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The fundamental need for portfolio diversification
In today's complex investment landscape, diversification isn't merely a recommendation—it's essential. Most investors begin their journey with conventional assets: quoted equities, cash, and bonds. While cash investments and bonds offer stability, they typically generate only modest returns. Publicly traded equities may offer higher growth potential, but they come with elevated risk due to market fluctuations, company performance variations, competitive pressures, and global events ranging from geopolitical conflicts to natural disasters.
The fundamental weakness of conventional investments lies in their limited diversification opportunities. When an entire asset class faces downward pressure, a portfolio heavily concentrated in that sector can experience significant value erosion. Even diversifying across various industry sectors within public equities cannot fully protect investors from broad market downturns.
Alternative investments: The key to true diversification
To achieve genuine portfolio diversification, savvy investors are increasingly turning to alternative investments—financial assets beyond traditional equities, bonds, and cash. These include private equity, venture capital, hedge funds, real estate, and commodities. While some alternatives require substantial capital and target institutional investors, options like venture capital have become increasingly accessible to individual investors.
The critical advantage of alternative investments lies in their operation within private rather than public markets, providing a degree of insulation from public market volatility. In today's environment of extreme market fluctuations, this separation has become particularly valuable.
Market volatility and the private company advantage
The current investment climate is characterised by unprecedented volatility in public markets. Economic uncertainties – Trump’s tariffs are a prime example – inflation concerns, and geopolitical tensions have created a roller-coaster environment for public equities. In this context, private companies offer a compelling buffer against such volatility.
Private companies, particularly early-stage ventures, operate with valuations determined by private negotiations rather than daily market sentiment. Their value is more closely tied to fundamental business development, strategic milestones, and growth trajectories rather than short-term market fluctuations. This creates a smoothing effect within a diversified portfolio, as these assets don't react in lockstep with public market swings.
Hardman & Co's perspective: alternative investment integration for enhanced growth without added risk
According to research by Hardman & Co, integrating alternative investments like EIS, SEIS or VCT into a conventional portfolio can significantly enhance growth potential without proportionally increasing overall portfolio risk. Their analysis demonstrates that the tax reliefs associated with SEIS effectively create a risk buffer that counterbalances the inherently higher risk of early-stage investing.
The 50% income tax relief, combined with capital gains tax advantages and loss relief provisions, creates what Hardman & Co describes as a "downside protection mechanism" that fundamentally alters the risk-reward equation. When these investments are spread across multiple companies in diverse sectors, the portfolio gains exposure to high-growth potential while the tax advantages provide substantive risk mitigation.
Venture capital: The optimal alternative investment
Among alternative investment options, venture capital stands out for its accessibility and diversification benefits. It allows investors to build exposure to numerous early-stage companies across multiple sectors with relatively modest capital commitment. While each individual startup investment carries significant risk, a diversified venture portfolio spreads this risk while maintaining exposure to potentially exceptional returns.
Most venture capital funds target 3x returns, but investments in breakthrough companies can deliver exponentially higher results. The venture capital landscape follows a power law distribution, where a small percentage of investments generate the majority of returns. This underscores the importance of portfolio diversification within the venture capital allocation itself.
EIS and SEIS vs. VCT: A clear advantage
When considering tax-advantaged venture investments in the UK, investors typically evaluate three options: Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS), and Venture Capital Trusts (VCT). While each offers tax benefits, EIS and SEIS present distinct advantages over VCTs for several key reasons:
EIS and SEIS investments provide direct access to companies at the earliest stages of development, when the potential for value creation is greatest. In contrast, VCTs often include companies at various stages of development, some of which may have already experienced significant growth. This means VCT investors may effectively "pay for past growth" rather than capturing the full value creation journey.
While VCTs offer 30% income tax relief (capped at £200,000), SEIS provides 50% relief (on up to £200,000), and EIS offers 30% relief on up to £1 million (or £2 million for knowledge-intensive companies). The structure of EIS and SEIS tax reliefs is also more advantageous, with capital gains tax reinvestment relief, disposal relief, inheritance tax benefits, and loss relief provisions creating a comprehensive protection framework.
EIS and SEIS funds typically provide clearer visibility into the underlying portfolio companies and investment strategies. By contrast, the publicly traded structure of VCTs can sometimes obscure the true nature and performance of underlying investments.
In today's volatile market environment, the direct access to private companies provided by EIS and SEIS offers superior insulation from public market fluctuations compared to VCTs, which as publicly traded entities can themselves be subject to market volatility regardless of their underlying portfolio performance.
Building a diversified portfolio with EIS and SEIS
For investors seeking to add alternative investments to their portfolio, EIS and SEIS funds offer accessible entry points. Key considerations when selecting a fund include:
Portfolio diversity: Funds that invest in a broad range of companies across multiple sectors provide better diversification and higher probability of capturing exceptional returns.
Investment minimum: Some funds are accessible with investments starting at £5,000, making them suitable for various investor profiles.
Track record: Evaluating the fund manager's historical performance and deal flow access.
Investment philosophy: Some funds take a highly selective approach with significant support for portfolio companies, while others emphasise broad market coverage with rigorous quality controls.
Conclusion
As traditional investments face heightened volatility and constrained returns, strategic diversification through alternative investments—particularly EIS and SEIS venture capital allocations—offers a compelling solution. These tax-advantaged investments provide enhanced growth potential without proportionally increasing portfolio risk, while also creating a buffer against public market volatility.
The superior tax advantages, early-stage access, and transparent structure of EIS and SEIS make them distinctly more attractive than VCTs for investors seeking to optimise their alternative investment allocation. By carefully selecting funds that align with personal investment objectives and risk tolerance, investors can build truly diversified portfolios positioned for both stability and growth in an increasingly unpredictable investment landscape.
The Access EIS Fund
Our primary EIS fund co-invests with proven angel investors to build large portfolios of hand-picked companies for our investors. It's a high risk investment, and we can't guarantee that every startup will be a unicorn, but we're confident that our approach is the smartest on the market. Even better, we can show you the data to prove it.
If you're interested and would like to find out the benefits of investing towards the start of the tax year, register with us to be notified when the fund is next open to investment.
