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Utilities ETFs Slump on Downgrades

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As the market continues to surge, investors are beginning to look away from low risk sectors, and towards higher beta plays. This has pushed many out of stocks and ETFs in the consumer staples, health care, and utilities segments as of late, and into ones like technology and consumer discretionary instead (see Buy These ETFs to Profit from Sector Rotation).

This trend has been especially pronounced in the utilities ETF segment recently, as the space was beating out the S&P 500 on a year-to-date basis. However, recent trading has pushed utility benchmarks below the S&P 500 when looking at 2013 so far, suggesting that the beginning of a downtrend may be at hand in this corner of the market. This could be especially true considering some recent downgrades which have reverberated across the utility ETF sector.

Downgrades in Focus

To start the Memorial-Day shortened week, the utilities sector experienced twin downgrades for two important companies in the sector. Deutsche Bank pushed Exelon (EXC - Free Report) to a hold from a buy, while Credit Suisse decreased their rank for FirstEnergy (FE - Free Report) to neutral from outperform.

These downgrades both came on worries over revenues in the near future for these companies, and some concerns about an oversupplied market which could keep a lid on prices. As a result, both EXC and FE experienced heavy volume in Tuesday trading, with FE falling about 6.6% on the day and EXC tumbling by about 7.7%.

Utility ETF Impact

As you might expect, this bearish news had a poor impact on many utility ETFs. However, thanks to the relatively spread out nature of the products, no funds were down more than 2%, suggesting that the pain wasn’t as bad when taking a fund look (see Two Sector ETFs to Buy in 2013).

Still, the trend isn’t great for utility ETFs especially considering the bearish outlook that some top names have for the space. Given this, investors may want to pay special attention to the following ETFs, as they have among the biggest holdings in EXC and FE in the utilities ETF sector:

Select Sector SPDR- Utilities ETF (XLU - Free Report)

This is easily the most popular utilities ETF on the market, with more than $5.8 billion in assets, and average daily volume of about 8.5 million shares. The product is also a low cost choice in the space, charging investors 18 basis points a year in fees.

The ETF was down about 1.2% in Tuesday trading, on volume that was roughly 2.5 times normal. The ETF devotes about 6.1% to EXC and 3.6% to FE, while holding about 30 other companies in its basket.

Vanguard Utilities ETF (VPU - Free Report)

Another popular option in the utilities space is VPU, a fund that has about $1.5 billion in assets under management, and volume of about 100,000 shares a day. While it may not be as popular as its SPDR counterpart, the fund is cheaper, charging investors just 14 basis points a year in fees (also read Can You Beat These High Dividend ETFs?).

VPU declined about 0.95% following the downgrades, on volume that was a little over three times normal. In terms of exposure, the Vanguard fund holds about 80 firms in total, and puts 4.9% in EXC and 3% in FE.

iShares Dow Jones Utilities ETF (IDU - Free Report)

iShares’ entrant in the Utilities ETF market is IDU, a fund that also has a billion under management, and volume around the 130,000 share level. The product is a bit more expensive than its counterparts too, charging 46 basis points a year in fees.

IDU was also the only one of the three to see volume that was less than average, as just 91,000 shares moved hands on the day. However, it did have a decent performance compared to the others, losing 0.9% on the day. In terms of holdings, much like in VPU, EXC accounted for 4.9% of assets while FE made up just under 3%.

Nuclear power also in focus

Additionally, investors should note that the nuclear power ETFs are also in focus thanks to this bearish report. That is because both EXC and FE have sizable allocations to nuclear power, suggesting that these funds can also be in for a rough ride thanks to the bearish news (read Uranium ETF Meltdown: Can Nuclear Power Bounce Back?).

Products in this category include the Market Vectors Uranium & Nuclear Energy ETF (NLR - Free Report) and the S&P Global Nuclear Energy Index Fund , both of which have sizable exposure to the aforementioned utility firms. In fact, EXC makes up about 7.7% of NLR while the two combine to account for about 9% in NUCL, so their weakened outlooks could trickle into this space as well.

Bottom Line

It could be a rough stretch for utility ETFs in the near term, as more investors look to cycle into high beta sectors. Beyond that though, there are some headwinds building in the segment, so investors should definitely watch out in the summer months ahead, and consider looking outside the utility ETF sector at least in the short term.

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Author is long EXC.

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