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Sector Review: Utility ETFs For High Yield And Stability

 July 11, 2010 06:36 PM
 


Investors are starting to pay more attention to Utility Stocks and Utility ETFs of late given the low interest rate environment that doesn't seem to have an end in sight.  With the 10-year Treasury hovering around 3% and the prospect of loss of principal one bonds when rates do rise eventually, the prospect of equities with yields greater than bond yields becomes particularly appealing.  Heck, even Target Date Mutual Funds behaved outrageously during the financial downturn, in many cases losing 30-40% for 2010 target dates.

In the individual large utilities space, companies like Exelon (EXC) and Dominion (D) are yielding about 5%, but they subject you to individual equity risk.  The following diversified Utility Stock ETFs are all yielding a respectable 4-5%.

[Related -Why dividend-paying utilities stocks could lag again in 2014]

iShares Dow Jones US Utilities Sector Index Fund (IDU)
Utilities Select Sector SPDR (XLU)
Vanguard Utilities ETF (VPU)

Why Utility Stock ETFs?

  • Yield – The yields are higher than any conventional income asset class, albeit with no guarantee of capital preservation.  With money markets, CDs and government bonds paying significantly less, investors are paying attention.
  • Smoothed Volatility - While the utility stock index is subject to equity risk like any other common stock, the overall volatility tends to be less than the broader market.  So, in a wildly bullish upswing, you could expect the Utilities to under-perform, but in a down market, historically, they have held their own compared to the broader market.  In a flat market, they outperform since the yields are close to double those of the broader market.
  • Potential for Capital Appreciation – As a side benefit, as a rising tide lifts all ships, as more investor inflows occur with the Trillions of dollars of cash on the sidelines in pensions, individual investor and sovereign accounts, expect capital appreciation as well, which you don't get in a CD or money market.  And Treasury Bond Yields can't go much lower, so don't expect appreciation in government bonds either.
  • Dividend Increases - Another benefit here is that over time, utilities tend to steadily increase their dividend payouts as earnings grow.  Again, you get no increase in a bond coupon.

Utility Stock ETFs Have Out-Performed

[Related -Bond Yields Rise On Stronger Economic Data]

In taking a look at the Utility ETF (XLU) vs.


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