The fund is benchmarked against the MSCI Europe index, which comprises approximately 580 stocks, and will contain 100-200 stocks. BlackRock Merrill Lynch says the portfolio will represent the risk characteristics of the index at country and industry level, with a higher average dividend yield. It expects to achieve a dividend of around 4 per cent from the equity portfolio, but income will be boosted through covered call options.
Covered call options are used to generate a steady flow of income that can be distributed or re-invested for higher total returns over time. A call option gives the buyer the right, but not the obligation, to buy an asset at an agreed price. A covered call is an strategy where the fund manager will hold a long position in an asset and sells call options on that asset to generate increased income.
The company aims to reach its target yield of 8 per cent a year by selling index call options on approximately 50 per cent of the portfolio. It says the additional income can provide a cushioning effect during market dips. with the overall blend of investments designed to provide equity-like returns, with reduced volatility.
The investment team begins by using quant screens to identify high dividend-paying stocks to give the underlying portfolio a higher yield relative to the benchmark index, while maintaining the overall characteristics of the benchmark.
The team then sells call options on 40-60 per cent of the portfolio to create the extra income. Typically they will be one month call options on the Eurostoxx 50, FTSE 100 and the Swiss Market Index. According to BlackRock Merrill Lynch, option premiums have increased with the increased volatility in the market, allowing extra income to be generated.
Fund manager Jonathan Clark joined the company in 1999 and is responsible for managing derivative strategies for BlackRock Merrill Lynch’s quantitative investments team, He is the lead fund manager for over $4bn in equity structured products. and has previous experience as a trader at MLC Investments, a hedge fund.
Investors may be looking to diversify through a European income fund that also provides the potential for capital growth potential. The use of covered call options may outperform when stockmarkets are falling, which will appeal to some investors, but the strategy may also result in a lower returns relative to the benchmark in a rising market.