Income alternatives to bonds as interest rates rise

For some investors, uncertainty in the bond market and a relentless rise in rates driven by inflation, geopolitical concerns and other factors is enough to throw in the towel, or at least significantly limit their exposure to fixed income.

While many advisors and strategists said bonds should remain part of a diversified investment portfolio, they are shifting allocation to lower-duration alternatives such as ultra-short bonds. Others are looking for complementary non-fixed income products for investors who want less exposure to bonds. “There are certainly a host of alternative strategies that can create current income in a portfolio,” said Tyler Glover, managing director of private wealth management consulting services at William Blair.

These options include insurance-linked securities, master limited partnerships, covered call ETFs, dividend-paying stocks, REITS, preferred stocks, asset-backed securities and merger arbitrage trades.

To be sure, there are caveats when investing in any of these options. “If you’re trying to generate alternative paths to income outside of bonds because of inflation risks and concern over rising rates, there’s a tradeoff between adding income from other sources and adding other risk to your portfolio,” said Matt Gentzkow, managing director of Coastal Bridge Advisors in Westport, Connecticut.

To generate more yield, or alternative sources of yield, you may have to take more risk, Gentzkow said. Investors also have to be careful not to put too many eggs in one basket. “You don’t just want one pool of income-generating assets that’s exposed to one specific sector,” he added. Additionally, some of the most popular income-oriented plays in the stock market are themselves interest-rate sensitive, which can dent the investment case for them.

With these caveats in mind, here are three broad categories with multiple investment options for investors seeking income outside traditional bonds. 

1. Staying within fixed income, but non-traditional bonds

Insurance-linked securities 

Paul Karger, co-founder and managing partner of TwinFocus Capital Partners in Boston, favors catastrophe bonds, also known as cat bonds, which are high-yield insurance-linked securities that allow insurers, reinsurers and governments to transfer the risk of natural disasters to capital market investors. 

The class often offers mid-to-high-single-digit returns, but the last several years have been unusually strong, with performance that’s not directly tied to traditional financial markets. Returns, however, can be negative in a year when there is a much higher than average incidence of catastrophes and insurance claims have to be paid out. 

Karger’s firm allocates 3% to 5% to cat bonds in almost all of its portfolios through mutual funds. Artemis, for example, has a primary focus in this market, with the Victory Pioneer CAT…