Finding diversified income streams for your ISA

There is a common misconception that income investing is just for those at or approaching retirement – the reality could not be further from the truth, it’s also an invaluable tool for those starting to grow their wealth.

A couple of examples come to mind when evaluating the power of dividends and reinvesting them. The first is a Barclays’s study which found that an investment of £100 in UK shares in 1899 would have been worth only £173 in real terms at the end of 2018 based on capital growth in the Barclays UK Equity Index alone*. If, however, all the dividends had been reinvested, the total value of the portfolio would have soared to £30,776 over the same period*.

The second is that Asia – often seen as the hotbed for growth investors – actually derives some 70% of its long-term equity returns from dividends**. In a nutshell, incorporating income strategies to your portfolio is almost an essential to help you reach your long-term goals – meaning you ignore them at your peril.

Four ways to add income to your portfolio

 1. Equity income funds

Equity income can be a valuable addition to any investor’s portfolio. Equity income funds primarily invest in stocks of companies that pay regular dividends. These funds focus on selecting companies with a history of stable earnings and a commitment to sharing profits with shareholders. By investing in such funds, investors can enjoy a consistent income stream in the form of dividends. Additionally, reinvesting your income, can provide a balanced approach to income and growth.

2. Fixed income funds

Including fixed income funds in your portfolio can provide stability and consistent returns. These securities pay regular interest to investors, offering a predictable income stream. Bonds have become increasingly more attractive today and can help balance the risk-return profile of your overall portfolio, while still offering a resilient source of income.

3. Alternative assets

Alternative assets encompass a broad category of investments beyond traditional stocks and bonds including private equity, commodities and real assets such as infrastructure. While the income generated from alternative assets can be less predictable, these investments can offer unique income streams with a lower correlation to wider markets.

4. Property

Property and real estate have long been a reliable source of income. While not everyone has the ability to buy a second home for rental income, investors do have access to real estate investment trusts (REITs). REITs, in particular, are companies that own, operate, or finance income-generating real estate across various sectors, such as residential, commercial, or industrial properties.

Here we take a closer look at each of the four areas and the funds that meet the bill.

Equity income exposure across regions

Equity income isn’t one size fits all. Within the sector there are a number of regional exposures offered to investors. The most familiar is probably the UK Equity Income sector. Simon Murphy, manager of the VT Tyndall Unconstrained UK Income fund, joined us recently on our podcast full of enthusiasm for the prospects for the UK market. The fund invests primarily in the mid-cap area of the market offering something different for those interested in UK income.

Read more: Has the tide turned for UK Equity income in 2024?

Access to a wide range of global equities is also popular. A fund such as JPM Global Equity Income, which invests in large to mega-cap stocks globally and has returned 82.7% for investors over five years*** is one option. Investors might also consider Guinness Global Equity Income, which as returned 76.8% over the same period***. The portfolio typically consists of around 35 equally-weighted stocks, which means that investments are very different from the benchmark index.

More regional exposure to income can further diversify a portfolio. Investing in a Asian equity income fund, for example, offers both income and the potential for stronger growth than we see in developed markets. One option for investors is the Jupiter Asian Income fund. Manager Jason Pidcock looks for companies with reliable dividends that can deliver both income and growth for investors.

Four fixed income funds yielding over 5%

After a tough few years in fixed income markets, with inflationary pressures and rising interest rates, bonds are now looking more attractive with yields high, risks diminishing and the economic cycle turning. This means fixed income funds may once again have real appeal for investors.

The Aegon High Yield Bond fund is an unconstrained, high-conviction, global high-yield bond fund with a current yield of 7.3%^. This fund differentiates itself from its peers through its high conviction and flexible approach, with almost half of the portfolio in the UK and US^^. Further afield is the M&G Emerging Markets Bond with a current yield of 6.6%^ the fund can invest in both government corporate bonds, denominated in local currencies or in the US dollar (‘hard’ currency).

As the name suggests, the Liontrust Sustainable Future Monthly Income Bond fund aims to produce a monthly income with some capital growth by investing in sustainable ideas. With a current yield of 5.8%^ the fund primarily invests in corporate bonds and some government bonds. Lastly, the Royal London Corporate Bond offers access to a portfolio of predominantly, but not exclusively, investment grade corporate bonds. With a current yield of 5.2%^.

Alternatives providing income for investors

As an investment opportunity, infrastructure has evolved in recent years to include digital infrastructure as a core component of the asset class. Infrastructure investments have historically centred around ‘real assets’ such as utilities, ports and transport systems such as airports. But as consumers and businesses have moved towards digitisation, the asset class has expanded to include mobile towers and data centres. Funds worth considering would be the likes of the First Sentier Global Listed Infrastructure fund or the Schroder Digital Infrastructure fund, which yield 3.3% and 2.4% respectively.
The term ‘specialist’ can house widely recognisable themes such a property and medical technology, albeit often within a sub-sector or structure that lies outside traditional categories. Owing in part to the increased accessibility of instruments such as ETFs and investment trusts, these more niche offerings present a viable income source and an alternative to mainstream asset classes. Funds investing in specialist assets include the likes of the VT Momentum Diversified Income fund, which yields 5.2%^^.

Adding property exposure to your ISA

Not everyone can afford to be a landlord and that’s okay! You can still get access to property in your portfolio in a variety of ways. One way is an open-ended property fund such as the CT European Real Estate Securities fund. This fund provides access to a portfolio of real estate securities listed in the UK and Europe. The fund has one of the best resourced and most experienced teams and returned 10.7% for investors compared to -2.9% for their benchmark, over five years^^. Manager Marcus Phayre-Mudge also manages the TR Property Investment Trust which provides access to both shares of property companies but also a small amount of physical property in the UK.

As with most portfolio construction, the key lies in diversification. You don’t want to rely on one source of income. By incorporating a mix of the above, you can create a well-rounded source of income. Remember: it’s essential to align your investment choices with your financial goals and risk tolerance, and conduct a periodic reassessment of your portfolio to ensure it remains aligned with your changing needs.

Read more: A guide to uncorrelated asset allocation

*Source: Liontrust Asset Management
**Source: Schroders, December 2022
***Source: FE Analytics, total returns in sterling, 21 February 2019 to 21 February 2024
^Source: FE Analytics, 22 February 2024
^^Source: fund factsheet, 31 December 2023