UK Edition
'BP and Shell won't be part of my 7pc yielding fund for long'
Investors who need a high level of income from their investments have not had many options recently. The yield on the FTSE 100 index of the UK’s biggest stocks is 3.6pc, and finding investments yielding 5pc or more that do not involve a substantial increase in risk is a difficult exercise.
However, there are a number of income funds designed specifically to maximise their payouts. Some of these use complicated financial instruments called “derivatives” to push their yield beyond 6pc.
Premier Optimum Income is one such fund. It has a historic yield of 7pc and has delivered above average total returns – combining capital and income – over one and three years, compared to its peer group.
The fund “sells options” to boost its income. In other words, it sells part of the future growth of a stock in return for an upfront payment, which it can then distribute as income.
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Telegraph Money spoke to manager Chris Wright about the fund’s use of derivatives, why he does not like oil giants BP and Shell, and what makes him sell a high yielding stock.
The ongoing charge for the fund is 1.03pc when bought through an investment platform.
How do you invest the fund and what puts you off a stock?
The aim of the fund is to provide a very high and growing income, and to maintain or grow gently the capital, so we look for high yielding stocks with some growth.
There is no one magic bullet, so we have a mix of “value”, or cheaper, unloved stocks and “quality” stocks that are more stable but more expensive.
I’m willing to buy low quality stocks at the right valuation, and pay more for something with qualities such as repeatable revenue.
A lack of growth tends to put me off a stock. It’s less easy now but I have always liked the yield and growth figures to add up to 10, so for a yield of 6pc you want growth of 4pc.
How much of the income comes from derivatives, and what is the downside?
In the past three years about 25pc of the income has been from derivatives. They help to lower the sharp up and down swings of the fund and increase the cash available to pay out.
However, by selling options if the market rises strongly we risk not getting all of the benefit.
What will make you sell a high yielding stock?
A lack of free cash flow – so when a company starts to expand in an unhealthy manner.
That has been a failure of companies over the past 30 years in Britain, America and Europe. Company management think they can walk on water if they have a lucky period.
I did not hold BP and Shell until recently because of this – they had been over-expanding oil supply.
We added them halfway through 2016 but I’ve made it clear they’re not permanent members of the fund.
They are dependent on the oil price, which they can’t control. We have been gently selling them recently.
You can allocate up to 20pc to stocks in continental Europe, how is that used?
The European market is twice the size of the UK and provides the opportunity to buy into different sectors, such as chemical companies and high-quality engineering businesses, which we tend not to have in the UK.
We also held financial companies BNP Paribas and Danske Bank, and they performed well towards the end of last year.
What dictates your pay?
I have a basic salary, and any bonus is ultimately tied to the profits of the company, but is roughly related to the amount of income the fund brings in.
What has been your biggest investment success and mistake?
One I have been pleased with is IT services company FDM. The share price fell so far post-Brexit that the yield was more than 4pc, with turnover increasing by 10pc to 20pc annually and a return on capital of more than 80pc. It generates buckets of cash.
I held defence firm Cobham when it had the first profit warning a couple of years ago and then dumped it. That hurt.
Do you have your own money in the fund?
Yes, it’s the biggest holding in my Sipp.
What would you have done if you hadn’t become a fund manager?
A colleague said I should have been a thespian.
Independent view
Authored by John Monaghan, senior investment research analyst at fund consultancy Square Mile
Premier Optimum Income is one of a relatively small number of UK equity income funds that aims to pay investors a higher income than the UK stock market.
While how the fund works is quite complex, in essence it uses derivative instruments, combined with traditional income-paying stocks (for example HSBC, BP and Shell) to form a portfolio that generates a higher income that is not available in the wider market.
We like the fact that this type of fund focuses on solving a real need for investors (delivering higher income) rather than simply aiming to generate high total returns.
We think that funds such as this have an important part to play in solving the income problem in today’s low-yield world.
Over the very long term there is unlikely to be too much difference in the total return, which is capital growth plus income, from funds such as these and more traditional equity income funds.
However, investors should bear in mind that in taking advantage of the higher yield available now, they may well sacrifice some of the growth of their capital in the future.
Investors in the Premier fund get income paid quarterly. Any fund charges are taken from the capital rather than the income stream.
The fund’s ongoing charge figure is higher than the average of its peer group, even when compared to similar higher-income strategies within the sector.
This is primarily due to the competition having more assets under management and so more room to make efficiencies.
Overall, we feel the fund’s OCF represents reasonable – but not good – value for money.
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