IA suspends yield requirements for equity income fund sectors

Enforcement of the rules in the current climate could result in managers chasing yield.

The Investment Association has suspended the income yield requirements of its equity income sectors for 12 months, due to the recent spate of dividend cuts.

For funds to be included in the UK Equity Income sector, they must provide an income which is more than 100% of the FTSE All Share’s yield at the fund's year-end, on a three-year rolling basis. On an annual basis, the fund must provide an income of more than 90% of the index.

The same rules apply to the Global Equity Income, but using the MSCI World index yield.

Those rules have been temporarily suspended owing to the large number of companies that have had to cut dividend payments due to the coronavirus crisis.

The new guidelines mean that the rule requiring funds to provide an annual income equal to 90% of the benchmark at year-end will be suspended for 12 months for any equity income fund whose financial year ends after February 2020.

For example, a fund with its financial year ending in May 2020 will not face expulsion from the sector for providing one-year income below 90% of the benchmark index’s yield.

The requirement to provide income equivalent to 100% of the index on a three-year basis has also been suspended. The IA says it will review the application of the three-year rolling test as the markets settle and the outlook clears.

The minimum yield rules are designed to ensure that any fund housed in the income sector is indeed producing a reasonable income for investors.

In 2018, Woodford Equity Income was removed from the IA UK Equity Income sector for failing to meet these income requirements.

The IA has taken the decision to suspend the enforcement of these rules as the recent slew of dividend cuts is likely to result in many funds failing the requirements. The resulting expulsions would be an unnecessary disruption to these sectors.

Enforcement of the rules could also result in managers changing their portfolios to meet the requirements – effectively chasing yield – which might not be in the best interest of investors.

Jonathan Lipkin, director of policy, strategy and research at the Investment Association says: “The measures we’ve introduced today will continue to provide savers with transparency on fund performance, while helping prevent short-term disruption to the equity income sectors, which are particularly affected by the economic consequences of Covid-19.”

Colin Morton, manager of the Franklin UK Equity Income fund and Franklin UK Rising Dividends fund, welcomes the move. He says: “Companies are facing truly unprecedented circumstances amid the Covid-19 pandemic, with many businesses being forced to close down as a result of very strict government containment measures around the world. 

“This exogenous crisis is understandably taking a toll on dividend policies, and the IA’s decision to suspend equity income yield requirements for 12 months seems a sensible approach given the current environment.”