Utilities ETFs

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Utility sector ETFs are getting more attention. A weaker U.S. consumer, system-wide deleveraging, and the prospect of lower global output make the regulated utilities look attractive. They have built-in profit margins, pay predictable cash dividends, and tend to reduce portfolio beta. Historically utility dividends have been a point or two below long-term treasury yields. Currently, the dividends on most utility ETFs are above long-term treasury yields. This suggests that at least relative to treasuries, utilities ETFs look oversold.

There are risks. Utilities tend to be sensitive to regulatory changes. It is not yet clear how potential new regulation will impact the industry. Also, on a comparative basis, the reliable dividends utilities pay look more attractive in the current low-yield environment. With treasury yields moving higher, dividends from utilities, and utilities themselves, look less attractive.

The chart below compares a utility benchmark, the Utilities Sector SPDR (NYSEArca:XLU) with a treasury bond benchmark, the iShares Barclay 7-10 Year Treasury ETF (NYSEArca:IEF), and an equity benchmark, the S&P Depositary Receipts (NYSEArca:SPY).

The chart shows how utilities fund XLU and treasury fund IEF diverged in mid-2008.

The utilities ETF in the chart above, XLU is a popular and inexpensive domestic ETF. With close to 2 billion in assets, it has captured most of the volume in the sector. Vanguard's Utilities ETF ( VPU ) is another example of a "plain vanilla" fund. Though roughly equivalent by expense ratio and by performance, VPU is far smaller. Because of its size and its options liquidity, for trading, XLU is the ETF to own. But some investors may find XLU pretty concentrated. Its top ten holdings represent more than 50% of total assets. A single company, Excelon Corporation ( EXC ) is close to 15% of the fund. For long term buy and holders, the Vanguard fund VPU is a good choice because of its more diversified holdings. A third broad domestic ETF, the Dow Jones Utilities (NYSEArca:IDU) provides a slightly different mix but with an expense ratio of 0.48%, it is more expensive than XLU or VPU.

Like other sector funds, the number of ETF offerings in the utilities sector has boomed in recent years. Investors in the sector now have allocation opportunities that include global diversified ETFs, strategic allocation ETFs, and specialty trading vehicles built to provide short exposure or leverage characteristics.

GLOBAL

The global utility ETF sector is a new area for many investors. Diversifying into global markets can provide the lower beta that is so important for utilities investing. Expense ratios for global ETFs tend to be higher and yields lower and the utilities sector is no exception. But here we think that this is a reasonable price to pay for efficient access to global markets. Of course, when selecting a global fund, U.S. investors want to be sure that the extra expense goes for holdings that are actually foreign. In this regard Wisdom Tree's Utilities Sector Fund (NYSEArca:DBU) outshines the other funds. All its top holdings are outside the U.S. We like DUB. Unfortunately, in part because of its holdings in water and gas utilities, DBU tends to offer lower yields in comparison with iShares Global Utilities Sector Index Fund (NYSEArca:JXI) and SPDR FTSE/Macquarie Global Infrastructure 100 ETF ( GII ), which both have more domestic exposure.

STRATEGY

PowerShares Dynamic Utilities ( PUI ) is the largest of the strategy-type ETFs. These ETFs are allocated according to non-published investment criteria. This is designed to appeal to investors who favor a valuation approach to allocation. It appears to us that this kind of approach is not typically worth the extra cost. Investors should note that in addition to the higher expense ratios, these funds often have much higher turnovers than the plain vanilla sector style funds like XLU and VPU. Higher turnover brings increased trading costs which are added on top of the higher expense ratios and can drag down returns.

SHORT/LEVERAGE

Proshares sponsors two utilities ETFs that can be useful for specific investors, both based on the Dow Jones Utilities Average. The first is a leveraged play, which is designed to return twice the performance of the index on a daily basis. In other words, returns should be something like 2x IDU, which is also built on the Dow Jones Index. The short fund Ultra Utilities ProShares ( UPW ) is a nice offering for investors whose accounts do not permit short positions. UPW saw big gains in the utilities sell-off during the credit crisis of 2008-2009. The high expense ratio though should be a red flag for longer-term investors. Both these ETFs can be good trading vehicles for the savvy, but we do not recommend them for most investors.

Utility ETFs and their expense ratios are listed below by focus.

BROAD DOMESTIC

  • Utilities Select Sector SPDR (NYSEArca:XLU), annual fees: 0.24%
  • Vanguard Utilities ETF (NYSEArca:VPU), annual fees: 0.25%
  • iShares Dow Jones U.S. Utilities Sector Index Fund, annual fees: 0.48%

INTERNATIONAL

  • SPDR FTSE/Macquarie Global Infrastructure 100 (NYSEArca:GII), annual fees: 0.59%
  • SPDR S&P International Sector ETF (NYSEArca:IPU), annual fees: 0.50%
  • iShares S&P Global Utilities Index Sector Fund (NYSEArca:JXI), annual fees:0.48%

STRATEGY

  • PowerShares Dynamic Utilities Portfolio (NYSEArca:PUI), annual fees:0.60%
  • First Trust AlphaDEX Fund (NYSEArca:FXU), annual fees: 0.70%

LEVERAGE/SHORT

  • Ultra Utilities ProShares ETF (NYSEArca:UPW), annual fees:0.95%
  • Ultra Short ProShares Utilities ETF (NYSEArca:SDP), annual fees:0.95%

EQUAL WEIGHT

  • Rydex S&P Equal Weight Utilities ETF, annual fees:0.50%

Jonathan Bernstein has been writing about ETFs since 2003 and is the author of Sector Trading: A Year in Exchange Traded Funds .



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: EXC , GII , PUI , UPW , VPU

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