Fidelity Enhanced Income Fund has a simple aim - a high and stable level of income from the UK stock market.
And while some UK equity income funds may be content to match the income yield of the market but little more, Enhanced Income is looking to decisively beat it. To do that, the fund’s manager Michael Clark not only seeks out high dividend paying stocks, but employs call options to boost income even further.
The process adds a layer of complexity to the fund’s management but at the heart of the call option process is a relatively simple bargain - the fund will agree to sell the right to buy a stock at an agreed price to a third party, and will adds the proceeds of that sale to the income being paid to investors.
It’s sometimes described as giving up part of total return in exchange for extra income. “There’s an element of truth in that,” Clark tells me. “It doesn’t always happen, but if you think about it the call option allows a third party to buy a stock from you at an agreed price, and if the real price rises above that, then you give up extra gain. But the process - when you do it systematically - allows us to add to the yield.”
It is that extra yield which makes the fund stand out and appeal to a certain type of investor. Its yield at the time of writing is 7%, above the 5% that Clark says the fund would produce without the call option process and well clear of the around 4% that the UK market has produced historically. For those using investments to live from, including in retirement, that level of yield is attractive, particularly if they are less concerned with capital growth. Please note this yield is not guaranteed and will fluctuate with the market.
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Clark must seek out strong dividends, of course, and he is cautiously optimistic that the UK will continue to produce shareholder rewards. “The UK market is actually quite defensive,” he says. “The mix of companies in the Footsie have produced dividends that have held up well during slowdowns in global growth. There will always be cuts - and we have seen some, like Vodafone - but it’s been made up in other areas. Banks are a sector where dividends have returned.”
Income levels on the UK market are dependent on a small group of very large payers, but Clark says this dividend concentration has eased versus four or five years ago, and that there’s now a healthy base of strong payers.
That doesn’t mean there aren’t risks. “When you see a yield at 9 or 10% it’s often the case that it isn’t delivered. One of the issues we’re watching closely right now is over-indebtedness. After nine or ten years of very low interest rates, some companies now have big debts and any slowdown immediately puts dividends under pressure. That’s essentially what happened with Vodafone and it’s something we always try to avoid.”
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The value of investments can go down as well as up so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.