Fund groups are considering the need for more innovation in the equity income space in a bid to meet the demand for yield – but are split as to whether derivative-based strategies are the answer.
Asset managers believe they must become “more relevant” to the income-based desires of clients, according an Investment Association survey of its membership. This comes after a period of healthy inflows into equity income strategies that now have to contend with lower yields on offer from certain stocks after years of capital appreciation.
The prospect of higher inflation has added to the difficulties in delivering a high, yet sustainable, real yield.
As a result, one area of potential interest is in income overlay strategies – which see fund managers run traditional equity income portfolios while selling call options to create an artificial additional layer of income. The space is currently dominated by Schroders, with Fidelity and RWC also offering products.
Some firms are tempted to challenge Schroders. Last week, the fund house itself announced it would seek to add a US fund to its Income Maximiser range, which currently comprises Asian, UK, Global and European offerings.
Aviva Investors head of UK wholesale Jeremy Leadsom said the firm was considering expanding its income offerings.
“There is a desperate need for income out there… and I think there is a potential demand for enhanced income products,” he said. “This is something we may consider [in future].”
Robert Bailey, head of UK wholesale distribution at Axa Investment Managers, said the firm was also looking at other income-based possibilities, but he took a cautious line on overlay strategies. While the products do offer a higher yield than basic equity income funds, this is done at the expense of capital growth – as writing call options involves sacrificing some potential upside.
“When looking at any kind of solution in this space, be it overlays, selling calls or whatever, we need to make sure that any additional risk is clearly understood,” he said.
Mr Leadsom added: “Buyers need to be aware – you will not get something for nothing. If you want income at all costs and are happy to take increased risk of capital loss, fine. But this would not suit everybody.”
Traditional strategies may not be under as much pressure as some had feared. Capita’s latest Dividend Monitor suggests those searching for yield may continue to find joy in the domestic market in 2017.
Capita spent much of 2016 urging caution on dividends, despite sterling weakness ultimately boosting payouts. In its latest report, the firm said underlying dividends fell by 2.6 per cent last year once the effect of the falling pound was removed.
However, it predicted underlying dividends will grow 7.5 per cent this year. While two-thirds of this was still down to a weaker sterling, one-third is based on assumptions firms that had previously cut or cancelled dividends will return to the market.
The report said: “There are still £500m of cuts to wash through but some of those companies which cancelled payouts will recommence distributions.”
Capita predicted total underlying dividends could reach £84.4bn, up from £78.5bn in 2016.
“The restarters could add £1.5bn to the total, weighted towards the end of the year. We expect exchange rate gains of approximately £3.7bn in 2017, weighted towards the first half of the year,” the report added.
Enhanced income funds
| Name | Size |
| Fidelity Enhanced Income | £503m |
| Fidelity Global Enhanced Income | £202m |
| Schroder Asian Income Maximiser | £304m |
| Schroder Income Maximiser | £1,041m |
| Schroder ISF Global Dividend Maximiser | £2,847m |
| Schroder ISF European Dividend Maximiser | £962m |
| RWC Enhanced Income | £370m |
