invesco Income and High Income produced yields of 4.31% and 4.16% respectively in 2008, compared with 10.7% from New Star UK Strategic Income.
As a result of the yield disparities, the IMA created UK Equity Income & Growth on January 1. The new sector is designed to accommodate funds that generate a yield of more than 90% of the FTSE All-Share yield and “produce a combination of both income and growth”. The association expects to review the equity income sectors next January or when “appropriate to market circumstances”.
However, advisers question whether creating a separate sector for lower-yielding equity income funds was worthwhile. In a statement, Hargreaves Lansdown said it sees “little logic behind the IMA’s decision to divide the sector”. First, it says, fund yields compared with the FTSE All-Share are “largely irrelevant” and, second, historic yield fails to take into account dividends that may be paid in the future.
Adviser Fund Index (AFI) panellists also question the benefits of categorising funds on income. “The importance of income versus total return boils down to the needs of individual clients,” says Justine Fearns, the head of research for AWD Chase de Vere. “But we tend to use total return-type products. The changes will not stop people investing in Neil Woodford’s funds – they like what he does. People invest in funds if they like the process and there are consistent total returns.”
Chris Wise, senior investment consultant at Bentley Jennison Financial Management, agrees and says income is largely irrelevant to his selection process. “We make a macro asset allocation call and if we decide to invest 50% in UK equities we ask: ‘who are the best managers?’ We want best-of-breed – it does not matter if the fund is in the UK Equity Income sector or UK All Companies. Alternatively, we employ a multi-manager and they make the call.”
Wise has direct exposure to Invesco Income in the Balanced and Cautious AFI indices and indirectly through Cazenove Multi-Manager Diversity in the Cautious benchmark. According to Cazenove, the firm’s £220m fund of funds had a 4.3% weighting in Invesco Income at the end of January. Both of Woodford’s funds received support from advisers across all three AFI indices in last November’s rebalancing.
For funds remaining in the UK Equity Income sector, hitting yield targets will be no easier in 2009, according to a report from Standard & Poor’s (S&P) last week. With banks no longer paying dividends, some portfolios are even boosting their exposure to bonds to make up the income shortfall. Michael Gifford, the manager of the Old Mutual Equity Income fund, has increased his fixed income weighting to 5%.
S&P data shows that the median UK Equity Income fund fell by 7.5% in the final quarter of 2008, taking its 12-month decline to 28.1% against falls of 29.9% and 31.1% for the FTSE All-Share and the median British growth fund respectively.