The Schroder UK income defensive fund has a target yield of 5-6 per cent with similar volatility to balanced funds. It will invest in 30-50 big and medium sized UK companies that pay high sustainable dividends.
These companies will generate strong cashflow – a factor that has become particularly important in recent months as the credit crunch has pushed up borrowing costs and piled pressure on companies with debt.
Schroders says a number of companies in the life assurance and media sectors generate significant cashflow, but their share prices seem too low. It is also looking at cyclical stocks that have been subject to sharp falls, but could provide attractive long-term opportunities.
Schroders will then exchange some of the potential growth on the equity portfolio for a premium by selling call options on the stocks. This strategy is designed to boost income for investors if the prices of the shares within the portfolio fall or do not rise above the target price.
Call options give the manager the right but not the obligation to buy shares at a set price before the option expires. If the share price subsequently rises, the manager will profit from the difference between this and the price of the call option.
The new fund’s strategy differs from income maximiser by also buying put options to provide a level of protection against big falls in share prices. Put options allow managers to profit from the difference between the price of the option and the actual share price in a falling market.
Buying a put option against a holding in the portfolio gives Schroders protection against a fall in the share price while allowing it to profit from a rise in the share price.
The fund allows investors to achieve income with a defensive strategy underlying it. However, this strategy is not new as Dawnay Day Quantum’s UK absolute income fund does the same thing. One potential downside for both funds is that the options strategy is complex and it may be difficult for investors to understand the risks involved.