Utility ETFs Return To Fore In 2014

May 16, 2014

Utilities make up the best-performing S&P 500 sector year-to-date.

The S&P 500 Index has again been reaching new highs recently after surging more than 30 percent last year, but it’s been a slow rollercoaster ride for investors thanks to mixed economic data in the U.S., a slowing Chinese economy and escalating tensions in Ukraine. That has favored utilities.

Indeed, investors who made utilities and related ETFs a part of their portfolios have enjoyed a different experience thus far in 2014 thanks to persistent ultra-low interest rates, courtesy of the Federal Reserve. The U.S. central bank has promised to keep rates low even as it starts to wind down its “quantitative easing” economic stimulus package.

“A lot of the best-performing stocks of last year are out of favor, and bond yields have surprised many by actually declining,” said Sumit Roy, managing editor of Hard Assets Investor. “That makes utilities attractive to investors seeking safety and income.”

Year-to-date, the $1.6 billion Vanguard Utilities ETF (VPU | A-98), the $725 million iShares U.S. Utilities ETF (IDU | A-97) and the $6 billion Utilities Select Sector SPDR Fund (XLU | A-93) are up more than 11 percent, compared with the $156 billion SPDR S&P 500 ETF’s (SPY | A-97) almost 2 percent increase.

XLU_Vs._VPU_Vs._IDU_Vs._SPY_YTD_Performance

Chart courtesy of StockCharts.com

On the asset-gathering front, XLU has garnered $1 billion in new assets, while VPU and IDU have attracted $111.2 million and $52.5 million, respectively, year-to-date, according to data compiled by ETF.com Analytics.

“XLU is one of the biggest asset gatherers this year, as investors look to have U.S. exposure, above-average dividend yields and safety,” said Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ.

While interest-rate moves in 2014 have benefited utilities companies, the interest-rate outlook in general is a negative for utilities companies, according to Spencer Bogart, an ETF.com analyst, alluding to signals from the Fed that it may raise rates earlier rather than later in 2015.

Bogart says that a long-term trend of falling interest rates favors utilities because these companies borrow heavily to pay for infrastructure investments in power generation. As a consequence, they stand to benefit from lower interest payments and stronger profits.

Year-to-date, benchmark 10-year Treasurys have dropped from 3.0 to 2.5 percent, according to data from the U.S. Department of Treasury, boosting the returns of utility-focused ETFs.

It was a different story for utility ETFs in 2013, as XLU, VPU and IDU had respectable returns of 10.5 percent, 12.2 percent and 12.0 percent, respectively, but all trailed the SPY’s 28.6 percent gain for the year. Yields on benchmark 10-year Treasurys shot up from 1.9 to 3.0 percent last year.

“Utilities underperformed last year as investors chased cyclical stocks,” Roy said. “The fact that bond yields also jumped significantly at the end of 2013 also weighed on the sector.”

Still, Bogart notes the fact that inflation has been a boon to the utilities sector.

“Utilities are a particularly troubled sector in high-inflation environments as they cope with rising input energy costs but struggle to pass those costs to consumers as their prices are highly regulated. The fact that inflation has been a nonevent thus far in 2014 is good for utilities,” he said.

 

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