Long-time readers know that preferred stocks play an important role in my client portfolios. They reduce volatility and generate income. With rock-bottom interest rates most investment-grade preferreds are near their highs, trading above par, and working out well. 

A preferred is a "hybrid" security with characteristics of both common stocks and bonds. Preferreds represent ownership in a company like common stock and rank senior to the common when it comes to dividends and in liquidation. They are junior to bonds but pay dividends (usually quarterly) like bonds pay interest (semi-annually).

After massive selling in March and then a near full recovery, the average investment-grade preferred now yields 5.8 percent and others yield 8 percent or more. Now that they have rallied back it’s harder to find attractive securities. But there are a few:

Our government may inflate its way out of the growing debt problem so I’m more than happy to own adjustable-rate issues. Plus, they trade under par. The Goldman Sachs Preferred ‘D’ (GS) and Morgan Stanley Preferred ‘A’ (MS) are paying their minimum dividend of 4 percent of par ($25). The current yield almost 4.7 percent, pay qualified dividends and are rated BB and BB+, respectively.

Investment-grade large-bank fixed-rate preferreds held up well and are already back to par value. One I hold is JP Morgan 6.10% Series AA (JPM). It went from $25.50 to $20.16 and is back to $25.32 and yields 6 percent. I also hold reinsurance company preferreds such as RenaissanceRE 5.375% Series E (RNR). It moved from $25.50 to $15.63 and has rallied back to $24.94. It yields 5.4 percent. Both pay qualified dividends.

One risk in preferreds is a rise interest rates. If the economy strengthens a lot because of all the stimulus, then there would be upward pressure on interest rates. If rates rise then the yields listed above become less attractive so prices would decline. Predicting interest rates is a frustrating exercise, which is why the smart investment approach is to have some exposure to assets that would do well if rates rise (equities) and some positions that would do well if they stay flat or fall (preferreds). 

The last two months have been a wild ride for preferred stocks. A big sell-off led to an amazing recovery. Normally I’m happy to collect dividends during the time of recovery. This time things recovered so quickly that only a few dividends were received. Amazing.