What should reform of the IA UK Equity Income sector (if any) look like?
Lee Robertson, Investment Quorum, Chris Gilchrist, Fiveways Financial Planning, John Monaghan, Square Mile Investment Consulting and Research and Dennis Hall, Yellowtail Financial Planning discuss the reform of the IA UK Equity Income sector
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Lee Robertson, chief executive, Investment Quorum
The Investment Association has launched discussions about how best to monitor income levels from funds listed in the UK Equity Income sector. The current requirements are to invest at least 80 per cent into UK equities and achieve a yield in excess of 110 per cent of the FTSE All-Share index yield at the fund’s year-end. Clearly, the latter rule has become difficult in recent times, given the number of UK companies that have slashed their dividends, with further cuts likely.
The consultation proposes three options. Firstly, lower the bar so funds only have to perform better than the index; secondly, have asset managers produce more statistics about their funds’ performances; or thirdly, make no changes to the rules for inclusion into the sector.
Regrettably, all three seem floored. We live in a low-inflation, low-interest rate and low-GDP world, which means a fund manager’s top priority must be to protect the unit holder’s investment by growing the capital and income wisely. They should not be restricted by any rule that might jeopardise this.
Chris Gilchrist, director, Fiveways Financial Planning
The IA’s decision to amalgamate the UK Income & Growth and UK Equity Income sectors in 2010 was a mistake. The “lower for longer” effects of quantitative easing include yield compression, which now distorts comparisons. As part of a sector reconstruction, the IA needs to insist all funds make comparable income data available.
For most of my working life, groups have been able to launch UK equity income funds at significant premiums to the yield on the All-Share index. But that is no longer possible. In those days, a 6 per cent yield told investors they were getting a high income at the expense of potential capital growth. Lower-yielding funds typically generated better total returns. Today, those signals do not work. At the same time, income growth has become more divergent and important, in part because of increasing longevity.
The UK Equity Income sector should be abolished. In its place we should have UK Equity High Income, with a yield target at least 10 per cent above that of the All-Share, and UK Income and Growth, with a starting yield up to 30 per cent below that of the All-Share. Instead of UK All Companies we should have UK Growth for all other UK equity funds.
The IA should require all equity funds with an income objective to provide comparable data. Funds should publish the growth rates of income per unit over three, five and 10 years on a calendar year basis, so investors can easily compare funds. This is more important than sector categorisation.
John Monaghan, senior investment research analyst, Square Mile Investment Consulting and Research
We think it is more important to assess funds against their stated objectives rather than against the sector. The challenge of defining the UK Equity Income sector satisfactorily has been a perennial one. There have been several instances over the years of funds being ejected from it: for example, Invesco Perpetual, Schroders and Henderson, and, most recently Rathbones, Montanaro and Evenlode. None of these was in response to a change in the investment strategy.
We would contend that, if investors are aware of the fund’s actual objectives and these are suitable, then the sector in which the fund resides and where it ranks is not that relevant. Surely the most pertinent question should be: has the objective been met?
A number of funds with the equity income label are managed on a total return basis, with the belief dividend reinvestment is a very important driver of long-term returns, with a small number committed to generating a steady or growing level of income. Herein lies the predicament: should greater emphasis be placed on what investors need in the future or what has happened in the past?
Dennis Hall, managing director, Yellowtail Financial Planning
The UK Equity Income sector is ripe for reform. Institutional trading desks process gazillions of bytes of information in nanoseconds, whereas the calculation for this sector takes information that could be a year old, using what comes across as an old 386 processor running Windows 95 to crunch the data. Surely they can do better than that?
Suggestions to retain a single annual valuation point but then calculate forward rather than back are also wide of the mark. While I would not want or need a daily calculation, it should not be too hard to take a monthly price feed and calculate the yield based on the previous 12 months’ income into the fund. Any short-term spike in capital values that would otherwise prevent a fund from meeting the yield criteria should be monitored over the following 12 months to allow any anticipated income increase to flow through.
While it is important not to penalise managers for generating capital growth, investors that want a growth fund can already select from a sector that ranks like with like.