What does Newton divi cut mean for equity income funds?

Newton’s flagship Higher Income fund recently announced it is cutting its yield target by between 20% and 25% in a move that calls into question the sustainability of delivering a consistently rising yield.

Investors flocked to the fund owing to its impressive yields that grew annually for the  past 15 consecutive years. Distributions in the last five years have been 4.6%, 5.7%, 7.2%, 7.6% and 7.9%, and its popularity has seen the fund grow to £2.5 billion.

Manager Tineke Frikkee (pictured) took pride in the fund’s impressive track record and level of discipline, recently saying it was still on track to deliver 3% annual dividend growth in the year to the end of June 2011. 

‘This contrasts markedly with the 10% decline in UK market dividends paid during 2008 and our previous forecast of a 10% decline in UK market dividends in 2009,’ she said.

However, the high yields have inevitably meant that the fund has missed out on opportunities for capital growth and the cut in the yield target aims to address this.

In the three years to the end of July, the fund returned 21.4% on a total return basis, against a 22.8% gain in the FTSE All Share. For the year ending July the fund has returned 10.9% versus a 14.9% rise in the benchmark.

Hargreaves Lansdown openly showed concern about the Newton Higher Income fund’s dividend policy in November 2010, when it removed it from its Wealth 150 buy list. The firm believed Frikkee was excessive in her use of covered call options as a means to hit the targets at the expense of growth.

Mark Dampier, head of research at Hargreaves Lansdown, said of the fund cutting its target: ‘It doesn’t come as any surprise. It’s just the right thing to do.’

Divi yields too high

But is the move also a sign that high dividend yields are increasingly hard to come by? Dampier argues that yields are already high on many funds, and on Newton’s Higher Income fund it was just too high.