Preferred stocks

October 14, 2011

The long, gradual decline in bond yields that started in the mid-1980s has culminated in an environment of very low interest rates. This has motivated many investors to seek assets that provide higher income. The high dividend payments offered by preferred stocks have naturally attracted the interest of these investors and their favorable tax treatment increases their attractiveness to taxable investors.

This paper examines the case for investing in preferred stocks. We begin by providing background information, and we then proceed to discuss the benefits and risks of investing in preferred stocks. Subsequently, we analyze the return behavior of preferred stocks, including the characteristics of expected return, volatility, and correlation with other asset classes. Finally, we address the issues institutional investors would face once the decision has been made to invest in preferred stocks. We conclude with a brief summary and a recommendation that a dedicated allocation to preferred stocks is not recommended for most institutional investors.