Utilities – one of the best performing sectors of 2014 – started the year on a good note with smart gains logged for January. An uncertain global economic outlook, interest rate cuts in developed to emerging markets, sliding commodity prices, political instability in Greece and a surprise move by the Swiss central bank to abandon its currency cap against the euro created panic among investors driving treasury yields lower at the start of the year (read:3 Utility ETFs Surging to Start 2015).
However, the sector has lately given up almost all of its gains and in fact is trading in the red in the year-to-date frame. The most popular product in the space – SPDR Select Sector - Utilities (NYSE:XLU – has lost 7.4% in the past one month as against a 4% return by SPDR S&P 500 (ARCA:SPY) over the same time frame.
An improved U.S. economy and a strong U.S. jobs report have sent government bond yields sharply higher in the past few weeks, making the utility sector less attractive. The U.S. economy has added more jobs than expected in January, fuelling optimism about the strength of the job market. Moreover, the U.S. average hourly earnings rose at a better-than-expected pace of 0.5% in January.
The upbeat labor market data has raised optimism about the pace of economic growth, leading many to believe that a rate hike by the Fed is surely on the cards this year. Expectations of a rate hike this year has caused the 10-year Treasury bond yield to spike to a four-week high of nearly 2%, a sharp and sudden increase from levels which were in the 1.65% range earlier in the month (read: Rising Interest Rates Are Great News for These Bond ETFs).
Utilities are quite sensitive to interest rates though they offer steady and strong yields. Thus, rising Treasury yields, an improving U.S. economy and strength in the jobs market have reduced the appeal of utilities as investors are shunning defensive bets to move to sectors more closely tied to growth. Moreover, utility companies rely on a large amount of debt for conducting operational activities. Hence, any rise in interest rates would push up their borrowing costs.
Given the rising yields and concerns over a hike in short-term rates this year, below we have highlighted some of the large-cap funds in this space which have been among the hardest hit by the move towards cyclical securities and away from safety. Investors who believe that this is just the beginning of the slide in the space should clearly stay away from this space.
XLU in Focus
XLU is the largest and the most popular ETF in its space with an asset base of $7.8 billion and average daily trading volume of 14.7 million shares. The fund is also one of the cheapest in its space with 15 basis points as expense fees.
The fund tracks the Utilities Select Sector Index, holding a basket of 30 stocks. Duke Energy (NYSE:DUK) occupies the top spot with 9.3% allocation, followed by NextEra Energy Inc (NYSE:NEE) and Southern Co, each with a little more than 7.5% exposure.
XLU has lost 4.4% in the year-to-date frame after having gained 16% in the past one year. The fund has a solid dividend yield of 3.31%
iShares US Utilities (NYSE:IDU)
The fund too gives investors an exposure to U.S. utility stocks and manages an asset base of $1.9 billion. IDU is home to 60 stocks and is also heavily concentrated in its top 10 holdings. Duke Energy Corp. (8.3%), NextEra Energy Inc. (6.65%) and Dominion Resources Inc (6.3%) are the top three holdings of the fund.
Sector-wise, the fund invests more than half of its assets in electric utilities, while the rest go towards multi-utilities, gas and water (see all Utilities/Infrastructure ETFs here).
The fund charges 43 basis points as fees and has a 30-day SEC yield of 2.62%. IDU has lost7% in the year-to-date frame and but up 16% in the past one year.
Vanguard Utilities (NYSE:VPU)
VPU tracks the MSCI US Investable Market Utilities 25/50 Index to provide exposure to a basket of 78 stocks. Sector-wise, electric utilities dominate here as well, followed by a 34% allocation to multi-utilities.
The fund is also quite popular in its space with an asset base of $2.1 billion and an average expense fee of 12 basis points. The fund has a 30-day SEC yield of 3.08% and has lost 7.2% in the past month.