Assessing the income generated by mutual funds has always been a tricky task for advisers. Managers often use different methodologies for calculating the yields of their underlying portfolios, making accurate comparisons almost impossible. The issue has become more important over the past few years, with the growth of the Investment Management Association’s (IMA) UK Equity Income sector.
Investors were attracted to the sector by star names, as well as strong performance. According to Morningstar, the average UK Equity Income portfolio generated a return of 20.6% and 18.26%, in 2005 and 2006 respectively. Figures from the IMA show that net retail sales of UK Equity Income funds rose from £400m in 2001 to £2.3 billion in 2006. The sector now accounts for about £54 billion in assets under management, second only in size to UK All Companies.
As a result, firms are keen to have a UK Equity Income presence, with the added benefit that a relatively small pool of funds – compared with UK All Companies – offers a greater chance to shine. But the sector’s reputation was hit by poor returns last year, as many funds were hurt by their exposure to financials. While the FTSE All-Share index and the UK All Companies sector posted low but positive returns in 2007, the average UK Equity Income fund fell by almost 2%.
This underperformance has intensified the focus on which funds are meeting the sector requirements. IMA rules state that funds should generate an income in excess of 110% of the yield of the FTSE All-Share. But investors have become concerned that many managers have been ignoring this stipulation, instead choosing to follow growth strategies. This is backed up by data from Financial Express, which shows that just nine funds in the sector hit their yield target over the past three years.
As reported in last week’s Fund Strategy, the IMA has tightened its monitoring of the sector. To simplify the process, the association has also introduced a standardised 12-month historic yield calculation that all managers will have to adopt before the start of 2009. If they fail to do so, funds run the risk of being moved to an alternative sector. Jane Lowe, the IMA’s director of markets, says this stricter approach was necessary to maintain the integrity of UK Equity Income.
“The criticism has been that the sector was not as well monitored as it might be,” says Lowe. “Also, because funds have not been using the same basis for calculating yields, investors have not been able to compare like with like. The new basis will show who is not doing what they should be doing.” Compliance with the rules will be monitored by the IMA’s performance category review committee, which consists of a panel of representatives from member firms.
Ben Yearsley, senior investment manager at Hargreaves Lansdown, supports the tougher stance but says total return is the most important measure. “If a fund is in a sector it should abide by the rules,” says Yearsley. “I have sympathy for managers who have been sticking to the rules, but it is no excuse for poor performance. I would not want to sacrifice capital for yield.” Yearsley adds that the IMA may need to consider the re-introduction of an income and growth sector to accommodate funds not hitting their yield target.
Comparing the new income data will also become easier with the arrival of a free-to-use website. Fundfact.com will be launched shortly and has been developed by Liontrust, New Star and Newton, in conjunction with Asset Risk Consultants. Visitors to the site can assess funds using a range of measures, including manager tenure, three-year performance, years of dividend growth and prospective yield. Jonathan Harbottle, marketing director at Liontrust, says the site will use data calculated under the new IMA method, as it becomes available.
Harbottle expects other fund firms will be keen to contribute towards the “small” maintenance charge of running the site after launch. “This website is about as good as it gets for investors at the moment,” he adds. A development meeting last week sought IFA input from both Mark Dampier, head of research at Hargreaves Lansdown, and Brian Dennehy, managing director at Dennehy Weller. Dampier says the site will allow a clearer debate on the future of UK Equity Income.
He points to criticism of the level of income generated by Invesco Perpetual’s Neil Woodford. “A lot of rubbish has been talked about yields,” says Dampier. “This website will allow investors to rank managers on who is growing their income most and who is growing their capital.”