The IA UK Equity Income sector has become increasingly popular over recent years as the demand for yield has only intensified owing to the ageing population and, thanks to extraordinary monetary policies from central banks, a genuine lack of attractive income opportunities. 
However, the large majority of the peer group can – understandably – only pay out the income they receive from the companies they hold.
There are a select few in the sector, though, that have the ability to boost their dividend pay-outs by extensively using covered call options.
This is a strategy whereby a manager buys shares and writes a call option on those same securities in order to generate a higher level of income from them. However, by taking that strategy, the excess income produced by writing the option also puts a ceiling over potential returns.
The funds which use such a strategy are constantly among the highest yielding in the IA UK Equity Income sector and also top the sector for dividend pay-outs over the years. However, given they are a relatively niche offering, little research has been done into how they stack up relative to each other and the rest of the sector.
Therefore, following a number of reader requests, we look at how the five ‘booster’ UK equity income funds have fared and see which might suit certain investors more than others.
How have they performed relative to the rest of the sector?
As mentioned before, there are five funds in the IA UK Equity Income sector that extensively use covered call options – Fidelity Enhanced Income, Insight Equity Income Booster, Premier Optimum Income, Santander Enhanced Income and Schroder Income Maximiser.
According to FE data, these funds have – on average – tended to underperform the IA UK Equity Income sector as a whole over the longer term, which is largely due to the fact that by using covered call options, a stock’s potential upside is capped at a certain price.
For example, a composite sector of the five funds has underperformed the wider peer group over one, three, five and 10-year periods.
Performance of sectors versus index over one, three, five and 10 years
Source: FE Analytics
There are market conditions where these funds tend to outperform the mean, however.
Not only are all five funds heavily biased towards mega-caps, but the high level of income they produce tends to mean they perform better relative to the market during times of stress.
This is shown by the fact that the average ‘booster’ fund beat the sector in 2007, 2008 and 2011. The likes of Schroder Income Maximiser turned in top quartile numbers in 2008 and Fidelity Enhanced Income considerably outperformed in 2011.
Which has been the best performer from a total return point of view?
Given these funds are at an immediate disadvantage from the point of view of outperforming the sector average in more positive market conditions, how have they performed relative to each other?
Unfortunately, most of these funds have been launched since the global financial crisis so we have had to use a five-year time frame for this analysis.
According to FE Analytics, Chris Wright’s five crown-rated Premier Optimum Income fund has been the standout performer from the group as it tops the mini sector over one, three and five years. It has also outperformed the FTSE All Share and been second quartile in the IA UK Equity Income sector over all of those time frames.
Performance of fund versus sectors and index over 5yrs
Source: FE Analytics
The £70m fund has also been the most consistent, beating the index in each of the last five calendar years and outperforming the IA UK Equity Income sector in four of those.
Premier Optimum Income, which has also navigated the recent volatility more effectively than others, has a number of contrarian positions. For example, intermingled with a number of mid and small-caps such as Conviviality, Wright counts Lloyds, BP and Rio Tinto as top 10 holdings.
The worst performing ‘booster’ fund over the medium term has tended to be Tim Rees’ Insight Equity Income Booster portfolio, which has underperformed against the FTSE All Share over one, three and five years and has been bottom quartile over all of those time frames.
Which has been the best for income?
While total returns are very important, most investors turn to ‘booster’ funds because of their income characteristics – so which have been the best performers in terms of yield, total dividends and dividend growth?
According to FE Analytics, Wright’s Premier Optimum Income fund has been the best performer from this respect as well.
Highest paying income ‘booster’ funds between 2011 and 2015
Source: FE Analytics *figures based on a £10,000 investment in January 2011
As the table above shows, it paid out the most on £10,000 between January 2011 through to the end of 2015 (£3,878.61) and distributed some £300 more than the average UK equity income ‘booster’ fund over the period.
Second on the list is the Insight offering, which despite its poor total returns, has paid out a high level of income. Sitting at the bottom of the list in total dividend payments, though, is Santander Enhanced Income Portfolio which distributed £3,005.75 on £10,000.
Though they have paid out far more than the IA UK Equity Income sector average over the past five or so years, none of the ‘booster’ funds have been able to consistently grow their dividends over time.
Michael Clark’s Fidelity Enhanced Income fund is only one which has come close to delivering consistent dividend growth, having only cut its dividend in one of the last five calendar years. That being said, its 2013 dividend was heavily reduced from the year before and Clark’s most recent distribution was still below the figure he paid out in 2012.
Fidelity Enhanced Income’s dividend history
Source: FE Analytics *figures based on a £10,000 investment in January 2011
From a yield perspective now (which is sure to please some of our readers) and FE data shows Insight Equity Income Booster has historically topped the list from this respect.
Historic yield of funds and sector
Source: FE Analytics
The table above shows the historic yield of the five funds in each of the last five years and the Insight fund is the only one to have offered a higher than average yield in each of them. At 8.2 per cent, it is also the sector’s highest yielder today.
Which has been the best for capital preservation?
Though yield and dividends are what most investors look for in ‘booster’ funds, capital preservation is also highly important as there is little point drawing a high level of income from a portfolio that has fallen considerably in price terms.
As mentioned earlier, the five ‘booster’ funds have tended to outperform during falling markets, but there are some which have been far better at shielding investors than others over the past five years.
The standout performer in this respect has been Fidelity Enhanced Income, thanks to Michael Clark’s ‘Safety of Income at a Reasonable Price’ approach to the UK equity market.
According to FE data, the fund has had the second lowest maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – in the whole sector over the last five years and has also been top decile for its annualised volatility.
While it has been second quartile for risk-adjusted returns in the whole sector over five years, it has had the highest Sharpe ratio out of the ‘booster’ funds
That performance profile has been achieved thanks to Fidelity Enhanced Income’s top decile gains in 2011 when the European sovereign debt crisis caused the likes of FTSE All Share to post losses of more than 3 per cent.
It seems the worst performer for capital preservation in the IA UK Equity Income ‘booster’ mini-sector has been Schroder Income Maximiser, which has been bottom quartile in the overall peer group for downside risk, maximum drawdown, number of negative periods, risk-adjusted returns and annualised volatility.
Not only did the £940m fund, which is run by Thomas See, post 9.48 per cent losses in 2011, it was also the worst performing member of the peer group last year with losses of 6.91 per cent thanks to its bets on financials, supermarkets and commodities.
It’s worth noting that Schroder Income Maximiser paid the second most amount in dividends that year, paying out £726.07 on £10,000 in 2015 – suggesting its yield was generated at the expense of capital.
