3 income bets that will keep working when Fed rate rises

The Federal Open Market Committee, the Federal Reserve's policy-setting committee, is going to announce today the results of its latest meeting to discuss the state of the economy and current monetary policy.

It is widely expected that the Fed will delay the first interest-rate hike since the recession until September at the earliest (the latest CNBC Fed Survey reflects this market bet, and I concur). But either way, investors are already trying to figure out what to do with their rate-sensitive, yield-focused investments.

Treasury bonds traders
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Below are four investments that gained popularity in the quest for higher yields during the zero-interest-rate policy implemented during the financial crisis. A rising-rate environment might mean less demand for these assets, but in the case of at least three of the asset classes, I believe their core benefits to a diversified portfolio remain intact.

1. REITs

REITs have undoubtedly benefited from historically low interest rates, since they are able to finance projects at attractive rates and investors in search of yield have pushed up share prices. We've seen REITs lag as an asset class in 2015 in anticipation of higher interest rates, but REITs have historically done well in rising-rate cycles.

According to a study done by financial advisory firm Gerstein Fisher, REITs have actually performed better in rising-rate periods than in falling-rate periods. This makes sense when you consider that REIT cash flows depend on occupancy and rental rates, both of which tend to do well when the economy is improving, and most rising rate cycles are the result of an improving economy.

Another consideration is that some REIT funds have global exposure that will provide additional diversification.

2. MLPs

The primary reasons investors should consider MLP exposure are the ability to earn tax-deferred income in a taxable account and the diversification benefit that comes from the low correlation MLPs have to traditional equity asset classes.

MLPs have gained popularity in recent years as an area for investors to play the U.S. energy renaissance and capture high, growing income distributions. Although this broad asset class has a limited history of performance during rising rate cycles, there are reasons to hold on to these positions when rates begin to rise.

Read MoreHow to invest in energy MLPs using funds, ETFs

The most important reason is related to the way MLPs are structured for tax purposes. The distributions from MLPs are largely tax-deferred until the investor sells the position. As a result, liquidating a position would trigger a tax bill. However, if you were to hold the position until death, you would never end up owing income tax on those distributions.

Another reason not to fear MLPs is the high level of U.S. energy infrastructure buildout needed over the next three to five years, which should allow the best-positioned MLPs to continue growing distributions.

Year-to-date flows into yield ETFs

Click to edit YTD Net Flows ($,M) AUM ($,M)
MLPs 1,166.66 21,245.07
REITs -2,614.23 38,405.74
High Dividend Yield -1,145.16 49,868.29
High Yield 1,430.05 43,933.49

(Source: FactSet Research Systems)

3. Dividend stocks

Dividend stocks come in all shapes and sizes, but demand for high-quality, large-cap dividend payers grew substantially over the past several years. The idea for many investors was to buy high-quality companies with rock-solid balance sheets that are providing more income through dividends than investors could earn in a bond portfolio.

In many respects this is a flawed strategy from the start, because the primary purpose of a bond portfolio is to reduce volatility. Dividend stocks do not have the same type of price safety that investment-grade bonds enjoy and, thus, should not be considered bond substitutes.

Read MoreAn ETF approach to retirement income that's catching on

That said, high-quality companies ought to continue paying their dividends through thick and thin, but all stocks are susceptible to the price volatility expected in a rising-rate environment. Some sectors, such as utilities, are more sensitive to interest-rate levels and are more likely to be laggards than a diversified conglomerate, pharmaceutical or consumer goods company.

4. High-yield bonds

High-yield bonds (also referred to as junk bonds) offer higher income than government bonds or investment-grade corporate bonds, but yield spreads have narrowed in the past several years due to investors reaching for yield. In other words, investors are being compensated less for the additional risk of lending to a less creditworthy issuer.

Relative to other bonds, high-yield bonds tend to be on the lower end of interest-rate sensitivity. This is because they are typically issued with terms of 10 years or less and are often callable after four or five years.

However, high-yield bond prices have price volatility that resembles that of stocks. If the economic outlook or corporate earnings were to deteriorate, high-yield bonds are likely to suffer. Because fixed income is supposed to be the safest part of your portfolio, investors should be wary of having more than a very modest portion of their fixed-income allocation in high-yield bonds.

Yield ETFs with the biggest YTD outflows

iShares U.S. Real Estate: ($1.64 billion)
Vanguard REIT: ($1.2 billion)
iShares iBoxx $ High Yield Corporate Bond: ($642.5 million)
iShares Select Dividend: ($722.6 million)
SPDR S&P Dividend: ($574 million)

(Source: FactSet Research Systems)

By Peter Lazaroff, CFP, CFA at St. Louis, Missouri-based investment advisor Plancorp