Eric Dutram: Despite recent market turmoil, 2012 has been a good year for the stock markets so far. After a dismal performance of the broader markets in the previous fiscal year, we finally seem to be treading along the paths of economic recovery, at least in the U.S.
However, while markets might be holding up relatively well in the U.S., European events continue to plague investor sentiment, causing many to withhold purchases of stocks at this time. Fortunately, there a few defensive sectors that could be interesting picks in this type of a market, namely those in the utility segment (see Greek ETF Plunges on Election Results).
This is because the products of this segment—such as power and water—can be viewed as necessities that have relatively stable demand. Energy and water are likely to be in high demand no matter what the situation is in Europe and thus could be more insulated from shocks in the marketplace.
Furthermore, the sector is also a popular destination for yield focused investors as well. Treasury rates are below 2% and many companies in the utilities sector pay out more than that to investors on a regular basis while still allowing for capital appreciation as well (read Three Cyclical ETFs That Are Surging Higher).
Given this combination of value and yield, along with the defensive nature of the space, it could be time to give this segment a closer look. For investors looking to play the utility sector, an ETF approach can be a solid idea. This technique can help to spread out assets among a wide variety of companies and reduce company specific risk for a very low cost.
Below, we highlight the ETFs in this sector which have an American focus and can be somewhat insulated from any foreign woes. We also discuss some of the pros and cons of each product, hopefully allowing investors to determine which utility ETF may be the best for their current situation:
Utilities Select Sector SPDR (NYSEARCA:XLU)
Launched in late 1998, XLU seeks to match the price and yield performance of the Utilities Select Sector Index before fees and expenses. The Index is a subset of the S&P 500 index which tracks the performance of companies engaged in the business of electric utilities, multi-utilities, independent power producers, energy traders and gas utilities. The index holds 32 securities in all and has net assets of $6.48 billion.
The ETF is appropriate for those investors who are looking for a targeted bet on regulated utilities, as well as independent producers and traders of power. XLU is by far the biggest as well as the most liquid ETF targeting this space, as indicated by its average daily volume of about 6.7 million shares.
Additionally, the fund targets the large cap space of the sector, focusing its assets on the biggest companies in the space. Partly thanks to this, the ETF is slightly concentrated in its top 10 holdings with 55.84% going to these stocks, a still reasonable level considering that it holds 32 securities in total.
Southern Co, Exelon Corp, Dominion Resources Inc, Duke Energy Corp and Nextera Energy Inc are some of its top holdings, meaning that a few household names are likely to be in the product.
XLU pays out a good yield of 3.90% per annum and charges investors a paltry 18 basis points in fees and expenses.
Vanguard Utilities ETF (NYSEARCA:VPU)
The ETF employs a full replication strategy and seeks to match the price and yield performance of the MSCI US Investable Market Utilities 25/50 Index. It is another low-cost option for conservative investors as it charges just 19 basis points in fees and expenses compared to a category average of 0.46%. Like most ETFs in the utilities space, VPU also pays out a good yield of 3.60% per annum. (see 11 Great Dividend ETFs)
The fund invests throughout all spectrums of market capitalization with a large cap bias. VPU holds 83 securities in all, with 45.7% of its total assets invested in the top 10 holdings.
iShares Dow Jones US Utilities (NYSEARCA:IDU)
The product debuted in the middle of 2000 and tracks the Dow Jones U.S. Utilities Index. The ETF employs a representative sampling technique of stock selection based on certain fundamental and market capitalization characteristics. Unfortunately, investors have to pay a steep amount as fees and expenses due to the sampling technique as it charges 0.47%.
IDU pays out a yield of 3.55% per annum and currently holds 68 securities in its portfolio. It has total assets of about $662.09 million with a 46.27% allocation towards the top 10 holdings.
The high expense ratio of the ETF compared to other ETFs in the utility space has, however, been justified. This is because IDU has performed relatively better than most of its counterparts, returning -1.46% quarterly as of 31st March 2012 and 12.48% on a yearly basis as of that date.
Focus Morningstar Utilities ETF (NYSEARCA:FUI)
FUI is another low cost choice for investors seeking exposure in the utility ETF space. It charges a paltry 19 basis points in fees and expenses. Having been in existence for just over a year, FUI has till now not been able to capture the interest of investors, as suggested by the average daily volume of 2,051 and total assets of $6.96 million.
FUI allocates the majority of its assets in electric utilities, followed by multi-utilities from a sector perspective. Partly due to this, the ETF has a large cap bias and predominantly places its bets on the biggest firms in the space.
Despite this, FUI has a relatively diversified portfolio, holding 70 securities with a 47.86% allocation towards the top 10 holdings. It is prudent to note that this product resembles any other large cap ETF targeting this space (see Three Unlucky Equity ETFs).
Like most of its counterparts it pays out a good yield of 3.55% per annum and in terms of capital gains it has returned 8.60% in the last one year period.
Guggenheim S&P 500 Equal Weight Utilities (NYSEARCA:RYU)
Launched in November of 2006, RYU seeks to match before-expense price and yield performance of the S&P Equal Weight Utilities Index. All the components within the index are given equal weightings; therefore the ETF does not have any bias as far as market capitalizations are concerned.
While many may argue about this methodology of stock weighting, it can actually work in favor of investors during certain market environments. After all, during a bull market, small caps tend to outperform their larger countparts, although they can lag during flights to safety (see Play A Consumer Recovery With These Discretionary ETFs).
The ETF presently holds 40 securities with total assets of $43.53 million and 26.43% allocation towards the top 10 holdings. The fund is comparatively expensive as compared to other products targeting this sector. It charges investors 50 basis points and has paid out a yield of 3.46% per year.
First Trust Utilities AlphaDEX (NYSEARCA:FXU)
The fund employs a unique AlphaDEX methodology of stock selection, which uses fundamental growth and value factors in order to pick securities. Various fundamental analysis factors are used to shortlist stocks. The stocks are then scored on the basis of these parameters with the top 75% high scored stocks becoming part of the fund portfolio.
The unique methodology comes with a hefty price for investors, as they are charged 0.70% in expenses, nearly 2.5 times other utility ETFs. The fund holds 50 securities in its portfolio currently and allocates 35.58% in the top 10 holdings. Comparatively, the ETF is not as high-yielding as most products in this space and pays out a yield of 1.86% per annum, but it does appear to be more spread out from a holdings perspective.
However, given its sustainability and popularity as suggested by its total assets of $163.84 million and average daily volume of 364,159, this might be a good option for investors looking for a systematic approach in the utilities sector.
PowerShares Dynamic Utilities (NYSEARCA:PUI)
Launched in October of 2005, PUI tracks the Dynamic Utilities Intellidex Index. The index shortlists stocks on the basis of various quantitative and qualitative parameters like price and earnings momentum, management action and value creation. The portfolio is rebalanced on a quarterly basis and holds 61 securities in its basket.
The fund has an even allocation across the entire spectrum of market capitalization. The ETF invests predominantly in electric utilities, multi-utilities and wired-line telecommunications. The product is appropriate for investors seeking value over the longer term.
This is because the unique stock selection technique employed by the ETF tracks down companies not only with an above-par growth potential, but also the quality of their management based on business decisions.
The ETF holds 25.39% of its total assets in the top 10 holdings. The fund has been in existence for almost seven years, but has total assets of only $43.03 million. The product charges 60 basis points in fees and expenses mainly thanks to the unique stock selection technique adopted by the PowerShares fund. However, like most of its counterparts, PUI pays out good yield of 2.73%.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>
In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.