Why Utilities Is The Top Performing Sector

July 07, 2016

John Bartlett is portfolio manager and electric utility analyst for Reaves Asset Management. Reaves launched the first actively managed utilities ETF, the Reaves Utilities ETF (UTES | D-79), in September 2015.

Since then, utilities have exploded to the upside, powering UTES to a gain of 32.24% versus 29.3% for the Utilities Select Sector SPDR Fund (XLU | A-89). ETF.com recently caught up with Bartlett to get his take on the space, including why an actively managed utilities ETF is something investors should consider.

 

ETF.com: Utilities are by far the best-performing sector this year. Is that simply because interest rates on government bonds are moving down so much?

John Bartlett: Yes; generally speaking, utilities―especially in the short term―tend to react pretty swiftly to changes in interest rates. That's a reflection of the fact that utilities trade on their yield.
When you look at the average utility, its P/E [price-to-earnings] ratio is a function of its dividend yield. Typically, the higher-yielding utilities have a higher valuation.

As far as how utilities have been reacting to interest rates, the relationship isn't static. It does vary, and I would say that the spread to Treasurys tends to creep up a little bit as interest rates go lower.

If we go back to 2014, utilities were the best-performing sector in the stock market. That was a period when we were really worried about deflation, and interest rates were quite low. The spread―the utility dividend yield over the 10-year Treasury yield―ended that year at about 100 basis points.

Then we fast-forward to 2015, and utilities were amongst the worst sectors in the stock market. We ended the year at about a 200 basis point spread to Treasurys. Today we're at about a 160 basis points spread to Treasurys.

As far as I'm concerned, we're in neutral territory for utilities, with 100 basis points being too hot, and 200 basis points being too cold, with 150 basis points or so being about right.

ETF.com: Aside from interest rates, are there other fundamental factors you look at when it comes to utilities? What's their outlook for growth in earnings and things like that?

Bartlett: Utilities are one of the few places in industrial America where investors tend to underpay for growth.
We try to invest for total return, so our portfolio typically looks a little bit more "growthy," a little less "yieldy." We try to focus on companies that have the opportunity and the desire to grow their income a little faster than average over time.

The average utility on a market-cap-weighted basis grows its earnings around 4%. The utilities in our portfolio are little bit higher, in the 5% to 6%, maybe even 7% range. We have one big holding that's probably going to grow its earnings around 12% for the next few years.

 

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