The fund is 57% invested in financials and 26% in utilities. About 15% is invested in the telecommunications and energy sectors. The largest holdings include Nexen Inc., U.S. Bancorp, MetLife, Barclays Bank, Goldman Sachs and Wells Fargo.
There are just a few open-end mutual funds that invest exclusively in preferred stocks. But there are a dozen closed-end preferred stock funds on the market. These funds use some leverage to boost yields and total return. Today, the asset coverage ratio of the closed-end funds is high, according to a Fitch Ratings report on closed-end fund leverage. Asset coverage is a test that determines a company's ability to cover debt obligations with its assets after all liabilities have been satisfied.
Cara Esser, an analyst with Morningstar Inc., Chicago, says that banks' new preferred issues should bode well for closed-end funds. Demand for high-quality preferred stocks is driving up prices.
"Closed-end fund managers have the flexibility in their management strategies compared to exchange-trade funds that mimic the preferred stocks market," she says. "It is likely they will include these new instruments in their portfolios. And many closed-end funds also hold preferred shares of utilities and telecommunications firms, mitigating some of the risks faced by the trust preferreds."
In this low-rate climate, money is pouring into income funds of all types. Net inflows into income and bond mutual funds totaled $166 billion year to date through May 2012, according to the Investment Company Institute, Washington, D.C.
Some advisors, however, question whether chasing high yields is worth the risk.
Preferred stocks, like bonds, are highly sensitive to changes in interest rates. Their prices may drop more than bonds' when interest rates rise.
"We recommend a small percentage in preferred stocks-not more than 20%," says Joseph S. Lucey, a Minneapolis investment advisor. "We combine preferred stocks with other types of bonds, as well as annuities when appropriate."
Lucey believes the financial system is still on precarious ground. So he invests in income funds that have about 15% of their holdings in preferred stocks.
William Donoghue, a Norwood, Mass.-based investment advisor, would rather invest in high-yield bonds and/or cash, based on a technical model he claims has outperformed the market.
"When you are at the bottom of an interest rate cycle, it is not if but when interest rates will rise that should be in the forefront of your mind," he says. "Preferred stocks are just stocks masquerading as bonds, and bonds are the wrong place to be when interest rates rise."