Fund Approach
Mutual funds offer a simple way to gain access to diversified portfolios of preferreds, including several low-cost ETFs. Flaherty & Crumrine's Preferred Income Opportunity Fund, for example, has delivered 10-year annualized gains of 7.73%. 

The major concern of most actively managed preferred funds is that they are largely closed-end vehicles. This means their actual market values can deviate substantially from the underlying net asset value of their investments. This can turn profits into losses when the so-called discount between the two widens.  But it also offers opportunities to buy assets on the cheap.

Using leverage to enhance the buying power of every dollar clients invest (bumping it up to as much as $1.50) enables closed-end funds to enhance yields and returns.   The risks of doing so were exposed during the financial crisis, when leverage exaggerated the losses of declining preferred prices.  When the market for auction rate preferreds (the source of leverage) froze, it forced fund managers to sell depressed preferreds at a bad time. The market value of closed-end fund preferreds were further hurt as investors fled these distressed situations.  But most funds have since found alternative, more dependable sources of leverage. Investors have returned, and the discounts have shrunk to more traditional levels.

Caveats
Advisors need to consider the tax exposure of specific issues. Those that pay dividends are likely delivering income taxed at a 15% rate for as long as the Bush-era tax cuts are in effect.  Preferreds that are backed by debt and paying interest are subject to income tax, creating a tax liability that can be at least twice that of dividend-yielding preferreds. Accordingly, trust preferreds are more appropriate for tax-deferred accounts.

While the low interest rate environment is not likely to change soon, borrowing costs will eventually rise. Preferred prices are based on spreads over ten-year Treasuries. This portion of the yield curve has moved up in recent months, even while the Fed has kept overnight rates steady. This may suggest that even when the central bank starts to normalize rates, long rates may remain stable.  The reason: The market may worry less about inflation if it sees the Fed moving against it.  And long rates are largely a measure of inflation expectations. 

Currently, according to the Bank of America Merrill Lynch Preferred Stock Fixed Rate Index, the average preferred yield is around 7% or 358 basis points above ten-year Treasuries, which were yielding 3.42% to maturity at the end of January.  But if Treasury yields were to permanently exceed 4.5%, preferred yields would likely bump up an additional 100 basis points.  This would mean a corresponding decline in preferred share prices to affect this yield shift.

The two-year rally preferreds have enjoyed is presenting another risk.  Investors should generally avoid higher coupon shares selling above the call price if the issues are presently callable since they can lose the entire premium paid above call at any time.  

As previously mentioned, financials may also be affected by regulatory changes to what may be counted as capital reserves. Regulators, for example, are taking aim at hybrid preferred securities. These issuances soared prior to the financial crisis because they could account for up to 15% of a financial's capital reserves. 

If ruled ineligible as reserves, many could be called even before their call date in accordance with Dodd-Frank regulations, warns McAlinden. Overall, the market could see consolidation of various types of preferreds.  And if new issues come with equity conversion triggers, this would compromise the reason for buying preferreds in the first place.

This all means that preferreds of large, diversified, name-brand firms may be the safest way to lock into attractive yields, according to experts.