Income-starved investors have flocked to corporate bonds, reducing spreads to levels that fail to compensate for underlying risks.

This scant risk premium makes many bonds a questionable bet at the moment, and savvy investors are looking further down the capital structure.

Preferred stock is one corner of the market that hasn’t garnered much interest lately; investors appear focused on bonds and equities. But preferred shares offer a bit more security than common stock and offer better prospects for price appreciation than bonds. To top it off, many quality names trade at attractive valuations.

iShares S&P US Preferred Stock Index (NYSE: PFF) is the best bet for investors seeking broad exposure to this asset class. Not only does the exchange-traded fund boast a solid portfolio, but its low expense ratio–just 0.48 percent–also means that investors keep more of their returns.

Financial names account for 88 percent of the fund’s investable assets, which is normal for funds of this sort. A month ago this concentration would have made us nervous; many of the portfolio holdings are issues from major money-center banks, the institutions that stood to lose the most from financial reform. But now that we have a clearer picture of what financial reform will entail–and the ramifications aren’t as dire as many had expected.

Banks may still use and trade some derivatives, though riskier transactions will have to be conducted through affailiated companies that don’t threaten the solvency of the banks themselves. Proprietary trading–a major profit center for the mega lenders–has been limited, though not eliminated, and banks will still have the leeway to invest up to 3 percent of capital in private-equity and hedge funds.

These are a few of the bill’s key provisions. As it stands, the legislation doesn’t appear to be a killer for the banking industry, and the group should enjoy plenty of upside once concerns over the bill die down.

Yielding over 7 percent, iShares S&P US Preferred Stock Index is the newest addition to the Income & Hedges Portfolio and rates a buy up to 40.