Keiron Root’s monthly review of developments in the investment fund markets

With investors increasingly focussed on income, and fund management houses keen to plug any gaps in their ranges of income-producing funds, it is an interesting time for the Investment Management Association (IMA) to make changes to its classification of UK Income funds.

Essentially, the old UK Equity Income sector is being split into two, a continuing UK Equity Income sector and a new UK Equity Income and Growth sector. The UK Equity Income sector continues to comprise those funds which ‘invest at least 80 per cent in UK equities and which aim to achieve a historic yield on the distributable income in excess of 110 per cent of the FTSE All-Share yield at the fund’s year-end’, while the UK Equity Income and Growth sector will include ‘Funds which invest at least 80 per cent of their assets in UK equities, aim to have a historic yield on the distributable income in excess of 90 per cent of the yield of the FTSE All-Share Index at the fund’s year-end and which aim to produce a combination of both income and growth.’

A changing reality
The IMA points out that these changes are the result of extensive consultation with members over 19 months, but not everyone is enamoured of them. Tony Yousefian, chief investment officer at multi-manager OPM Fund Management, is certainly of the opinion that ‘One could view the IMA’s decision as one which, like the Charge of the Light Brigade, was one of the least well timed. Shares that typically qualify for inclusion in equity income funds, like BP, are struggling to maintain dividends in the current climate. When the maelstrom eventually passes, these intrinsically strong and robust companies will resume profitable growth – and ergo dividend growth.’

He asks, ‘Why, in the meantime, disrupt the Equity Income sector, especially as it is understandably one of the most popular with the general public? Holders of these funds are the mainstay of the battalion of British savers and, heaven knows, the base rate cuts have savaged them enough already.’

The problem is that a fund’s inclusion in the UK Equity Income sector is dependent on a complex calculation of its historic yield, which, in some cases, will have been affected by dividend cuts that may prove to be only temporary. The Association states that ‘it is recognised that the composition of market yield is changing fast and is subject to uncertainty over the coming period. The IMA will continue to monitor the situation and the sectors will be reviewed in January 2010, or such time as is appropriate to market circumstances.’

Focusing on the blue-chips
A couple of funds are also moving into the new sector from the UK All Companies category, including the Rathbone Blue Chip Income and Growth Fund, the new name for the Rathbone Income and Growth Fund, to reflect the fact that at least 75 per cent of its portfolio is in blue-chip equities. Another income-orientated portfolio with a FTSE 100 focus is AXA Framlington UK Blue Chip Equity Income Fund.

This new launch is part of the fund rationalisation programme that has been implemented by AXA Investment Managers over the past year to streamline its fund range and fully integrate the Framlington funds into the AXA set up. Consequently, the AXA UK Equity Income Fund has been merged into the new fund.

And on the subject of fund mergers, Jupiter has announced plans to merge its Global Technology Fund into its Global Managed Fund. Subject to gaining the approval of unit-holders, the intention is to merge the funds on 24 April 2009.

The logic for the merger is convincing. Sebastian Radcliffe, manager of the soon-to-be-departed Jupiter Global Technology Fund (and a member of the team that runs the Global Managed Fund), observes that ‘While there are still a number of very high-quality technology companies in existence, the bursting of the dot-com bubble has, over time, resulted in a geographic narrowing of the sector. Given the anaemic outlook for economic growth, we do not expect this to change and, as a result, believe the more diversified approach to global investing offered by the Jupiter Global Managed Fund will be more effective in the future.’

Broadening the focus
There is also the question of scale. Jupiter’s technology fund is only £25 million in size, which is tiny for a retail investment fund, while its Global Managed fund is a much more respectable £159 million. Not only should investors get a much broader spread of investments, there will also be economies of scale for the fund management house.

Certainly, the argument is that the merger is in the best interests of investors, given that the tech fund is down 24 per cent over five years compared with a rise of over 30 per cent for the managed fund over the same period, but what will be of possible concern to the managers of the remaining specialist open-ended retail technology funds (of which there are 11), is that Jupiter Global Technology has actually been the best-performing fund in the sector over the past six months – down ‘only’ 22 per cent, compared with a sector average of -27.5 per cent.

The demise of Jupiter Global Technology emphasises the increasing pressure that traditional managed sector specialist funds are under. With the rise of exchange-traded funds (ETFs), it is going to become increasingly difficult for fund management houses to justify running single sector, actively managed funds, and the level of charges that accompany them, when investors who want exposure to a particular market sector can simply buy an ETF much more cheaply, and without the added risk that the manager’s stock selection might underperform the sector average.

Adding value
The counter argument is, of course, that a good specialist fund manager can add value by outperforming their chosen sector as a whole. And there is some truth in this. For while there has been a tendency in the past to regard the performance of sector specialist funds as largely attributable to the relative strength or weakness of the sector in which they invest, the current performance numbers suggest that the cumulative affects of the ups and downs of the past decade have highlighted the importance of having a manager that can deliver a degree of outperformance.

Currently, there are half a dozen global market sectors that are the focus of these specialist portfolios. Property funds and Technology & Telecoms funds have their own dedicated IMA sectors, and within the ‘Specialist’ sector you find funds concentrating on Financials, Biotech & Healthcare, Commodities & Natural Resources and Infrastructure, alongside a number of geographically specific funds that don’t fit into other IMA categories.

Relatively few of these funds have ten-year track records, but among those that do some of the figures are revealing.

Take for example, the four funds established for at least that period concentrating on Financials. As you might expect, the returns from most of these funds are looking pretty anaemic at the moment – over ten years to the end of February, the funds managed by SWIP, AXA Framlington and JPMorgan were down by 14.37, 22.8 and 33.71 per cent respectively.

This might not come as a surprise until you compare them with Jupiter’s Financial Opportunities Fund, which was up 302 per cent over the same period. (I should also point out that there is a fifth fund concentrating specifically on the insurance sector, managed by insurance specialist Hiscox, which has a respectable ten-year performance, up nearly 60 per cent). Such figures serve to underline the importance not only of making the right decisions as to which type of fund you should invest in, but also choosing the right manager.

Capital preservation
Indeed, the funds research team at stockbroker Killik & Co put out a bullish recommendation for the Jupiter Financial Opportunities Fund at the beginning of March, emphasising its attractions as a capital preservation vehicle in these troubled times. Killik’s head of research, Mick Gilligan, points out that ‘The portfolio has been defensively positioned since the first signs of the credit market deterioration began to emerge. The fund still has no exposure to UK listed bank shares – HBOS, Barclays and RBS have been held over the past year on a short-term trading view, but we understand these have since been disposed of.’

He adds, ‘ The manager, Philip Gibbs, sees no reason to change his cautious stance given current conditions. He remains concerned about the speed of the global economic decline and the ongoing problems facing banks. Gibbs is almost unique within the long-only unit trust universe in his response to the economic and market crisis. He has made capital preservation a priority. We advocate this fund for investors who want the option of medium- to long-term equity market exposure but for whom capital preservation in the short term is key.’