UK equity income funds using cover call options to enhance the dividend and those focused on smaller companies are among the best for income generation, according to the experts. 
The average yield for the IA UK Equity Income sector is 4 per cent, which sounds pretty good in the current climate. However, the sector average is being dragged higher by a few funds with enhanced income characteristics.
Adrian Lowcock, investment director at Architas, said: “Equity income has continued to offer attractive yields as companies are able to grow their profits and their yields.”
However, he notes that last year many companies paid dividends which were not fully funded by current earnings, instead borrowing (at low rates) or paying dividends from retained earnings from previous years.
“Investors seeking income want some security over future dividends as a cut downline will not all mean they see a drop in their income but also a likely fall in the value of the shares,” Lowcock (pictured) said.
Therefore, having outlined what is a high yield in various sectors and looked at the fixed income space, below FE Trustnet looks at funds both with covered-call options and those without that are providing investors with a generous amount of income.
Those with options
Naturally, the highest income-earners are those that use covered-call options to enhance the dividend; though this can come at the expense of some capital returns.
“The highest yielding of these funds is Schroder Income Maximiser, which yield over 7 per cent,” Lowcock said, and it is the choice of BMO Global Asset Management co-head of multi-manager solutions Rob Burdett.
The manager of the F&C MM Navigator Distribution fund said: “Equities in general is the area we are happiest with because you’ve got, even on an average basis, a yield that is materially above cash, materially above inflation and will grow this year.”
“Schroder Income Maximiser – which has a cover call structure on top –gets you to 7.17 per cent and we’re quite happy to give up some capital growth with the elevated levels in the market,” he added.
The £1bn fund has been a bottom quartile performer over the last three years, returning 17.93 per cent, but has been above average over five and 10 years.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The core portfolio comes from the Schroder Income fund run by value-focused FE Alpha Managers Nick Kirrage and Kevin Murphy, while the options book is run by Mike Hodgson. The trio took over the fund in July last year from Thomas See who had been in charge since 2009.
Since the team have begun overseeing the fund, it has slightly outperformed both the sector and benchmark by 1.75 and 1.17 percentage points respectively. The fund has a yield of 7 per cent and a clean ongoing charges figure (OCF) of 0.91 per cent.
Another potential fund using cover-call options is Fidelity Moneybuilder Dividend, according to Architas’ Lowcock.
“Michael Clark has a more conservative investment style than many fund managers in the UK equity income sector,” he said.
“He looks for companies with understandable business models, strong balance sheets and predictable cashflows, and those he believes will be able to deliver sustainable dividends. These are mostly mid or large-size UK companies.
“Clark will take full advantage of the flexibility his mandate gives him to invest up to 20 per cent of the fund in businesses listed outside the UK.
“His cautious investment style means he tends to favour certain industries such as consumer goods, tobacco and healthcare.”
The fund has struggled over the last six months but over the longer term has outperformed its sector and benchmark over three, five and 10 year-periods.
Performance of fund vs sector and benchmark since manager start
Source: FE Analytics
Indeed, since Clark took over the £1.1bn fund in July 2008, it has outperformed the sector and benchmark by 20.48 and 31.91 percentage points respectively.
The four-crown rated fund has a yield of 4.17 per cent and an OCF of 0.67 per cent.
Those without options
Of the funds which do not use covered-call options to enhance the dividend, those focused on smaller companies (or across the market cap spectrum) might provide investors with a good yield for the appropriate level of risk.
Lowcock suggests FE Alpha Manager Siddarth Chand Lall’s £1.5bn Marlborough Multi Cap Income fund, of which he has been sole manager since 2015, having previously co-managed the fund alongside industry veteran Giles Hargreave since its launch in July 2011.
“The fund is very actively managed with the manager constantly reassessing the outlook for his investments, having a strict sell discipline which he believes is important when investing in small and mid-sized companies,” said Lowcock.
“The aim of the fund is to invest in companies with good income yield but also the potential to grow that yield. Close analysis of the financial statements is important as this helps the manager determine the sustainability of the dividend.”
The fund, which has a yield of 4.15 per cent has been a top quartile performer over the last five years, returning 103.43 per cent.
Performance of fund vs sector over 5yrs
Source: FE Analytics
It holds 12.7 per cent of its portfolio in micro-cap stocks (under £250m), 38.5 per cent in small cap (£250m-£1bn) and 36 per cent in mid-caps. The fund has an OCF of 0.8 per cent.
Another option, according to BMO’s Burdett, is MI Chelverton UK Equity Income which is a small-cap specialist currently yielding 3.57 per cent.
The £505m fund, run by David Horner and David Taylor, is 31 per cent invested in companies with a market capitalisation of more than £1bn, with the remainder in those less than £1bn.
It has been a top quartile performer in the IA UK Equity Income sector over one, three and five years, returning 127.92 over the last half decade; it has been the best performer over a three-year period.
Looking ahead this year, the managers remain positive on the prospects of domestically-focused smaller companies.
In the latest factsheet the managers noted: “Given the relatively high domestic focus of our small and mid-cap investment universe it is interesting to note an increasing number of commentators now expecting sterling to start appreciating against major currencies by the end of the year, a view we have had for some time.
“In itself this may translate into a small tailwind for UK earnings but importantly it could precipitate a sentiment shift amongst investors back towards UK earnings, and those sectors such as housebuilding and retail that have been under pressure recently.
“Our domestic economy remains broadly supportive of small and mid-cap performance and valuations with fears over falling real wages on one hand being countered by supportive monetary policy, good export performance and the resilience of the services sector on the other.”
The fund has an OCF of 0.89 per cent.