The latest: Schroder Income Maximiser

Schroder Income Maximiser revolutionised the previously staid world of UK equity income funds on its launch in 2005. The 7% yield target far exceeded the income available from conventional UK equity funds; The FTSE All-Share currently yields just 3.4%

The fund has been run by Kevin Murphy and Nick Kirrage since 2010, who also run the Schroder Recovery fund. Murphy and Kirrage took over the fund in 2010 when former manager Nick Purves jumped ship to RWC – Purves’ RWC Enhanced Income fund pursues a similar strategy.

At its heart, the fund has a great deal in common with the Schroder Income, also run by Murphy and Kirrage. Both funds invest primarily in FTSE 100 and FTSE 250 stocks, but unusually for income funds they are not solely focused on current income. In fact, they are prepared to invest in zero yielding stocks, provided they also provide dividend growth and capital growth. To achieve the latter they take a value approach, buying cheap, out of favour names – this suits the managers, who also run the Schroder Recovery fund.

The managers also make use of their ability to invest up to 20% of the portfolio in overseas stocks, where they are more attractively valued than those in the UK. The portfolio currently includes PC maker Hewlett Packard, healthcare names Merck and Pfizer and chipmaker Intel.

Covered calls

Where Income Maximiser differs from Schroder Income is the higher yield. To achieve this, the fund employs a covered call strategy. This involves a call option, a type of derivative which gives the holder the right to buy a share at a fixed price.

The managers sell call options on the stocks in their portfolio (the term covered call indicates that the fund owns the stock in question). This restricts potential growth in each stock to the level the option is set at, typically 10% or so a quarter. However, the money they receive for the options (the premium) can be paid out as income, increasing the fund’s yield.

We expect covered call funds to perform best in falling or level markets, but to underperform in strongly rising markets – any additional upside in the quarter beyond the level of the options is lost. Since launch the performance of Schroder Income Maximiser has been similar in total return terms to Schroder Income – holders have received more income but less capital growth.

How it has done

In recent years the fund’s value bias has led them to invest heavily in banks, which they believed to be particularly cheap compared to other sectors. Over 30% of the portfolio was in financials at the end of 2013, with the top 10 including Barclays and Lloyds plus insurers Resolution and Legal & General.

This led the fund to struggle in 2010 and 2011 as investors sought safety and consumer staples stocks were flavor of the month. However, the managers stuck to their guns and were rewarded as fears over the eurozone subsided and the global economy seemed to be on more stable footing. Their portfolio bounced back in 2012 and 2013.

With many UK income funds investing in similar stocks, the fund’s unusual style provides valuable diversification for client portfolios. The fund has also consistently met its 7% yield target since launch, a valuable attribute in what is still a low yield world.

Tom White is senior analyst at Bestinvest

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