Investment Association to overhaul UK equity income sector definition
The Investment Association (IA) has paved the way for an overhaul of the UK equity income fund sector by launching a consultation on its controversial yield requirements.
To qualify for the UK equity income sector under the current rules, a fund has to be invested at least 80% in UK equities and to achieve a yield in excess of 110% of the FTSE All Share index yield at the fund's year end.
However, this means that managers who grow the capital of their fund can be penalised. For example:
- Fund A starts the year at a price of £1 per unit and ends the year at £1.10 per unit, while producing an income of 5p over the year. The historic yield of the fund is therefore calculated as 4.55% (5p/110p).
- Fund B starts the year at a price of £1 per unit and ends the year at £0.90 per unit, producing an income of 5p over the year. The historic yield of the fund is calculated as 5.56% (5p/90p).
While the manager of fund A has done a good job of increasing the fund's capital, and hence its price, this has the effect of lowering the yield. This in turn means the fund is more likely to get kicked out of the sector.
£19 billion of income funds currently sit in the UK all companies sector, having been exiled from the UK equity income sector for not having produced sufficient income under the present rules of the IA.
Now, the IA has put forward three options for redrawing the definition of the sector.
The first option is to maintain the current definition. The second is to lower the bar and simply require funds to produce more income than the FTSE All-Share. The third is to require funds to produce more in-depth income statistics.
Laith Khalaf, senior analyst at Hargreaves Lansdown, comments: "The key to creating a rising dividend stream for investors is building capital, yet managers are being penalised for taking this long-term approach.
"We believe the best solution for the sector is to calculate a fund's yield based on its price at the start of the year, not at the end. That way managers are not hobbling themselves by boosting the fund's capital over the year."
While the consultation is a positive move to tackle the issue, Khalaf believes the proposals reported so far "either don't do enough to ensure investors are getting a premium income, or shove this industry hot potato onto the investor's plate, which simply isn't fair".
"Investors in UK equity income funds just want to know their fund is doing what it says on the tin."
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.