The Investment Association (IA) has announced plans to water down the yield requirement for the UK equity income fund sector.
As things stand today, funds that sit in the IA's UK equity income sector have to achieve a yield in excess of 110% of the FTSE All Share index yield at the fund's year end. Those who fail this hurdle over a three-year rolling period are exiled from the sector.
But from next month the yield requirement will fall to 100% of the FTSE All Share, so in other words funds have to merely match whatever the index is yielding.
A review of the sector's rules was instigated last year, after various funds failed to deliver on the yield front and as a result were kicked out of the sector, including Henderson UK Equity Income & Growth fund, managed by James Henderson, and the Invesco Perpetual High Income and Income funds, managed by Mark Barnett.
Under the new rule the new three-year rolling yield target is set at 100%, but failure to achieve 90% of the FTSE All Share index yield in any one year period will result in a fund being removed from the sector. In addition, member funds must have at least 80 per cent UK equity exposure.
Galina Dimitrova, director of Capital Markets at the IA, says: "The primary purpose of the IA sectors is to serve the needs of consumers and their advisers. Any change to how they are classified must be done in their best interests.
"The decision to lower the yield hurdle has come after comprehensive consumer research and industry consultation. The change is designed to ensure that consumers and advisers have better visibility of the choice of equity income products that exceed their respective market yields."
Historically, funds expelled from the equity income sector have tended to end up in the large and very diverse UK all companies sector where they risk disappearing from income investors' radar.
The change should ensure that more lower-yielding but high-quality funds avoid expulsion and can easily be compared with peers.
This yield requirement is controversial and can punish top-performing funds.
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, meanwhile, 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.
Darius McDermott, managing director of FundCalibre, describes the move to lower the yield requirement as 'sensible'.
He adds: "It means that UK equity funds aiming to produce a yield can be compared fairly and easily, which has to be a good thing. Importantly, it also means fund managers are not being forced to chase a yield, and possibly even deviate from their investment strategy, just to remain in a sector.
"We fully expect the majority of the 20 or so funds removed from the sector in recent years to go back in in the coming months."
This story was originally written for our sister magazine, Money Observer.