In the ultra-low interest rate environment, the hunt for steady income led investors to invest in high dividend paying companies, including many utility companies. Also, as the U.S. economic growth continued to be uninspiring, sectors like utility played their defensive role and acted as a safe haven for investors (‘No Taper’ and the Impact on Broad Market ETFs).
However, after four years of lacklustre performance, U.S. economy is finally back on track for stronger growth. The improvement does not seem to have acted in favour of the utility sector as investors left their defensive attributes and shifted their assets to riskier investments.
Also, the utility sector seemed to be in trouble on account of rising interest rates speculation over the Fed taper (3 ETFs for Rising Interest Rate).
During the second quarter, the yield on the benchmark 10-year Treasury note has inched up by about 60 basis points thereby hurting utility stocks. The S&P also recently downgraded the utilities sector to underweight. In fact, the utility sector turned out to be one of the worst performers in September when eight out of 10 S&P sectors recorded new highs.
However, the Fed’s decision to continue with its bond purchase program until it sees more evidence of economic growth brought a sound rally to the U.S. stock market. Among others, utility sector rebounded after a dreadful performance between April to August. As interest rates moved downwards, utility sector was seen back on track (3 Sector ETFs to Profit from Rising Interest Rates).
Utility Sector in Focus
The demand for utility services is primarily driven by the state of the economy. If the economy is doing well, it will create new jobs, resulting in increased demand for housing and in turn, driving demand for utility services. In addition to growing demand through households, increasing demand from the business sector, particularly manufacturing, also plays a role in growth Comprehensive Guide to Utility ETF Investing).
Utility ETFs in Focus
An ETF tracking the broad utility sector, Utilities Select Sector SPDR Fund (XLU) recorded a gain of 2.9% after Fed’s ‘no taper’ announcement. XLU is one of the most popular and widely traded utility ETFs.
The ETF manages an asset base of $5.37 billion. This fund holds 33 stocks and the top 10 companies get a share of 57.5% net assets. The fund has a dividend yield of 4.05% and charges a fee of 18 basis points.
Among individual holdings, top stocks in the ETF include Duke Energy, Southern Co, and Dominion Resources comprising 9.27%, 7.72% and 7.62%, respectively, of total net asset
(Consider This ETF for a Better Investment in Utilities).
Another ETF tracking the industry, Vanguard Utilities ETF (VPU) increased 2.95% after the Fed announcement. The fund manages an asset base of $1.38 billion as it holds 79 stocks and the top 10 companies hold 46.98% of total net assets. The average daily volume is about 53,149. This fund charges a fee of 14 basis points annually.
The top three individual holdings in the VPU ETF include Duke Energy, Southern Co. and Dominion Resources with asset allocation of 8.47%, 6.80% and 5.54%, respectively.
Yet another ETF that soared on the Fed’s decision is iShares Dow Jones US Utilities (IDU) which increased 2.89%.
The fund manages an asset base of $835.1 million. IDU presently holds 65 companies. The top 10 companies hold 48.87% of total net assets. The fund charges a fee of 48 basis points annually.
Once again Duke Energy, Southern Co. and Dominion Resources hold the top three spots in the IDU fund with 7.93%, 6.07% and 6% of the net assets, respectively.
We hardly find utilities posting eye-catching numbers, but these companies are generally stable due to the regulated nature of operations, and they are loyal to shareholders.
Investment in the utility sector is more suited for income-oriented, long-term investors looking for a modest but stable return.
However, investors should note that gain in the sector may prove to be a short term story as the Fed may taper its bond purchase in the near future which will ultimately hamper the sector (No Taper? No Problem for these Dividend ETFs)
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