Producing a total return of 20% (in GBP) and a 3.7% realised yield in 2015 was not enough to save Montanaro’s UK Income Fund from facing ejection from the IA UK Equity Income sector.
This is because the IA calculates yield based on the year-end NAV of a fund, which as Montanaro points out, ironically “penalises successful funds.”
“Bizarrely, had we produced lower returns for our clients - or even lost them money - we would have been rewarded by keeping our place in the sector. This makes little sense to us and is clearly not in the best interest of clients,” the asset manager stated.
Montanaro maintained that if IA had used the starting NAV of its UK Income Fund, the fund would have matched the 3.7% FTSE-All Share yield requirement.
Montanaro also added that the IA’s current yield target forces UK Equity income managers to take a real gamble by purchasing the highest yielding companies “that are often also both the lowest quality and riskiest investments.” This has the unfortunate unintended consequence of driving fund managers into struggling sectors, such as oil and gas, commodity and banking.
The asset manager vowed that it would “not sacrifice quality for the sake of reaching an arbitrary yield target just to ensure sector inclusion.”
If the IA wants to refine its criteria for measuring the best performers in the UK Equity Income sector, it “should instead consider the absolute level of income generated by a fund and the growth of this income over time,” said Montanaro. After all, “an optically high yield does not necessarily provide a good income; or indeed any income at all!”
Despite the news it would be leaving the IA UK Equity Income sector, Montanaro's head of business development, Tom Norman-Butler, reassured investors that this would have no impact on the way the fund is managed:
“We will continue to seek the highest quality Small and MidCap companies offering an attractive dividend yield and growing dividends.”