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BLOG: How to build an income portfolio with your ISA

BLOG: How to build an income portfolio with your ISA
Your Money
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Your Money

Higher interest rates mean it is a lot easier to build an income-generating ISA portfolio now than it has been for some years.

Previously, investors were getting very low yields on bonds, struggling to get 4% prior to the start of the current interest rate hiking cycle, which began in earnest in 2022. This has completely changed now, because interest rates have increased so much in the UK and the US in particular.

Bonds are not the only asset you should include in an income portfolio, however. Here are some other options for building an income portfolio.

Global equity income

Gaining exposure to a wide range of companies around the world is a great way to spread your investment risk, and a global equity income fund should be a core holding for your ISA.

We like the M&G Global Dividend fund, which provides an opportunity to diversify income streams by investing in companies that provide stable and rising dividends, perfect for investors who are worried they are over-reliant on the same few companies for their dividend yield.

With an historic yield of 2.49% M&G Global Dividend is typically not the highest-paying income fund, but it does offer a rising income stream (to help with your long-term purchasing power) and excellent total returns for investors.

Government bonds

We like Government bonds, typically those issued by the UK (gilts) or the US (Treasuries), as they have virtually no credit risk (we do not expect the UK or US Governments to default on their bond payments any time soon).

Today, 10-year gilts offer investors a risk-free yield of 3.97%, and a 10-year Treasury is offering 4.07%. For both, these are among the highest yields we have seen for many years.

The biggest holding in the Invesco Tactical Bond fund is UK gilts, and it also invests in US Treasuries. Stuart Edwards, manager of the fund, says “we think the level of reward (yield) is attractive for such high credit quality assets”.

He also likes some Government bonds in non-core European markets and in emerging markets, “where we can pick up higher yields”.

Government bonds have been offering their highest yields in well over a decade, he says, adding the macroeconomic backdrop – slowing growth and weaker inflation – is supportive for bonds.

UK small-caps

UK equity income is very unloved at the moment, in particular the UK small-cap income sector. But this means investors have the opportunity to pick up a bargain, and add diversification.

The WS Montanaro UK Income fund focuses on small and medium-sized businesses that offer an attractive dividend yield or the potential for dividend growth.

Guido Dacie-Lombardo, the fund’s manager, points out small caps outperformed large caps by 3.1% a year between 1955 and 2023. Small caps can also grow their earnings faster, and have delivered higher dividend growth, by 1.3% a year over the same time period.

Spreading investment risk is another factor – many large-cap income funds hold the same stocks, as there are only 24 very large UK companies with a yield over 3%, according to internal research conducted by Montanaro, which are typically concentrated in the energy and banking sectors.

“We therefore believe it is better to blend a large-cap income fund with a small-cap income fund for diversification,” says Dacie-Lombardo, especially now, as small caps tend to do better as inflation and interest rates start falling.

Asian income

Finally it is worth considering an Asian fund for your ISA income portfolio, as you can pick up some good dividends from the region.

Jupiter Asian Income offers a yield just over 4%. It also offers access to developed markets via Australia, while its income mandate offers a lower-risk approach to the region.

“When looking at Asia for income, we expect Australia to outperform many of its developed market peers over the longer term,” says Jupiter Asian Income manager Jason Pidcock, who points to its stable democracy, productive workforce, many successful companies with significant market shares and solid barriers to entry, and very few state-owned enterprises.

Pidcock is also positive about India, which offers strong growth opportunities in many domestic-focused sectors, as well as increasingly among exporters.

“Asia is home to a number of world class technology companies that are the enablers of artificial intelligence. The net cash balance sheets of the technology companies that we own in our fund will enable them to translate earnings growth into dividend growth,” he adds.

Alternative investment trusts

Under-appreciated in the area of yielding assets are investment trusts that invest in alternative assets, such as renewable energy, shipping, aircraft leasing, supermarkets, care homes and music royalties.

Alternative income investment trusts grew rapidly during the period of ultra-low interest rates, but have fallen out of favour since interest rates began rising as investors switched to bonds.

Some alternative investment trusts have gone from yielding 4-5% to 8-9% now, offering income investors an incredible opportunity.

A good way to invest in a broad range of alternative investment trusts is via the Waverton Multi Asset Income, which has roughly 20% in these or the VT Momentum Diversified Income fund which has roughly 30%.

Juliet Schooling Latter is research director at Chelsea Financial Services and FundCalibre