While Cholwill said he “has no axe to grind” with the IA (his Royal London Equity Income Fund comfortably met the 110% FTSE All-Share yield requirement), he felt compelled to submit his views ahead of the IA’s consultation because a review of its procedures was long overdue.
The IA has required funds within the equity income sector to yield 110% above the FTSE All-Share index over a rolling three year period since 2010. Meanwhile, the market has changed substantially, said Cholwill.
One of the most apparent changes in recent years concerns dividend yields. Whereas decades ago, roughly 75% of stocks were outperforming the market, now only a mere 25% are producing higher yields than the FTSE All-Share Index, Cholwill stated.
“The universe of investable stocks has gone down,” said Cholwill. “The sheer scale of dividend cuts in unexpected sectors like food retail and utilities,” are a testament to this sea change.
The wide-ranging nature of these dividend cuts means that a number of funds are going to find meeting the IA’s yield requirement a more painful experience than they did previously, especially given the predominance of mega-caps in the sector. And when you have big dividend cuts, you often have poorly performing share prices.
Lower hurdles and durable solutions
The IA’s yield requirement should reflect the fact that UK dividends are lagging behind most other major markets, Cholwill said. Failing to do so would be prohibitive to future members of the sector, restrictive to current members and generally bad for morale.
According to Cholwill, lowering the IA’s UK Equity Income threshold will not only ensure more equity income managers are able to meet that criteria, but that benefits to investors will be even more obvious.
“With corporate and government bonds looking less attractive due to increasing negative interest rates, investors are looking to dividend yields from equity income to bolster their own income in a low interest rate world,” said Cholwill.
He also emphasised that the IA’s revised yield requirement should encourage a balance between dividend yield and dividend growth.
Concentrating chiefly on high dividend yield will pressure investors to make riskier investments or possibly to dip into capital reserves in order to meet the IA’s quota. Besides, a reasonable dividend yield of 3-3.5% is still a decent prospect over the medium term, said Cholwill.
“We need clarity going forward,” Cholwill underlined, in order to foster “a healthy vibrant equity income sector.” For that to happen, the IA will need to come up with “a solution that is durable and in the best interest of all concerned.”