Utilities-focused exchange-traded funds as a group have been strong performers this year, with many of them outpacing the roughly 10 percent gain on the S&P 500 Index.
That’s surprising given that utilities weren’t expected to do well this year as the Federal Reserve continued to normalize monetary policy. The Fed has raised rates three times since December 2016 and is expected to hike rates once more this year. Prior to the tightening cycle, income-seeking investors piled into utilities ETFs for their attractive dividends in an otherwise low-yield environment. However, with the Fed raising rates, conventional wisdom suggested these securities would falter.
But a couple of fundamental factors are supporting the utilities sector. Christopher Muir, an equity analyst at CFRA Research who covers utilities, says spending by utilities for new natural gas-fired and renewable energy plants—in part to replace older and smaller coal plants—is allowing regulated rates to rise. Those higher rates are being charged to customers and leading to higher revenues.
And greater infrastructure spending in some states lets companies recover money spent on capital improvements faster because there is less regulatory lag. “All of these things combine with increasing industrial electric and gas demand due to an improving economy to grow revenues and EPS (earnings per share),” Muir says. “Cost control efforts are likely to further enhance EPS growth.”
There are 22 domestic and global utilities ETFs, with a mix of passive, market-cap weighted and smart-beta funds, as counted by ETFdb.com. A few funds mix utilities and infrastructure, making them less pure-play.
For global funds, the best-fit pure-play utilities ETF is the iShares Global Utilities ETF (JXI), up 18.6 percent year-to-date, with $161 million in assets. Its outperformance is likely because it’s benefitting from the gains from the global economic upswing that has helped ex-U.S. investments rise.
Domestic pure-play utilities funds are most likely to be impacted by a Fed rate hike. Looking at the holdings of these ETFs shows significant similarities, whether active, passive or smart beta. That’s not surprising since it’s a niche sector, but the returns for the most part show that at least now, strategy makes little difference.
By far the largest category of companies held by domestic utilities-focused ETFs are electric utilities and independent power producers, which includes companies such as Duke Energy, Exelon and Consolidated Edison. The second-largest category comprises so-called multi-line utilities that typically produce and distribute electricity and natural gas.
Considering these two sector categories are responsible for 75 percent of any domestic utilities ETF, it’s not surprising to see returns within the same range.
The biggest passive funds are some of the better performers. The Utilities Select Sector SPDR Fund (XLU) is up 14.6 percent and has $7.9 billion in assets under management. The Vanguard Utilities ETF (VPU) is up 14.4 percent and has $2.7 billion in AUM, while the iShares U.S. Utilities (IDU) rounds out the top three with $864 million and is up 14.3 percent. Their expense ratios are 14 basis points, 10 basis points and 44 basis points, respectively.