Utilities ETFs are a good choice for investors looking for
yield if they are able to tolerate a little equity exposure.
Utilities ETFs hold portfolios of regulated utility companies
with guaranteed profit margins. They pay hefty dividends.
Currently, utility ETF dividends yield about 2% more than
benchmark U.S. treasury bonds.
Utilities and their dividends are historically stable. Utility
income and profit is inelastic. It fluctuates within a tight band
of demand for water, electricity, and natural gas. The price of
utility ETFs is further also anchored by their dividends.
Utility ETFs like other utility funds are not counter
cyclical, but they are defensive. Utility ETFs have a beta of
around 0.5. This means that although they tend to move with the
equity markets, they move up less then benchmark equities when
the market goes up and down less when the market goes down.
The chart below compares a key utilities ETF, the Utilities
Select Sector SPDR (NYSEArca:XLU) with a fixed income benchmark,
the iShares Barclays 7-10 Year U.S. Treasury (NYSEArca:IEF) and
an equity benchmark, the Standard and Poor's Depository Receipts
As the chart shows, over the past 12 months the utility ETF
XLU has split the difference between fixed income and equity. XLU
has outperformed treasury bonds, underperformed equity. Notable
is that on the big run-up from May to December of 2009, as the
market reacted to being oversold in March 2009, XLU parperformed
the SPY. XLU did not participate in this year's rally, the sharp
move up in the first few months of 2010. They provided defense
against the recent sell-off.
Risks to utility investing include sensitivity to regulatory
changes, interest rate risk and systematic market risk. From a
regulatory perspective, the biggest challenge to utilities from
the Obama administration is uncertainty surrounding greenhouse
gas legislation. Change on greenhouse gasses is coming slower
than some utilities industry experts feared. Although utilities
can do well in a regulated environment, certainly they profited
handsomely from the hands-off approach of the Bush years. Some
current proposals, such as building a smart grid and cleaner
energy incentives for utilities, though they sometimes receive
criticism from the industry, may benefit the industry in the
longer run by removing uncertainty and encouraging
Because they compete with U.S. treasury bonds for yield,
utilities ETFs also tend to be sensitive to interest rate
changes. This also is less of a factor in the current
environment. Interest rates are forecast to remain at low levels
and many investors are buying U.S. treasury bonds out of fear or
necessity rather than for their yield.
Concerning systematic risk, unlike treasury bonds and gold,
utilities are not a safe haven per se. But with their low beta
and the company-specific diversification provided by the ETF
structure, utilities ETFs can be expected to outperform in both
sideways markets and down markets.
In addition to domestically focused ETFs, several ETFs provide
exposure to global utilities markets. In the past few years,
global utilities ETFs have been more expensive than domestic
funds. Their yields were lower compared to domestic utility
funds. But with the dollar strengthening recently,
internationally focused utilities ETFs have fallen sharply in
comparison with their domestic brethren. Although yields on
international utilities ETFs are not as regular as domestic
funds, it appears that prices have fallen faster than yields.
Yields in international utilities funds in some cases now exceed
domestic yields. The chart below, which compares XLU with Wisdom
Tree's Utilities Sector Fund (NYSEArca:DBU), shows the steep fall
in the price of an international utility fund.
As the chart shows, the two funds have diverged widely in the
last year. All DBU's top holdings are outside the U.S. 75% are in
Europe. DBU can be compared to iShares Global Utilities Sector
Index Fund (NYSEArca:JXI), which has more domestic exposure and
currently pays lower yields.
The most important utilities sector ETFs and their expense
Utilities Select Sector SPDR (NYSEArca:XLU), annual fees:
Vanguard Utilities ETF (NYSEArca:VPU), annual fees: 0.25%
iShares Dow Jones U.S. Utilities Sector Index Fund
(NYSEArca:IDU), annual fees: 0.48%
iShares S&P Global Utilities Index Sector Fund
(NYSEArca:JXI), annual fees:0.48%
Wisdom Tree's Utilities Sector Fund (NYSEArca:DBU), annual
PowerShares Dynamic Utilities Portfolio (NYSEArca:PUI), annual
First Trust AlphaDEX Fund (NYSEArca:FXU), annual fees:
Ultra Utilities ProShares ETF (NYSEArca:UPW), annual
Ultra Short ProShares Utilities ETF (NYSEArca:SDP), annual
has been writing about ETFs since 2003 and is the author of
Sector Trading: A Year in Exchange Traded