At a recent investment conference in Manhattan, one of the themes discussed by various exchange-traded fund companies was how to deal with the threat of rising interest rates. At a time when some financial advisors are seeking cover by escaping fixed-income investments, Dominic Maister, director of the iShares due diligence team at BlackRock, reminded the audience that fixed-income strategists traditionally combat the inflation threat by altering maturity and duration rather than bailing on the asset class altogether.  

Toward that end, the industry is seeing continued expansion of fixed-income ETFs. iShares, for example, now has 35 such offerings, enabling advisors to create customized responses to rising rates.

"Let's say you want diversified fixed income exposure with duration that's comparable to the Barclays Aggregate Bond index, but with much higher yield," Maister said. "You can blend three indices that offer a higher percentage of investment-grade credit alongside mortgages and Treasuries. You end up with an index that has the look and feel of the aggregate, but with a slightly higher yield."

Maister added that if you want the same sector exposure as the aggregate index, but with shorter duration, combine shorter duration credit indexes with shorter duration Treasuries, mortgages and agencies. He said this results in a modified aggregate index with lower duration and slightly lower yield.

Panelists also see a trend of shifting to equities that yield more than most government debt, or at least provide decent yield with minimum volatility. One recently launched dividend-focused ETF from iShares, the High Dividend Equity Fund (HDV)--which invests in companies such as The Coca-Cola Co. and Johnson & Johnson--focuses on higher-quality and lower-beta type stocks that don't necessarily offer the highest yields.

Some ETF companies report growing interest in emerging market income funds. Luciano Siracusano, Wisdom Tree's chief investment strategist, said that since last August nearly $1 billion has been invested in his firm's Emerging Market Local Debt Fund (ELD).  And since March, more than $258 million has made its way into Wisdom Tree's Asia Local Debt Fund (ALD).

Siracusano said his firm's short-duration currency ETFs can act as alternative income plays in a rising interest rate environment. He said the Wisdom Tree Dreyfus Emerging Currency Fund (CEW) offers equally-weighted exposure to 12 emerging market currencies, while the Wisdom Tree Dreyfus Commodity Currency Fund (CCX) offers currency exposure to major commodity exporting countries. He added that besides delivering higher yields, these products used as a way to help investors diversify out of the dollar without needing to periodically roll in and out of currency contracts.

While there has been significant growth in "long" income funds, ETF specialists were mindful of accelerating demand for short Treasury funds as a simple way to protect investors from falling bond prices.  Despite the Federal Reserve's reticence to seriously discuss pushing up rates, at some point the Fed will have to end the era of cheap money.

--Eric Uhlfelder