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Using alternative income streams within a portfolio

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Understanding current trends in income

One way for managers and investors to access alternatives is via an investment trust.

Peter Elston, chief investment officer at Seneca Investment Managers, explains the advantages of using investment trusts to allocate to alternative assets.

“Income streams tend to be inflation linked, either explicitly as in the case of infrastructure – price tariffs that are based on RPI – or implicitly as in property – rental income streams tend to be linked to broader inflation,” he reasons. 

“Furthermore, the share prices of the trusts themselves on the whole exhibit low volatility and low correlation in relation to broader equity markets. The combination of these market attributes, as well as the higher, index linked income streams, means that adding them to a portfolio can both enhance return and lower volatility.”

Not the answer

But for some managers, alternatives are not the answer – simply diversifying away from bonds and equities does not necessarily guarantee any more income.

Will McIntosh-Whyte and David Coombs, who manage the Rathbone Multi-Asset Portfolio Funds, issue a note of caution about alternative income, that if something seems too good to be true, it probably is.

“We always remind ourselves that return is linked to risk,” explains Mr McIntosh-Whyte. 

“If something offers a significantly higher yield, it tends to be because of the higher risks involved. 

“One area that we have found income at a reasonable price is in structured products. These are contracts with investment banks offering cash payments that are dependent on certain market conditions or events – for example, the S&P 500 doesn’t fall more than 50 per cent.”

Another strategy the managers use in their portfolios is to make the most of market dislocations to lock in yield.

But he admits: “These are higher risk strategies than the traditional sources of portfolio income. 

“To ensure our cash flow is solid, we buy short-dated, high-coupon government and investment grade bonds. These give our portfolio a high ‘natural’ cash flow in return for a small capital loss at redemption. This capital erosion is offset by the superior capital growth we target from our equity investments.”

Infrastructure boom or bust?

Andrew Morgan, portfolio manager of Alpha:r2 at Walker Crips, says alternative investments can potentially meet some of the perennial need for income, “particularly infrastructure funds where the underlying investments tend to have good visibility of earnings and therefore relatively stable cashflow and income payments”.

Infrastructure has been in the headlines for all the wrong reasons lately though, following the collapse of the contractor Carillion, leaving many infrastructure projects unfinished.