The trend towards further innovation in European ETFs continues with the launch of the first-ever preferred shares fund designed to add another option for investors seeking alternative sources of yield. The new PowerShares Preferred Shares UCITS ETF also represents the first fund launched by Invesco since it bought Source in May this year. Although technically equities, preferred shares have fixed dividends and thus tend to behave more like bonds with an average annual yield of over 5%. Chris Mellor, executive director for equities product management at Invesco PowerShares (EMEA) went through with ETF Stream how the fund has been put together and talked through what investors need to be aware of when opting to take this income route.

What is the differentiator here for this fund?

This is the first launch of a preferred equity ETF in Europe. The fund is managed by our experienced portfolio manager, Jeff Kernagis, who has been running PowerShares Prefs ETFs in the US for almost 10 years (currently $9bn total AUM).

Why should investors consider this fund?

This is a diversifying asset for investors who are looking for income. In a low-return world, traditional sources of income now offer yields of less than 2.5% and many investors are having to look further afield to find income. We have seen rising investor demand for higher yielding areas of the market such as MLPs (8% yield), emerging market bonds (5.7%) and US high yield (5.2%). If you are taking additional risk into your portfolio in order to increase yield, it makes sense to diversify across different strategies and asset classes. The addition of our Preferred Shares ETF gives investors another alternative, with a yield of 5.8% and a lower than average correlation with most other income options.

What are the downsides to preferred shares? What do you think investors need to be aware of before they invest in a preferred shares ETF?

I wouldn't describe it as a downside but investors need to be aware that preferred shares are not the same as common equity. They are hybrid securities which means that they are technically equities but have certain characteristics that make them behave more like bonds (e.g. fixed dividends that must be paid before dividends to common stock holders). They are higher in the company capital structure than common equities but subordinate to a company's debt instruments, so companies attract investors in preferreds by paying a higher dividend rate than they pay on their bonds.

What type of investor will this fund appeal to?

The key focus of this fund is on delivering income so it is likely to appeal to investors looking for regular income from a less correlated source than traditional fixed income or high yield equities.

How is the index which this fund tracks constructed?

The ETF tracks the BofAML Diversified Core Plus Fixed Rate Preferred Securities Net Total Return Index which selects USD denominated pref shares and preferred-like senior and subordinated debt in $25/25/100 increments (so-called baby bonds). Securities must be rated at least B-/B3 (on average between S&P and Moody's) and be issued from a corporate based in an investment grade country. The index is market-cap weighted, rebalancing monthly, and is specifically designed to meet UCITS diversification rules.

Which areas you are particularly looking at for further innovation?

We have a long-tradition of offering innovative and differentiated products at both Source and PowerShares, of which this new Pref Shares UCITS ETF is a good example, and we expect to continue this. There are a number of new product areas we are looking at including extending our innovative liquidity-filtered sector products to the single-factor product space as well as examining the scope for multi-asset ETFs to name but two.