Don’t be fooled by maximiser funds

One of the goals of central bank policy in recent years has been to force investors to take more risks. And whatever else low interest rates and quantitative easing have done to our economy, one glance at asset prices shows that central bankers have succeeded on this score. Yields on 'safe' government bonds (and most others), as well as interest rates on savings, have been driven to record low levels as bond prices have been pushed ever higher.

It's tough to find tempting dividend yields in the stockmarket too, as share prices have gone up. In short, income has become increasingly hard to come by.So it's easy to see why so-called maximiser funds have caught the attention of so many investors, saysKyle Caldwell in The Sunday Telegraph. These funds, with names like "Schroder Income Maximiser" and "Fidelity Enhanced Income", offer yields of more than 6% and sometimes as much as 8%.

That's an extremely enticing offer in a climate where your average FTSE 100 share yields just 3.5%, and the typical UK equity income fund doesn't offer much more. But as we all know, there aren't any free lunches in investing if a return looks unusually high, it's because there's risk involved. So what's the catch?

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What it boils down to is that these funds sacrifice tomorrow's growth to pay today's income. Managers use derivatives to swap future capital gains for a cash payment now. This creates immediate income for investors at a higher rate than the dividend income paid out by the underlying shares but it means that at least some of the long-term growth is given away. And remember that if the other party is willing to do the deal, then the chances are that the future growth is being sold, if not cheaply, then certainly not at a spectacularly beneficial price.Performance so far bears this out.

As Caldwell notes, if you compare the five oldest maximiser funds to the average UK equity income fund, they fare badly. For example, in total return terms, if you'd invested £10,000 five years ago, you'd have made £5,960 out of the Premier Optimum Income fund £4,500 income and £1,460 capital growth. But the typical UK income fund would have paid £8,060 £2,770 in income and £5,290 in capital growth.

So there's no reason to be distracted by the high yields on these funds. If you want income, two strong active options have been PFS Chelverton UK Equity Income, which yields 4.5%, and has returned roughly 150% over the past five years, and Unicorn UK Income, which yields 4%, with a return of nearly 140% over the same period.