An equity fund with a reliable 7% yield

That, as we argued earlier this year, may well prompt some to recalibrate portfolios to an extent, with a greater focus on those easy wins available today. Some believe that equities are out and bonds are in, thanks to the latter's ability to deliver near-risk-free income above 5 per cent. But such an approach comes with its own drawbacks: bonds and cash won’t pay out so handsomely forever, for one. They also do nothing to keep up with inflation over time, while bond investors have had to stomach a great deal of volatility in return for their coupon payments. Equities also always retain limitless capacity for growth.

This doesn’t mean investors have had an easy time navigating the income opportunities outside of cash and fixed income. Take investment trusts, where many a fund has become "cheap" but strains are also beginning to show. The sector has been awash with consolidation efforts, strategic reviews and tender offers, causing potential disruption to the bargain hunters who have piled in. Some dividends have fallen victims, too, with Hipgnosis Songs (SONG) and Digital 9 Infrastructure (DGI9) recently canning payouts in the face of balance sheet pressures. Company shares also face their own challenges, with AJ Bell’s latest dividend report noting that aggregate dividend forecasts for the FTSE 100 for this year and next have continued to fall, as earnings expectations falter.

As such, investors might welcome a more straightforward and predictable income play in their portfolio, and Schroder Income Maximiser (GB00BDD2F083) fits the bill. In some ways the fund is a conventional UK equity income play: it focuses to a large extent on high-yielding UK-listed blue chips, with HSBC (HSBA), Shell (SHEL), BP (BP.) and Barclays (BARC) among its top holdings. Unsurprisingly, given its income focus, it also carries a value bias and a heavy weighting to sectors such as financials.

All this helps the portfolio to generate a good level of yield, enabling it to play a key role in an income portfolio. However, the fund manages to top up this income by selling options on its underlying holdings, in pursuit of a target yield of 7 per cent a year. This feature – from which the ‘maximiser’ name is partly derived – works by offering investors the right to buy a certain number of shares at a set price, within a set period.

Investors might view such a high distribution rate, or the use of financial instruments to help achieve it, as a red flag. However, the fund – which launched in 2005 – has a solid history. As James Klempster, deputy head of multi-asset strategies at asset manager Liontrust and a holder of the fund, notes: “The fund’s track record of consistently achieving distributions above 7 per cent since 2006 is a useful feature for our income-focused portfolios. The fund has successfully achieved its yield target in various market environments and cycles, underscoring its reliability as an income-generating strategy.”

A big part of this consistency is down to risk management. Alongside its value tilt – and in line with many a dividend-oriented portfolio – the Schroders team applies particular attention to balance sheet risks, helping to minimise the chances of backing value traps. Klempster points to the fund’s ample resources, which combine the expertise of established value managers such as Kevin Murphy with the “maximiser” strategy used to top up the yield. Such reliability should create breathing room for riskier (and less diversified) holdings in an income portfolio – at least in theory. 

The catch?

That diversification includes Italian energy giant Eni (IT:ENI) and tech giant Intel (US:INTC) among the fund’s top holdings, and a 12.3 per cent allocation to European shares. That shouldn’t be seen as a negative, as the overseas exposure allows the fund to diversify beyond the UK and into more highly-rated markets. This is also less of an uncommon sight in UK equity funds than some might assume, given the role overseas shares play in several UK income funds and value portfolios.

Schroder Income Maximiser comes with a decent level of diversification in other respects: the sizes of its 44 holdings are reasonably small, limiting stock-specific risk, with its most prominent holding representing just 3.8 per cent of the portfolio at the end of September.

Drawbacks relate, instead, to the fact that the fund focuses so purely on income. Those investors who buy options from the fund can bank gains on the relevant shares above a certain level and over a set duration. By sacrificing such gains, the fund can lag the market and other peers when shares are rallying hard, meaning it should also end up sacrificing capital growth over longer periods for the sake of superior yield. Investors should be aware of this trade-off and may well wish to hold it alongside stocks or funds that offer more in the way of growth.

The real cost of this approach is admittedly difficult to quantify: Schroder Income Maximiser has slightly underperformed the FTSE All-Share over a five and 10-year period but has acquitted itself well more recently. The fund raced ahead of both the index and its fund sector average return in 2021 and has made modest gains both last year and in 2023 so far, again beating both the market and rival funds. A one-year Sharpe ratio of 1.2 (as calculated by Trustnet) also suggests the fund has been a good source of excess returns relative to its volatility. For any investor concerned with how to navigate income stocks in a high interest rate environment, this is a positive sign.

Otherwise, the fund comes with some of the usual risks that are familiar to UK investors and value stalwarts: that its beleaguered market of choice performs poorly, hitting returns. We certainly saw that in 2020, when investors took a hit to the tune of around 17 per cent. It’s also worth noting that the fund’s fee looks relatively steep – although its returns after fees do hold up well. Given the FTSE 100 is expected to deliver a yield of 3.9 per cent this year, according to AJ Bell analysis, Schroder Income Maximiser probably delivers enough on the income front to justify its fees when compared with both the passive funds that track the market and its active rivals.

The fund certainly comes with a trade-off, but one that nervous income investors should be able to overlook. As investors think of new ways to extract income from their portfolios, this is a fund that should serve as a reliable and competitive source of yield.