Utility services undoubtedly play a major role in a nation’s economic progress as cheap and abundant supply of power keeps the wheels of development rolling. With development comes the need for more power, as cities expand and the use of new gadgets increases. However, everything comes at a price, as green-house gases emitted by large utilities cause irrevocable damage to the environment.
Per U.S. Energy Information Administration (EIA), total energy use in the U.S. will increase to 106.3 quadrillion Btu in 2040 from 95 quadrillion Btu in 2012. Most of this demand is expected to come from the Industrial sector followed by the Commercial sector.
Even so, the utilities have been under review for a long time. The climate action plan of the U.S. President followed by the U.S. Environmental Protection Agency's (EPA) proposal for tightening the rules to set up new power plants are putting immense pressure on power producing units. Recently, the EPA proposed a rule to lower carbon dioxide emissions from power plants by 30% by 2030 from 2005 levels (read: What is Behind the Recent Clean Energy ETF Surge?).
To meet the stringent regulation, utilities are now gradually shifting their emphasis towards natural gas and alternate energy sources to produce power. The utility operators are also implementing new technologies in generation and distribution of power.
Utilities are by their very nature monopolistic businesses. As a result, the sector is highly regulated as the essential supplies cater to basic human needs, and governments try to ensure the prices of these supplies – water, electricity, etc. – stay within reasonable limits.
The utilities, on the other hand, try to increase prices through the filing of rate cases. The investments and costs incurred for the modernization and maintenance of reliable services are recovered through these rate cases.
Mainly, the steady performance of the companies lures investors to the utility space. The biggest positive for the utilities is that there is hardly any viable substitute for utility services (read:3 Utility ETFs Surviving the Market Turmoil).
ETFs to Tap the Sector
The services provided by the utilities are always in demand. Added to this any positive movement in the economy tends to increase the demand for utility services. In addition, consistent payment of dividends makes utility ETFs attractive. The defensive nature of operations insulates these ETFs from market turbulence (see all utility ETFs here).
Below, we highlight the ETFs in the Utility sector which primarily have a U.S. bias.
Utilities Select Sector SPDR (XLU - ETF report)
XLU is one of the most popular and widely traded utility ETFs. The main purpose of this fund is to provide investment results that correspond to the performance of the utilities select sector index. The index includes communications services, electrical power providers, and natural gas distributors.
Launched on December 15, 1998, XLU has an asset base of $5.5 billion. This fund holds 31 stocks and the top 10 companies hold a 59.45% share of total net assets. The average daily volume (3 months) is 12,509,709 shares. The fund has a dividend yield of 3.49% and an expense ratio of 0.18%.
Among individual holdings, Duke Energy Corporation, NextEra Energy Inc. and Dominion Resources comprising 8.84%, 8.09% and 7.66%, respectively, of total net assets take up the top three spots.
Vanguard Utilities ETF (VPU - ETF report)
This ETF aims to match the performance of the MSCI US Investable Market Utilities Index. The ETF was launched on January 15, 2004. Presently this fund manages an asset base of $1.6 billion.
This fund holds 78 stocks and the top 10 companies hold 48.51% of total net assets. The average daily volume (3 months) is 131,846 shares. The product has a dividend yield of 3.41% and an expense ratio of 0.14%.
The top three individual holdings in the ETF include Duke Energy Corporation, NextEra Energy Inc. and Dominion Resources with asset allocation of 7.91%, 6.54% and 6.34%, respectively.
iShares Dow Jones US Utilities (IDU - ETF report)
The fund seeks to match the performance and yield of the Dow Jones U.S. Utilities Sector Index. The ETF manages an asset base of $0.7 billion. Launched on June 11, 2000, IDU presently holds 63 companies.
The top 10 companies comprise 49.36% of total net assets. The average daily volume (3 months) is 77,238 shares. The fund has a dividend yield of 3.04% and an expense ratio of 0.48%.
Duke Energy Corporation, NextEra Energy Inc. and Dominion Resources comprising 7.87%, 6.65% and 6.29%, respectively, of total net assets take up the top three spots.
Guggenheim S&P 500 Eq Weight Utilities (RYU - ETF report)
The fund seeks to replicate the performance of the S&P 500 Equal Weighted Telecommunication Services and Utilities sector. RYU debuted on October 31, 2006, and currently has 36 companies, with the top 10 holdings comprising 31.28% of total net assets. The average daily volume (3 months) is 32,835 shares. The fund has a dividend yield of 3.23% and an expense ratio of 0.50%.
The top three stocks include Pepco Holdings Inc., CenturyLink Inc. and Exelon Corp. with asset allocation of 3.64%, 3.28% and 3.20%, respectively.
First Trust Utilities AlphaDEX (FXU - ETF report)
FXU seeks investment results that correspond generally to the price and yield of the StrataQuant Utilities AlphaDex Index. Launched on May 7, 2007, the fund manages an asset base of $221.0 million. The average daily volume (3 months) is 129,918 shares.
The product holds 45 stocks in total in its basket, with the top 10 companies comprising 39.88% of total net assets. The fund has a dividend yield of 3.49% and an expense ratio of 0.70%.
Entergy Corp., Level 3 Communications Inc. and Telephone and Data Systems, Inc. are the top three holdings with fund allocation of 4.54%, 4.48% and 4.25%, respectively.
PowerShares Dynamic Utilities (PUI - ETF report)
The ETF is linked to the DWA Utilities Technical Leaders Index, which is designed to identify companies that are showing relative strength (momentum). Formed on October 25, 2005, the ETF has assets worth $41.9 million.
The average daily volume (3 months) is 8,026 shares. It is spread across 44 companies with the top 10 holdings comprising 41.04% of total net assets. The fund has a dividend yield of 2.17% and an expense ratio of 0.60%.
The top three stocks include Sempra Energy, ONEOK Inc. and Duke Energy Corporation, with asset allocation of 5.12%, 4.88% and 4.70%, respectively.
To Sum Up
The biggest positive for the utilities is that there is hardly any viable substitute for their services. This is the most fundamental strength of the industry. Moreover, increasing demand drives this industry forward.
The power producers are trying to find out new means and innovative technology to produce more power at a cheaper rate. We all know the reserves of fossil fuels, the primary source for power generation, are limited and cannot be replenished. In addition, fossil fuel usage increases air pollution, so the shift is on to generate more power from renewable and alternate sources.
Though the percentage of alternate or green energy in the power generation fuel mix does not compare to coal at present levels, the shift is surely on. Traditional operators are now compelled to diversify their fuel basket and increasingly generate power from other less harmful sources. Even while operating coal-fired generation plants, stringent regulations have ensured that they make necessary additions to curb pollution.
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. The majority of utility operators also benefited from a severe U.S. winter that perked up demand. In the end, the strength lies in their value and yield. So, investors looking for a steady return on their investments could take a Utility ETF approach.
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