Many investors think ISA investing is all about sticking equities away for the long term and forgetting about them. However, we think there are good reasons for allocating to alternative income-generating assets in your ISA, even for those concerned with long-term capital growth.
We think that many investors don’t fully appreciate the benefit of reducing the volatility on a portfolio. When thinking about long-term returns, the tendency is to think of the average return in the long run as what you will get, and to think of volatility as a measure of the mark to market “discomfort” along the way. However, this ignores the devastating effect of sequencing risk, and the fact that a particular average annual return can be consistent with negative eventual outcomes. Adding uncorrelated assets, such as alternative income funds, to your portfolio can massively reduce the risk of a terrible investment outcome, and, as we shall see, without necessarily reducing the expected return.
This is certainly true when you consider how favourably the returns of these alternative income funds compare to those from equities in recent years, another fact we think is under-appreciated, and which sets them apart from traditional diversifiers such as high-quality bonds.
There is no guarantee that future return patterns represent the past, of course. With respect to the alternative income funds we consider below, there are specific risks to capital which have to be considered. However, we think that there is a way to use these trusts taking these risks into consideration. The re-investment of the income from these trusts, reliable in the short term, gives the investor the opportunity to “pound-cost-average” their investment in equities when they look cheap, or reinvest in the same high yielding alternative assets. We consider how this might work below, and look at a range of alternative income funds that might be suitable.
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