Income maximiser funds use derivatives to boost their income so typically offer higher yields than conventional funds
To do this they sacrifice some of the capital growth of their holdings
For this reason they are not a good idea if you are looking for the best possible total return over the long term
2020 was a tough year for income investors with 505 UK-listed companies having cancelled, cut, or suspended their dividends between 1 January and 23 November, according to fund provider GraniteShares. And although some companies have resumed dividend payments it is likely to take a while for payments to get back to where they were.
Being well diversified geographically and tapping into overseas equity income is a key way to mitigate falls in the UK, though overseas companies have also not been immune to the economic problems that have resulted from the Covid-19 pandemic. Another potential option is income maximiser funds which invest in equities, but also use derivatives to boost their income and typically offer higher yields than conventional equity income funds.
Income maximiser funds write covered call options on shares they hold and the buyers of the options, for example, investment banks, pay the funds a fee. This means that income maximiser funds can earn more income than conventional equity income funds. But the option buyers are entitled to any rise in the prices of the shares on which they buy options above a certain level over a set period of time, for example three months. As a result, income maximiser funds sacrifice some of the potential capital growth of the shares on which they have sold options.
But income maximiser funds' managers can choose which stocks they wish to sell the upside on and retain the full growth on stocks they think will perform particularly well.
Darius McDermott, managing director at Chelsea Financial Services, says income maximiser funds could be an option if you are prepared to sacrifice some long term capital growth potential for extra income, and appreciate equity risk.
Rob Morgan, pensions and investments analyst at Charles Stanley, adds that you could use them tactically over short term periods if markets are choppy or have a small allocation to them to boost your income.
How much you allocate to income maximiser funds depends on how much income you need from your portfolio, and how much you are getting from conventional sources. But commentators generally agree that they should only account for a small part of your portfolio, for example, Mr McDermott says that up to 10 to 20 per cent of an income portfolio could be in these types of funds.
Risk and sacrifice
However, Ben Yearsley, director at Shore Financial Planning, thinks that you should not turn to income maximiser funds unless you require a very high level of income immediately.
“These funds are trading future capital growth for high income today,” he says. “You are effectively capping your upside. The type of market you are in determines how much of a problem this is. In falling markets it’s not an issue and you should be better off than with normal funds. But in strongly rising markets [income maximiser funds] will underperform as they continually run into the cap.”
Income maximiser funds are likely to underperform conventional equity income funds when markets are rising, but could be protected from the full downside when markets are falling and be less impacted than conventional equity income funds.
Schroder Income Maximiser Fund’s (GB00BDD2F083) literature, for example, states that its “investment strategy will typically underperform a similar portfolio without derivatives in periods when the underlying stock prices are rising, and outperform when the underlying stock prices are falling.”
“If equities go up over time with an income maximiser fund you are locking in constant under performance,” says Mr McDermott. "For example, Schroder Asian Income Maximiser (GB00BDD29F14) and Fidelity Global Enhanced Income (GB00BD1NLJ41) are [similar to the] basic income funds run by the same companies [Schroder Asian Income (GB00BDD29849) and Fidelity Global Dividend (GB00B7778087)]. So in any meaningful periods of performance Schroder Asian Income Maximiser and Fidelity Global Enhanced Income under perform the basic income funds. You are giving up performance for that income.”
Mr Morgan also points out that when markets are going up and volatility is low the prices funds get paid for selling call options are not as good.
“You lose both the upside and the premium is not great,” he says. “So income maximiser funds are best in choppy markets when investors pay more for options, and the fund doesn’t lose as much or any upside. These can be good if markets go sideways or fall. But markets tend to go up over the longer term so these have under performed plain vanilla income funds. If you are looking to max total return don’t use them over the longer term.”
He argues that, for example, at the moment the UK in particular is under valued so an income maximiser fund might not be appropriate if you are looking to make a good total return from any recovery. And the more you have in these the less you have in funds that could grow income.
Mr Morgan adds that as the income these funds get from selling covered call options changes all the time, you should monitor them and be prepared to change your view on them more often than with a conventional fund.
Although income maximiser funds can limit volatility and may be slightly lower risk than conventional equity income funds, they still expose your portfolio to the downside risk of the stock market. So you should consider them as part of your equity allocation.
For example, on a risk scale of one to seven, Schroders ranks its Income Maximiser Fund as 6 and says: “A fund is in categories 4 to 7 where it can take higher risks in search of potentially higher rewards, and its price may rise and fall accordingly.”
It is also important to pick an income maximiser fund of which the management team has the appropriate expertise both in stock picking and using call options.
Funds for maximum income
David Liddell, chief executive of online investment service IpsoFacto Investor, likes Schroder Income Maximiser (GB00BDD2F083), one of the most established funds of this kind which launched in 2005. It aims for an income of 7 per cent a year by investing at least 80 per cent of its assets in UK equities which its managers think have long term income and capital growth potential. To enhance the yield, the fund’s managers sell short dated call options over individual securities, portfolios of securities or indices held by the fund, by agreeing strike prices above which potential capital growth is sold.
It had a 12 month yield of 7.37 per cent as of 4 January, according to Morningstar. “This fund has a reasonably good risk adjusted record over five years in the UK equity income sector,” adds Mr Liddell.
This fund invests in a smaller than usual number of stocks - 37 at the end of November - and can invest heavily in specific types of companies or sectors. A fund which invests in a smaller number of stocks may fluctuate more in value than a fund which invests in a larger number, as it is more concentrated and less diversified.
Schroder Income Maximiser has been run by highly experienced managers Nick Kirrage and Kevin Murphy since May 2010, alongside Mike Hodgson since July 2016. They run it according to a value investment style which has not done well over the past decade.
But “Schroder Income Maximiser could be a good strategy if value performs,” says Mr McDermott. “The UK may now start to get global attention [following a Brexit deal with Europe]. The UK has been very unloved [and this market has substantial weightings to] value sectors.”
Mr Morgan suggests RWC Enhanced Income (LU1017299824) which has over 80 per cent of its assets invested in the UK. It is run by an experienced investment team which includes Ian Lance, Nick Purves and John Teahan. They joined RWC in 2010 from Schroders where they ran income funds including Schroder Income Maximiser.
RWC Enhanced Income had a 12 month yield of 3.41 per cent as of 4 January.
The fund has a pro-cyclical bias, reflecting where value was in the market prior to the coronavirus so benefited greatly from the value versus momentum rotation during November. The managers had increased exposure to oil majors at the start of that month in which out performance was led by financials and energy stocks. The covered call overlay strategy was a detractor due to the rally in equity markets, but they have reduced the portfolio coverage level to protect upside participation and reduced downside protection.
There are a number of income maximiser funds focused on markets other than the UK. But as with any overseas equity fund these incur currency risk which can go for or against you.
Fidelity Global Enhanced Income aims to increase its value and deliver an income at least 50 per cent more than the income produced by the companies included in MSCI All Country World Index. It had a yield of 4.85 per cent as of 4 January.
Its managers invest in companies they think offer the prospect of sustained dividend growth over the long term, favouring ones with consistent cash flows, understandable business models, and little or no debt. They add to the income by writing call options on a portion of its holdings to achieve a balance between income generation and capital growth potential.
Schroders runs various income maximiser funds including Schroder ISF Global Dividend Maximiser (LU0966866922) and Schroder US Equity Income Maximiser (GB00BYP25698). Mr McDermott highlights Schroder Asian Income Maximiser (GB00BDD29F14) which targets an income of 7 per cent and had a 12 month yield of 6.48 per cent as of 4 January, according to Morningstar.
The fund invests at least 80 per cent of its assets in Asian equities, excluding those listed in Japan, and its managers boost the income by selling short dated call options, agreeing strike prices above which potential capital growth is sold. This fund typically under performs a similar portfolio without derivatives when stock prices are rising but has the potential to outperform when stock prices are falling.
The fund is well diversified with 63 holdings at the end of November in sectors including IT, financials, real estate and communication services. It could also be a good diversifier to other Asian funds with over weights to Taiwan and Australia, relative to MSCI AC Pacific ex Japan index, which accounted for 19.6 and 16.5 per cent of its assets, respectively, at the end of November. The fund is also very underweight China relative to this index.
The fund has been run by experienced Asia manager Richard Sennitt since launch in June 2010, alongside Mr Hodgson since July 2016.
|Fund/benchmark||6 month total return (%)||1 year total return (%)||3 year cumulative total return (%)||5 year cumulative total return (%)||10 year cumulative total return (%)||Ongoing charge (%)|
|Schroder Income Maximiser||10.25||-16.95||-10.73||16.93||0.84|
|RWC Enhanced Income**||10.90||-9.50||-1.34||9.37||31.29||1.15|
|FTSE All Share index||9.33||-9.82||-2.71||28.46||71.91|
|Investment Association (IA) UK Equity Income sector average||11.98||-10.66||-4.04||16.28||76.56|
|Fidelity Global Enhanced Income||3.51||4.65||24.52||62.72||0.94|
|Fidelity Global Dividend||4.49||5.97||30.50||70.48||0.93|
|Schroder ISF Global Dividend Maximiser||12.49||-10.52||-6.15||33.89||95.01||1.05|
|MSCI World index||11.18||12.32||33.68||91.67||193.53|
|IA Global Equity Income sector average||10.19||3.30||15.40||56.92||119.99|
|Schroder Asian Income Maximiser||11.19||5.86||10.29||62.73||90.52||0.86|
|Schroder Asian Income||19.08||13.63||21.44||86.74||0.84|
|MSCI AC Pacific ex Japan index||17.19||19.24||25.23||100.76||114.32|
|IA Asia Pacific Excluding Japan sector average||19.34||20.02||25.34||97.40||105.18|
|Schroder US Equity Income Maximiser||9.13||8.90||31.48||0.39|
|S&P 500 index||9.51||12.67||39.03||98.14||242.07|
|IA North America sector average||12.31||16.14||42.52||103.68||244.26|
|Source: FE Analytics as at 31 December 2020, Morningstar.|
|** The history of this unit/share class has been extended, at FE fundinfo's discretion, to give a sense of a longer track record of the fund as a whole.|