The Investment Association (IA) has paved the way for an overhaul of the UK Equity Income sector by launching a consultation on its disputed yield requirements, Investment Adviser can reveal.
The trade body is to survey asset managers over the next four weeks with a view to introducing a more “transparent” way of monitoring funds’ production of income.
A consultation document, seen by Investment Adviser, has acknowledged the increasing “controversy” over the need for funds to yield 10 per cent more than the FTSE All-Share over a rolling three-year period.
Seventeen funds have been ejected from the sector since 2013 for failing to pass this hurdle, and more recently concerns have grown that the requirement may push managers to buy high-yielding mega-caps whose payouts are at risk.
The consultation has emphasised that existing rules did not intend to “dictate fund strategies”, but maintained UK equity income funds should be held to a measurable target.
Members are presented with three options: no change; replace the 110 per cent hurdle with a requirement to yield more than the All-Share over three years; or scrap yield rules in favour of specific disclosure relating to income generation.
The third option could involve disclosing net yield, income growth, total returns, volatility and a figure showing absolute net income over five years based on £100 invested, according to the document.
It adds: “Transparency could be part of the solution. The presentation of funds’ income delivery is important and improving that could be an option.”
The number of funds falling foul of the three-year rule, introduced in 2010, has led to criticism by managers, commentators and sell-side analysts.
In February, Société Générale quantitative research head Andrew Lapthorne called on the IA to change its rules, suggesting the current system may have led corporates to prioritise payouts at the expense of their other responsibilities.
“Our advice to the IA is this - remove the 110 per cent threshold. Measure instead the ability of a fund manager to deliver an above-average income stream versus that of the market over a full business cycle. You never know, it may encourage chief executives to focus more on their businesses,” Mr Lapthorne said.
Fund firms have also claimed the rule penalises funds whose yield suffers because holdings rise sharply in value, and those who prioritise gradual dividend growth over headline yield.
Selectors reacted positively to the news of the consultation. “It is an issue that needs to be addressed. I would be surprised [if the outcome] was no change,” said Laith Khalaf, senior analyst at Hargreaves Lansdown.
The review raises the prospect of managers returning funds to the sector. Mark Barnett’s Invesco Perpetual Income portfolios and Nick Kirrage and Kevin Murphy’s Schroder Income fund are among the highest-profile products to have been affected.
Schroders’ global income fund was similarly removed from the Global Equity Income sector earlier this year. But the IA consultation said the trade body was not currently proposing to change this sector’s own 110 per cent yield requirement.
