An opportunity for attractive tax-advantaged yield is out there for investors hunting income – if they're willing to accept some risk. Preferred securities have some characteristics of fixed income and stocks. They trade on exchanges like equities, but they also provide investors a stream of income like a bond. Those payments can come quarterly. Yields on preferreds have been attractive as of late, trading above 6% and largely rising more than rates on corporate bonds and long-term Treasury yields, according to Collin Martin, head of fixed income research and strategy at Schwab Center for Financial Research. He recently said that his team sees value in that area, particularly as the conflict in the Middle East and higher oil prices have created some volatility in long-dated rates. "We've seen a lot of movement in Treasury yields, and we still expect a lot of volatility," he said. "For most bond investors, we're not suggesting they focus too much on long maturity, long duration investments. That said, we're still comfortable with preferreds, even though they are long duration." Rate sensitivity, tax-advantaged income Preferreds have maturity dates that are long or are perpetual. This long maturity makes their prices fluctuate when rates move. That means a sudden spike in rates will push their prices lower. Martin noted that even though preferreds are rate sensitive, the yields are attractive for individuals seeking income. He also said that investors might appreciate their tax benefits. While bonds offer interest income that's taxed as ordinary income – a rate of up to 37% -- preferred may pay income that's treated as a qualified dividend and subject to a rate of 0%,15% or 20%, depending on the investors' taxable income. An eye on risk As tantalizing as the high tax-advantaged yield may be, investors should avoid loading up on exposure to preferreds. "In a classic 60/40 binary asset allocation, we see it as part of the fixed income allocation," said Martin. He noted that investors should start with core holdings like Treasurys, investment grade corporates and municipals, and treat riskier components like preferreds as something complementary within a diversfied portfolio. Investors should also make sure that if they're building an allocation toward preferreds that they manage concentration risk. Financial institutions and utilities tend to participate in the market. Credit quality of the issuer also matters. "Right now, we think a lot of the highly rated banks and financials are in good shape," said Martin. "Their balance sheets are strong." An exchange traded fund holding preferreds may help investors manage the issue of overconcentration. Names in that space include the VanEck Preferred Securities ex Financials ETF (PFXF) , which has a total return of about 9% year to date, according to Morningstar. The fund's expense ratio weighs in at 0.4%. The iShares Preferred and Income Securities ETF (PFF) , meanwhile, has a total return of more than 3% year to date and an expense ratio of 0.45%.
<small>Source: CNBC</small>
