Redefining income – dividend requirements suspended

In a rare move, the rules for what constitutes an income fund have been changed.

What counts as an income fund?

The Investment Association (IA), the trade body for investment fund managers, sets detailed criteria for no less than 39 different investment sectors, ranging from Japanese Smaller Companies to Volatility Managed. The IA also monitors the funds in each sector to ensure they do not stray from the relevant criteria. The Association’s goal is to enable investors and their advisers to compare like with like, which to some extent explains the proliferation of sectors.

Changes to sector definitions are rare and usually occur after much consultation because of the disruption which they can cause. However, in April the IA announced a near instant revision to two popular sectors: UK Equity Income and Global Equity Income.

Unsurprisingly, prior to the IA’s announcement both these funds had definitions which required them to produce a minimum level of dividend income. Broadly speaking these were:

· 90% of the last year’s dividend yield for the relevant index (FTSE All-Share Index for UK Equity Income and MSCI World Index for Global Equity Income); and

· 100% of the average yield for the relevant index on a rolling three-year basis.

Both these requirements have now been suspended, the first for twelve months and the second pending review “as the markets settle and the outlook clears”. The reason for the IA’s rapid suspension is the market’s reaction (and in some cases regulators’ reactions) to the Covid-19 pandemic. Many companies have decided – or, for example, in the case of major UK banks, been told – to stop dividend payments. Conservation of cash in the face of such a dramatic change to the economic environment makes financial sense from a corporate viewpoint, but for investors, it means a sudden loss of income.

If you hold any of the 144 funds within the two affected equity income sectors, you are likely to see a drop in the dividends paid, albeit often with a few months lag. That fall is not necessarily a reason to sell: before taking any action in this type of situation, make sure you seek professional advice.

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