Advisers seeking to create an equity income portfolio that is properly diversified should have exposure to alternative income products, according to Gary Potter, who jointly runs a range of multi-manager funds at BMO Asset Management.
Among the funds he runs is the £979m Navigator Distribution fund, which has a current yield of 5.6 per cent.
Mr Potter said: “To build an income portfolio that is diversified you need to have exposure to different countries, every market can have a place in an income portfolio now, different investment styles and particularly to alternative income funds.
"If you have all of that then the income will be coming from a lot of different sources, including sources that are not correlated to wider markets; we have an investment in a fund that owns holiday parks in the UK, for example, and the performance of wider equity markets does not really affect that.
"We also own the Schroders Income fund, which uses the value style of investing, a style that has been out of favour in recent times, as growth type funds have performed much better, but owning both styles allows for proper diversification, and protects for when market sentiment shifts to favouring a different style. ”
Alternative income funds in areas such as student property, doctors surgeries and aircraft leasing have attracted inflows in recent years, particularly as an alternative to bonds, where yields have been very low, and prompted income investors to replace their bond allocation with an alternative.
He added that a major mistake many investors make when creating an equity income portfolio is they buy a number of funds and think this is creating diversification, but if you then look at the funds, you notice they all have significant investments in a relatively small number of the large, well known, income stocks.
"So while it may look like diversification at the fund level, at the individual stock level it's not diversified at all, and that can create a problem if there is volatility in markets.”
Robin Geffen, manager of the Liontrust Balanced Fund, has highlighted this as an issue with UK equity income funds, stating that many such funds are relying on a small number of the largest companies in the FTSE 100 for dividends, which could be an issue if those companies then struggle.