Type: Unit trust
Aim: Income and growth by investing in a portfolio of big and medium sized UK companies and derivatives
Minimum investment: Lump sum £1,000, monthly £50
Investment split: 100% in big and medium sized UK companies and derivatives
Isa link: Yes
Charges Initial 5.25%, annual 1.5%:
Commission: Initial 3%, renewal 0.5%
Tel: 020 7658 3894
Schroders has expanded its range of equity income products with a fund that boost income though a more defensive derivative-based strategy than used in the Schroder income maximiser product.
Chadney Bulgin partner Bruce Bulgin notes that the Schroder UK defensive income fund is an addition to Schroders stable of UK income funds and is an area where Schroders can demonstrate considerable expertise. “The long-standing Schroder income fund is a long only offering and the more recent addition to the range has been the income maximiser, which uses derivatives in the form of covered call options to generate high levels of income,” says Bulgin.
He says the new fund is a variation on the income maximiser product with an above average level of income, but also some downside protection in return for a slightly lower level of income. “It also uses put options. On this basis, the fund is highly attractive for income seeking investors. However, income levels are above average when compared with a long only fund and could be useful for a range of investors seeking high levels of income, which Schroders estimate to be in the range of 5 to 6 per cent.”
Bulgin points out that income is distributed quarterly and is quoted as being net of basic rate tax. “ The fund is based on a core range of quality UK equity income stocks broadly similar to the mainstream Schroder Income fund. By using options there is downside protection in falling markets some of which is paid for by reducing the potential for growth,” he says.
Looking at the charges, Bulgin highlights the estimated total expense ratio of 1.75 per cent, which he regards as average for a fund of this type. However, he thinks the initial charge of 5.25 per cent is on the high side. “Many advisers will buy the fund through platforms and may be able to take advantage of volume discounts and other incentives in respect of the initial charge. There is daily dealing so unlike other products that use derivatives to generate income or growth there are no lock-ins,” he adds.
Placing the literature in the spotlight, Bulgin is impressed. “The literature is comprehensive and makes a good attempt to explain a relatively complex concept. Unlike a pure income producing investment, there is also scope for capital growth, albeit this can be linked to market conditions. Market movements in recent months appear to be of benefit to this fund,” he says.
Discussing the potential drawbacks of the fund Bulgin says: “Inevitably the complexity of the fund is a negative and some clients may find it difficult to understand how it works. The charges are taken from capital, which can impact on capital growth.”
Bulgin believes that some commentators may liken the product to other structured products, which is unfair in his view owing to the liquidity of the fund. “The fact that the fund is benchmarked against the IMA specialist sector is unfortunate in that the target market is those seeking income,” says Bulgin.
Bulgin also mentions that Schroders Structured Investments head Richard Lloyd has recently announced his resignation. “However Schroders underlying process is robust and providing the team remains in place the process should remain the same.
“In the event – probably unlikely at the moment – that we experience steady stockmarket growth then the fund will underperform, when compared with a traditional long only fund,” he says.
He also observes that the estimated number of holdings is below average when compared with a mainstream income fund due to the need for Schroders to write derivatives contracts on the individual holdings. This means there is more risk than traditional funds with more underlying holdings.
Scanning the market for possible competitors Bulgin says: “There is little competition in the UK although funds of this type are popular in the US. It is likely that funds of this nature will become more popular because of the high level of income coupled with downside protection.
“Other advisers and investors will opt for mainstream long only income funds; bond funds and hybrids such as distribution and cautious managed funds made up of bonds and equities.”
Summing up Bulgin says: “Schroders is a leading player in the equity income and derivatives market so it should be on to a winner with the new fund. It is attractive for a wide range of uses including trustees seeking a high level of income, with some underlying growth, as well as for the mainstream investor.
“Daily dealing is attractive and the fund can be included in an Isa wrapper as well as offshore bonds and Sipps. Over the longer term it is likely that it will be included as an insured life or pension fund option.”
He concludes that we are likely to see an increase in funds of this type, that use derivatives contracts to provide capital protection, high levels of income or a combination of both.
Suitability to market: Good
Investment strategy: Good
Adviser remuneration: Good