With the Fed having slashed rates, bank accounts and CDs being little more than places to squirrel away cash, and real yields on Treasurys edging negative, most investors see a tough environment in which to find yield.

    But venture just slightly beyond familiar places advisors look for income and one can find opportunities that come around perhaps once a decade.

Here's the irony: The same factors that are making today's investment climate so frightening-dysfunctional financial markets, soaring credit spreads, frozen liquidity-is what's generating some remarkable yield plays for investors who understand the sky isn't falling.

    Take the banking crisis. Brand name financials have written off tens of billions in securitized loans. All this makes investors rightfully wary. But these massive balance sheet hits have required many banks to head en masse to the capital markets to replenish their depleted Tier 1 reserves to meet regulatory and rating agency standards for adequate lending and operating ratios. The result: Merrill Lynch, HSBC, Barclays and JP Morgan have recently issued investment-grade preferred shares with coupons of around 8% and higher. They aren't guaranteed. But if the banks miss even one payment, it would send future borrowing costs spiraling.

    This upward yield trend has spread across much of the debt market as borrowers are paying dearly to unlock credit, which seized up last summer. "Because of the severity of the financial crisis, markets started treating all credits as high risk," explains Daniel Campbell, the former head of hybrid capital securities at Deutsche Bank, who is now a consultant. "Credit spreads-the difference between Treasurys and investment-grade securities-blew out regardless of the assets backing them as everything was getting painted with the same fearful brush." This spelled trouble for borrowers, but opportunity for shrewd investors.

    Fear is distorting investors' perception of many high-yield investments. Mariana Bush, a closed-end fund research analyst at Wachovia Securities, points out that the current 1% default rate of first-lien corporate loans remains well below historical averages. And Adnan Akant, head of foreign exchange and alpha strategy at the global fixed-income manager Fischer Francis Trees & Watts (a firm with $31 billion under management), sees the greatest fixed-income opportunities in mortgage-related assets that are trading at a 20% discount to their intrinsic value.

    Let's walk through some less-well-known income plays that are not geared to an improving equity market. An investor who takes a prudent approach to these riskier investments-an approach in which he doesn't instantly sell the securities if they hit patches of turbulence-will be compensated with yields that are superior to what most investors are currently earning.

Preferred Stocks

    If you owned preferred stocks before the financial crisis struck last summer, you've seen their value plummet by 20%. This has pushed up yields on many traditional preferreds from around 6% to 7.5%.

    A tremendous amount of bad news drove this shift, and it's not likely that there will be new, unexpected shocks that will drastically push yields much higher. Therefore, phasing into a series of highly rated preferreds, especially financials, may be a rare opportunity, not only because they will allow you to lock in high yields (which in many instances are currently taxed at a low 15%) but also because preferreds could benefit from significant capital appreciation once credit spreads ease.

    Gregory Phelps, the co-portfolio manager of a series of John Hancock preferred funds, believes that "we are seeing a virtual replay of the same distressed story of the 1990-1991 recession when huge real estate write-downs hit big money center banks, which ended up issuing high-yielding preferreds to replenish their reserves."

    He thinks many of the recent new issues are a no brainer-like the $2.5 billion Merrill Lynch 8⅝% preferreds, which S&P rates 'A-'. He also likes the new, slightly lower yielding Citigroup, JP Morgan, HSBC and Barclays preferreds. All are tax advantaged, and corporations that qualify pay taxes on only 30% of the dividends. So if you think these institutions are going to survive the current turmoil, these preferreds may be golden investments.

Foreign Bonds And Cash Deposits
    Yield on foreign government debt varies as economies move through different phases of the growth cycle. This means that a place like Australia, which has seen 15 years of uninterrupted growth averaging more than 3.6% a year with 4% inflation, has high overnight rates. Over the last two years, the central bank in Australia has regularly pushed up rates from 5.5% to 7.75%.

    Scott Hixon, Invesco's currency and asset allocation specialist, believes that one-year Australian bank cash deposits, yielding 8.1%, are solid bets. The largest risk: If the dollar's protracted fall comes to an end, as many analysts are now speculating, then unhedged international investors may be faced with the prospect of losing value as foreign currencies depreciate against the dollar.

    But Hixon is not concerned about that for the near term. "The huge interest-rate differential between the U.S. and Australia," says Hixon, "is driving a carry trade whose momentum will support the Aussie dollar for at least another year, even if the commodity bubble, which has been driving Australian securities, begins to deflate."

    A second riskier foreign debt play with even greater upside is Icelandic debt. The developed, fast-growing North Atlantic economy has been fighting huge current-account deficits and inflation as Icelanders' consumer and business spending abroad far outpaces exports. Iceland recently saw its currency collapse 30%. The country's central bank raised interest rates to 15% in late March in an effort to reverse the krona's decline and maintain adequate foreign financing. This is a repeat of events from two years ago, from which the currency and economy had recovered.

    Though it's hard for advisors to gain access to Iceland's small bond and treasury market, Adnan Akant has identified the 'AAA'-rated, 9.5% June 2009 bonds issued by the European Investment Bank (the long-term lending arm of the European Union).These bonds are trading around par, and Akant sees them as a good way to access Iceland's debt market. "The currency should eventually rally from today's current lows as high rates attract local financing," he concludes. But even if it doesn't, he says, by the time these bonds mature investors can simply roll over their investments into longer-term issues.

High Dividend Yielding Stocks
    Graham Secker, Morgan Stanley's U.K. strategist, explains that when yields on large-cap stocks surpass those of government bonds-a phenomenon that has only happened twice over the last 50 years in the U.K.-shares have subsequently soared.

    This past March, Secker observed that the average yield of FTSE 100 stocks hit 4.14% as yields on five-year gilts fell to 3.97%. Around the same time, the average yield of Dow 30 stocks matched five-year Treasury rates.

    Still, a rally in these stocks could be undermined by any protracted fallout from the unprecedented financial mess. The stocks' surge could also be undone by declining earnings and subsequent dividend cuts. Nevertheless, Secker sees a bunch of attractive nonfinancial stocks with secure yields well above 4%, including Vodafone, British Petroleum and Scottish & Southern Energy. In the states, comparable plays include Verizon and Consolidated Edison.

    Attractive income plays may also be found in the common shares of beaten down financials, which are clearing their books of troubled securities but which, at the same time, have maintained their profitability and dividend payouts. Examples of these players are HSBC, Swiss Re and Bank of America.

Closed-End Funds
    The majority of closed-end funds borrow up to one-third of their assets to enhance returns. But this practice has cost them over the past year and accelerated their declines. And investors have veered from such leveraged investments, so the discount from their net asset value at which these funds trade has plunged deeper.

    But these events may have created a rare opportunity for new investors in a variety of income-focused funds. Doug Bond, a portfolio manager of the $420 million Cohen & Steers Closed-End Opportunities Fund (which invests in various closed-end funds), reports that, municipal bond funds aside, the current average yield across the closed-end fund market is 9.2%-the highest it has been since the asset class revived in 2001.

    But the recent performance of Bond's diversified fund reflects the risks of investing in income-focused funds. Over the past year through April 25, the fund is off 12% despite a current yield of 8.9%.

    CAVEAT: Current high yields don't guarantee profitability.

    But if the worst of the financial crisis has passed, then new investors may be able to lock into funds when their yields are peaking, discounts are bottoming and the potential total return is the most favorable.

    The same things that make high-grade preferred stocks attractive also make funds that invest in them attractive. Gregory Phelps' John Hancock Preferred Income III fund lost more than 12% over the past year through April 25 as credit spreads widened and the fund's discount increased. But year to date, the fund is up more than 5% as the discount has improved from -10% to -6.9%. Its current yield is 8.23%.

    Corporate loan funds invest in below-investment-grade securities that are often first-lien debt. This puts them higher up in the capital structure than high-yield bonds, explains Wachovia's Mariana Bush. While she agrees that this asset class comes with above-average risk in the short term, the decline in underlying loan values, which hit a low of $0.86 on the dollar in early April, and the stable low default rate of 1% make a compelling longer-term case for these securities.

    One of the funds that Bush analyzes is Legg Mason's LMP Corporate Loan Fund, which she calls conservative. It lost 14.64% over the past year, but nearly two-thirds of that was due to an expanding discount. And then, in the month that ended April 25, while the fund's NAV was up 1.26%, its market value climbed 5.64%. If the discount, which is currently 6.49%, continues to close, it could make the fund's trailing 9% yield quite compelling.

Bond thinks covered-call funds are a defensive way to maintain equity exposure that can offer regular income in most markets by hedging downside risk. The funds do this by selling call options on their long holdings, which generate premium income. But the funds do give away upside potential when markets significantly rise because they must sell securities that have rallied. The universe of 42 such funds are currently yielding 10.5% and trading at a discount of 7%, nearly the widest levels these funds have been at since they started up four years ago.

    Bond likes the Nuveen Equity Premium Advantage Fund, which is long in the Nasdaq 100 and the S&P 500. The fund is off more than 10% over the last year. It trades at a discount of nearly 11.5%, 450 basis points over the industry average, primarily because of market inefficiency, explains Bond. This has boosted its current yield to 10.44%.

    In considering various income options, investors must remember that there is no such thing as a risk-free play. Even Treasurys and CDs could end up losing money if they generate negative real returns after accounting for inflation. And one could end up in the red with high-grade long-term U.S. corporate bonds if interest rates and credit spreads rise. So the smartest play may be looking beyond the typical sources of secure income, especially now. But be sure you know exactly what you're buying for your clients.