First, the vast majority of major utilities use coal and natural gas to generate power. In fact, electricity prices are primarily driven by the price of coal and natural gas, in addition to market forces influenced by supply and demand. With this in mind, it’s relatively easy to see the high correlation between the energy and utility sectors.
Secondly, utilities have started to get over their biggest hurdle, government legislation on greenhouse gases, which has been known to drive up operational costs. In fact, a group of utility companies have come together and formed the American Businesses for Clean Energy, which is pushing for clean energy initiatives which will make then benefit from new energy policies.
Thirdly, many utility companies will benefit from President Barack Obama’s initiative to help fund an energy grid modernization. The Obama administration announced that it will distribute to some utilities, private companies, and municipalities grants in the range of $400,000 to $200 million to build a smart-energy grid. Many believe that once implemented, the new energy grid modernization will decrease consumer dependency on electricity, cutting into utility revenues, but this will likely not take place for many years to come.
Lastly, utility stocks are known to pay out high dividends, which could be a good thing to add to a portfolio in the case of deflation. They’re also known to have relatively low betas, which could help lower the risk levels of a portfolio.
Two ways to play the utilities sector include:
- iShares Dow Jones US Utilities Sector Index Fund (NYSE:IDU) which allocates nearly 72.2% of its assets to holdings that are related to electricity and 27.6% to gas, water and multi-utilities. Some top holdings include Southern Co (NYSE:SO), Exelon Corp. (NYSE:EXC) and Dominion Resources Inc. (NYSE:D).
- Utilities Select Sector SPDR (NYSE:XLU), which allocates 53.75% of its assets to electric utilities, 39.24% to multi-utilities, 5.16% to independent power producers and energy traders and 1.85% to gas utilities. XLU’s top holdings are similar to those of IDU’s, but not as concentrated in regards to holdings as a percent of net assets.
Written By Kevin Grewal From ETF Tutor Disclosure: No Positions
Kevin Grewal is the founder, editor and publisher of ETF Tutor and serves as the editor at www.SmartStops.net, where he focuses on mitigating risk and implementing exit strategies to preserve equity. Additionally, he is the editor at The ETF Institute, which is the only independent organization providing financial professionals with certification, education, and training pertaining to exchange-traded funds (ETFs). Prior to this, Grewal was a quantitative analyst at a small hedge fund where he constructed portfolios dealing with stock lending, exchange-traded funds, arbitrage mechanisms and alternative investments. He is an expert at dealing with ETFs and holds a bachelor’s degree from the University of California along with a MBA from the California State University, Fullerton. He is a contributing author on The Street – his articles can also be found published on various sites including Yahoo! Finance, The Globe and Mail , Daily Markets, MSN Money, Seeking Alpha, Fidelity Investments, Traders Library, and Minyanville.