Utility & REIT Funds Come Roaring Back

July 11, 2014

Power Plant Vs Office Tower

I lumped utilities and REITs together due to their similar returns and correlations to fixed income over the past 12 months. Yet other performance aspects differ, supporting the traditional role of utilities as a defensive play. Volatility—a stand-alone measure of risk—over the past three years is much lower for utilities than for REITs. Utilities also have the edge on diversification in your portfolio than REITs based on three-year correlations to equity.

table 3 yr Vol & Corr

And for income investors in taxable accounts, the cash flows from REIT ETFs are taxed at the higher ordinary income rate rather than as qualified dividends, as is the case for utilities. That’s due to the pass-through nature of REITs’ legal structure.

Interest rates alone won’t determine the course for these sectors in the near term. Still, as investors continue to fret over the duration in the fixed-income side of their portfolio, recent history shows that interest-rate risk doesn’t stop at the fixed-income edge of the asset allocation pie chart.

The flip side is that the great performance by utilities and REITs seen in the first part of 2014 may have further to run. The low-rate environment lingers on, inflation remains low and equity markets have taken tapering in stride.

Income plays remain attractive even from a total-return perspective as prospects for growth remain uncertain. In short, utilities and REITs may well continue on their merry path through the rest of 2014. Just know that investors may again head for the exits if rates rise, bringing prices down with them.

At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.


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