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Schroder income maximiser – enhancing client income in a low return world

Trying to generate a high income from investments during times oflow inflation, low bond yields and low interest rates can be very difficult. To try and achieve this in the current environment, many funds are investing in very high-yielding stocks, or higher-yielding bonds – which may mean greater risk to investors’ portfolios. Equity income funds, on the other hand, have the advantage of giving investors the opportunity to receive a high level of income, generated from stock dividends from more financially sound and stable companies, along with the potential for capital growth.

With this low rate environment in mind, Schroders has identified an opportunity to create an equity based fund that should provide a higher income using a unique approach.

A new approach to income investing

Schroder Income Maximiser is a new fund that aims to generate a high income from the UK stockmarket. It will use an innovative approach, investing in stocks and selling options with the aim of producing a higher level of income than is possible for a traditional equity income fund.

This actively managed fund will invest in a carefully selected, high quality portfolio of 30-40 UK large cap stocks paying high, sustainable dividends. The stocks in the portfolio will be selected by Nick Purves, manager of the AA-rated Schroder Income Fund1.

To enhance the income on the portfolio, “covered call options” will be sold on each of the stocks. The fee (premium) Schroder Income Maximiser receives from selling these options will help to boost the yield on the fund. Of course, the trade-off for the extra income is that the potential for capital growth will be restricted.

The options market

What is a call option?

A call option is a contract that gives the option buyer the right, but not the obligation, to buy a share at a fixed price (the strike price) on a specified date in the future. The seller of an option contract charges a fee or a “premium” for this privilege.

What is a covered call option?

The term “covered” means that the seller of the call option also owns the underlying stock they are selling the call on. Covered calls are sold because the seller prefers to receive a known premium income in exchange for a potential, but uncertain, gain in the stock price. In the case of Schroder Income Maximiser, this “premium” is used to enhance the yield.- Covered call writing may be considered a more conservative strategy than outright stock ownership, because the seller’s downside risk on each stock holding is reduced by the premium he receives from selling the call option.- Whether or not an option is ever exercised, the seller keeps the premium. The strategy allows the Schroder Income Maximiser to exchange an uncertain future benefit (any rise in share price above the strike price) for an agreed premium payment.- The development that has made this possible is the growth of a large derivative market which places a value on such uncertain outcomes based on share price volatility. There is a well developed market for buy- ing and selling options that has been in existence for many years (just as there is for trading stocks) so Schroders should be able to achieve a reasonable premium for selling covered call options in all normal market conditions.- It is important to note that the pricing of options does not require buyers of covered call options to take a view on market direction. There- fore the extra income will not be driven by the expected direction of the market (ie. an expectation of whether it will go up or down) but will be based principally on market expectations of the volatility of the underlying stocks.

The effect of different market conditions

A traditional equity income fund relies on dividends from the stocks it holds to provide a regular income, and also aims for a measure of capital growth as these stock prices rise.

Schroder Income Maximiser does the same, but aims to enhance income by the sale of covered call options. This will involve some sacri- fice of capital gain if stock prices rise sharply.

Assuming that the market is not extremely volatile, the likely performance of Schroder Income Maximiser compared to a traditional UK equity income fund is summarised below:

In flat markets – Schroder Income Maximiser has the potential to outper- form the more traditional UK equity income fund because the stocks are less likely to grow above the strike price set on the options. The fund will receive a higher income, without being penalised in practice from the capped upside.

In rising markets – If rises are dramatic, the fund is more likely to underperform a traditional UK equity income fund because of the effect of the capped capital growth. If rises are more gradual, the fund has the potential to outperform dependent on whether the increases are broadly based or more stock specific.

In declining markets – Schroder Income Maximiser has the poten- tial to outperform, because the higher income is less likely to be offset by any effects of capped capital growth.

In volatile markets trading sideways – performance will be driven by more stock specific issues so it is difficult to make generalisations.

The income and growth of the fund as a whole will depend on the performance of the individual holdings.

How the fund is managed

Schroder Income Maximiser will benefit from two layers of specialist management expertise:

Richard Lloyd, the fund manager, will take responsibility for all invest- ment decisions and the day-to-day running of the fund. Richard is the Head of Schroders’ Structured Investments Team and will be in charge of the covered call options strategy. His team manages over 3.5* billion of structured investments assets and has 18 years of derivatives and options trading experience.

The equity portfolio will be selected by Nick Purves, manager of the top-performing Schroder Income Fund. These stocks will be derived predominantly from the FTSE 100 component of the Schroder Income Fund.

This combination of expertise will ensure the innovative aspects of the fund will be co-ordinated and managed by a proven team of experts, each a specialist in their field.

Unlike similar products in the marketplace, Schroder Income Maximiser is an authorised unit trust with no lock-in period and daily dealing.

Key features

w Targeting 7%2 yield in current market conditions – significantly higher than most her income fundsw Seeks income from UK large cap stocks and the sale of covered call optionsw Potential for capital growthw Suitable for clients seeking to a higher incomew Quarterly income paymentsw Authorised unit trust with no lock-in period and daily dealingw Backed by Schroders’ financial strength, investment expertise and resources.

Schroder Income Maximiser laun- ches on 7 November 2005. There is a two-week offer period from 24 October to 4 November when there is a discount on the initial charge.

For more information, visit or call Schroder Investor Services on 0800 718 777*.

1 The Schroder Income Fund is AA-rated by Standard & Poor’s as at August 2005 and Forsyth-OBSR as at July 2005.

2 The gross yield quoted is an estimate and is not guaranteed.For professional advisers only. This material is not suitable for private customers. Source for funds under management and experience: Schroders as at 30 June 2005. The gross yield quoted is an estimate and is not guaranteed. The fund will make use of derivatives, which can involve a high degree of risk and can be more volatile. This fund should only be considered as a long-term investment. Portfolios which invest in a smaller number of stocks carry more risk than funds spread across a larger number of companies. As the annual management fee of Schroder Income Maximiser is charged to capital, the distributable income of the fund may be higher but the fund’s capital value may be eroded which will affect future performance of the fund. *For your security, communications may be taped or monitored.

Issued in September 2005 by Schroder Investments Limited, 31 Gresham Street, London EC2V 7QA. Registered No: 2015527. Authorised and regulated by the Financial Services Authority


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