Fidelity has published its latest Advisor Investment Pulse Survey, finding that retirement-focused financial advisers are squarely focused on boosting diversification and downside protection in client portfolios.

Given the machinations in Washington and state capitols across the U.S., tied to booming equity markets, it’s no surprise Fidelity finds “the government/economy” and “portfolio management” remained the top two areas of focus in Q2 2017. Additionally, the survey found that financial advisers have become increasingly concerned about market volatility and equity market level, ranked third and fourth, respectively.

The previous edition of the adviser survey found interest rates ranked No. 3, dropping to ninth-most important in Q2. Fidelity says this is somewhat perplexing given the current rising rate environment and advisers’ focus on downside risk.

“With the stock market near record levels, advisers have become increasingly focused on making sure their clients’ portfolios are well diversified across the different asset classes, whether it’s equity or fixed income,” notes Robert Litle, head of intermediary sales, Fidelity Institutional Asset Management. “In this environment, we are seeing greater attention among advisers to protecting clients from any downside risk.”

Litle recommends, given the difficulty in predicting the direction and pace of interest rate changes with any certainty, that advisers should “consider different market and interest rate scenarios as they help investors stick to their long-term investment plans.” Simply put, interest rates “should remain top-of-mind for advisers, given the Federal Reserve’s forecasts for a gradual increase in interest rates.”

The Fidelity research points out that actively managed U.S. large-cap funds “have tended to outperform in months when interest rates were rising, and tended to underperform when rates were falling or flat … One reason could be that the average actively managed U.S. large-cap fund has historically held relatively more mid-cap exposure than its benchmark index.”

NEXT: Concerns about the downside 

Fidelity goes on to explain how, over the past few decades, mid-cap stocks with capitalizations of tens of billions down to $1 to $2 billion, have had higher dispersion of returns than mega-caps: “Higher dispersion in a group of stocks, which measures the difference of all the individual stock returns from the overall index, suggests potentially greater opportunities for active managers to leverage their stock selection skills, buy winners, avoid losers and thus earn higher excess returns.”

Fidelity’s research shows that concerns about the equity market levels and possible downside risk are leading many advisers to look for “opportunities to generate yield and income,” rising from No. 11 to No. 6 in the rankings from Q1 to Q2.

“As they do so, advisers should consider a possible valuation dynamic in the current market, which suggests another potential benefit for actively managed funds,” Fidelity suggests.

As the adviser survey report lays out, in recent years, the yield on 10-year Treasury bonds has become comparable to the dividend yield of U.S. large-cap stocks, “and many income-seeking investors have replaced bonds with high-dividend stocks in their portfolios.”

“Since high-dividend stocks tend to be in defensive market sectors like consumer staples, real estate, telecommunication services and utilities, the increased demand has inflated the prices of stocks in defensive sectors, pushing their price-to-earnings ratios to a 20-year high, relative to the rest of the market,” Fidelity explains. “However, a rise in Treasury bond yields could lead to a decrease in demand, resulting in lower P/E ratios and deflated returns. Many actively managed funds try to avoid overweighting stocks that are priced much higher than typical valuations and in some cases maintain greater exposure to non-defensive sectors, which have tended to beat the index when rates rise.”