The search for yield doesn't stop with common stock. Historically low interest rates have made bond yields less attractive, helped push stock markets to record highs, and caused investing in preferred shares to balloon. Preferred stock is a stock-bond hybrid that pays a coupon well in excess of government bonds.

Companies issue preferred stock as a way to raise money. In the pecking order of who gets paid if the company goes bankrupt, preferred shareholders have priority before common stockholders but after bondholders.

[See: 11 of the Best Fixed-Income Funds to Buy .]

As long as a company stays financially healthy, this extra risk means bigger payouts to holders of preferred stock. "It has a lot more yield potential and stability than common stock, but it also is not quite as dependable as investment-grade bonds," says Jeff Reeves, executive editor at financial website InvestorPlace.com.

People have been buying preferred shares because it's harder to get yield in government or high-quality company debt, says Chris Bertelsen, chief investment officer with Aviance Capital Management in Sarasota, Florida. Yields on preferred shares, in general, are trading about 5.5 percent to 6 percent, well above the recent 10-year Treasury yield of 2.35 percent, Bertelsen says.

Like bonds, there is an inverse relationship between the value of preferred stock and interest rates. As rates rise, preferred shares tend to drop in price. But even though short-term interest rates are rising, Jay Hatfield, CEO of New York-based Infrastructure Capital Advisors, thinks that it's still a good time to buy preferred shares.

The risk from rising interest rates may not be immediate. Because preferred shares typically have a long maturity date, or none at all, companies entice investors to buy the shares instead of 30-year Treasurys by offering a higher coupon. When interest rates rise, companies must raise the coupon on new preferred shares.

Just because the federal funds rate is rising doesn't mean that long-term interest rates will rise as well, says Hatfield, who manages the InfraCap REIT Preferred exchange-traded fund (ticker: PFFR ). In fact, he thinks demand from pension funds will support longer-dated Treasury bonds. Also, when short-term rates rise, long-term rates can be stable or drop because of lower inflation potential, Hatfield says.

If the Federal Reserve continues raising rates to get ahead of inflation , as it is doing now, then the next couple of rate hikes may not affect prices of preferred shares directly, Hatfield says. If inflation picks up, however, longer term interest rates would also rise and preferred shares would sell off, he says.

[Read: How to Play Income Investments When Rates are Rising .]

That possibility worries Doug Crimmins, senior portfolio manager at Relative Value Partners in Northbrook, Illinios. He is staying away from run-of-the-mill preferred shares with their typically long durations in part because he thinks the Fed's likely rate trajectory makes for too much interest rate risk. Instead, he buys preferred shares that have a high coupon and allow the issuer to redeem, or call, them at a certain price relatively soon. If the company calls the shares at the appointed date, investors will still reap a certain percentage and will get even more if the company waits to call the shares or doesn't call them at all, he says.

Another way to address duration risk is to buy fixed-to-floating preferred shares. They start out with fixed rates but at a certain date pay a floating rate based on what interest rates do, he says.

Borrowing to Invest Is Risky Business

Funds simplify investing in the shares. Although Crimmins likes buying preferred shares directly because passively managed ETFs can have a lower yield, researching preferred shares is difficult for average investors to do. It would be a full-time job, Bertelsen says. While common stock has a universal share value or dividend yield, one company can have various forms of preferred stock that are valued differently and have different yields, Reeves says. "Simply finding the correct symbol or order info for the specific preferred shares you are looking for can be a chore for the average investor," he says.

Investing in preferred shares through a fund , however, minimizes an investor's research and offers instant diversification. "Any one company can always run into trouble," Hatfield says.

Reeves recommends the passively managed iShares U.S. Preferred Stock ETF ( PFF ), while Bertelsen prefers active management like that offered by the First Trust Preferred Securities and Income ETF ( FPE ). Actively managed funds can shorten the duration risk of their holdings, buy shares of companies with reasonably high credit quality and adjust their portfolio as needed when interest rates rise.

[See: 9 of the Best High-Yield ETFs on the Market .]

That kind of risk mitigation could pay off if the Fed raises rates more sharply than expected over the next 18 months to two years, as preferred shares would face headwinds, Bertelsen says. That's particularly true for passively managed ETFs because they don't rebalance their holdings that often, he says.

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