Investors Pivot to Alternative Income Sources Amid Bond Market Volatility

Driven by persistent inflation, geopolitical instability, and a relentless climb in interest rates, some investors are reducing their exposure to traditional fixed-income securities. While financial advisors maintain that bonds remain a vital component of diversified portfolios, many are reallocating toward shorter-duration assets or seeking income through non-traditional channels.

“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. Potential alternatives include insurance-linked securities, master limited partnerships (MLPs), covered call ETFs, dividend-paying stocks, real estate investment trusts (REITs), preferred stocks, asset-backed securities, and merger arbitrage trades.

However, experts caution that these options involve trade-offs. Matt Gentzkow, managing director of Coastal Bridge Advisors, noted that generating yield outside of bonds often requires assuming additional risk. He warned investors against concentrating too heavily in a single sector and highlighted that many income-focused equity plays are themselves sensitive to rising interest rates.

With major bond categories experiencing significant drawdowns as rates have surged, investors are exploring several alternative categories for income generation:

Non-Traditional Fixed Income

Paul Karger, co-founder of TwinFocus Capital Partners, favors catastrophe bonds, or “cat bonds.” These high-yield insurance-linked securities allow insurers and governments to transfer natural disaster risk to capital market investors. The asset class typically offers mid-to-high-single-digit returns and has shown performance largely uncorrelated with traditional financial markets, though returns can turn negative following years with above-average catastrophe activity.

Karger’s firm allocates between 3% and 5% of its portfolios to cat bonds via mutual funds. The Victory Pioneer CAT Bond Fund recently surpassed $2 billion in assets under management. For those seeking ETF exposure, the Brookmont Catastrophic Bond ETF (ILS) posted a year-to-date return of 5.57% as of Aug. 31, though it carries a relatively high expense ratio of 1.58%.

Income-Generating Equities

Dividend-paying stocks offer potential for capital appreciation and dividend growth, though they come with higher volatility than bonds. Morningstar identified the Capital Group Dividend Value ETF (CGDV), Fidelity High Dividend ETF (FDVV), and JPMorgan Dividend Leaders ETF (JDIV) as top passive income options for 2026.

REITs provide income through dividends and share price appreciation but carry a different risk profile than bonds due to constant repricing. According to Morningstar, top REIT ETFs include the Dimensional US Real Estate ETF (DFAR), Schwab US REIT ETF (SCHH), and SPDR Dow Jones Global Real Estate ETF (RWO).

Master limited partnerships, which invest in energy infrastructure such as oil and gas pipelines, traditionally offer high yields and tax advantages. However, Michael W. Crook, chief investment officer at Janney Montgomery Scott, expressed caution in the current environment. With the 10-year Treasury yield in the upper 4% range, the yield premium of MLPs is less compelling than it was when rates were near 1% in 2021. The Global X MLP ETF (MLPA), which focuses on midstream pipelines, reported a 30-day SEC yield of 6.82% as of Sept. 4.

Preferred stocks, which sit senior to common equity, also face interest rate sensitivity. The iShares Preferred & Income Securities ETF (PFF) had a 30-day SEC yield of 6.52% as of July 31 with an expense ratio of 0.45%.

Alternative Investment Funds

Merger arbitrage strategies exploit the price differential between a merger announcement and its completion. Jeff Mortimer of Elyxium Wealth noted that this approach offers returns uncorrelated with interest rate risk, producing a risk/return profile similar to bonds. Morningstar highlights that while upside is capped, downside risk increases if deals fall through. Notable ETFs include the NYLIM Merger Arbitrage ETF (MNA), AltShares Merger Arbitrage ETF (ARB), and ProShares Merger ETF (MRGR), with expense ratios ranging from 0.75% to 0.77%.

Alternative Lending

Stuart Katz, chief investment officer at Robertson Stephens, is exploring private market strategies that lend against real assets like rail cars and gas wells. These collateralized asset-backed lending opportunities often have durations of one to three years and generate tax-deferred yields between 6% and 10%. Although less sensitive to rising rates, these investments carry liquidity risk and potential asset depreciation. The Janus Henderson Asset-Backed Securities ETF (JABS), which focuses on U.S. consumer lending, has a net expense ratio of 0.33%.