Boring Utilities ETFs Could Get Advisors Excited Soon
If you promise not to fall asleep, I’ll explain why the epically mundane utilities sector is starting to look like a place where dividend investors can go hunting. It has been a tough stretch for dividend stocks in general, and the utilities sector in particular. The sector leader in ETF assets, the $12 billion Utilities Select Sector SPDR ETF (XLU), has underperformed the SPDR S&P 500 ETF Trust (SPY) by more than 25% in total over the past three years.
That’s not as bad as it gets for utilities, but it is close. And it continues a more than 13-year trend in which XLU underperforms SPY on a three-year rolling return basis. That has been the case more than 90% of the time (using monthly returns). But if past performance were an indication of future returns, advisors would see a different disclaimer at the bottom of every fund ad, wouldn’t they?
It wasn’t always this way. For most of the first decade of this century (2000-2009), XLU routinely outperformed SPY. At the peak of that winning streak in April 2007, XLU gained 97% in a 3-year period that ended that month, versus 41% for SPY. Investors who have not been active in the markets for more than 20 years probably would need some convincing that those are facts. They are.
Bull Case for XLU, Utilities
So, what is the bull case for XLU, since simply expecting a laggard to magically revert to the mean is not the type of investment strategy that advisors can rely on with skeptical clients? It starts with interest rates.
Utilities are often considered a “safe haven” in the equity market, especially for big money managers with mandates to only invest in stocks. At times when the whole market is one big sea of ink, the higher dividend yield and relative stability of these companies’ business models is about the closest thing managers can get to a bond-like escape valve.
The other interest rate related aspect of utility investing is that if the stock market starts to sniff out a situation where Treasury rates may need to come down in a panic due to the country’s heavy debt burden and recession concerns, that could also play into the hands of the sector some simply refer to as “Utes,” which brings up reminders of the University of Utah’s sports teams as well as a famous scene from the movie My Cousin Vinny.
Utilities ETFs: Boring But Beautiful in 2024?
Utilities are regulated entities, and while there is more competition than there used to be decades ago, this is still a market sector where companies operate as near-monopolies. In economies like the US, where market forces and competition are dominant factors, the utilities sector stands out because consumers cannot simply shop around for where to get their electricity. If you live in a certain town, that provider is already in place, and utility commissions regulate the rates they can charge.
That makes for a set of boring, stable dividend stocks that comprise the top-heavy XLU, where five of its 30 stock holdings account for more than 40% of assets. XLU yields 3.2%, about 2.5 times that of SPY.
There are 12 ETFs in the etf.com database devoted specifically to utilities, and most land around the same yield range as XLU, except for those with a mix of global stocks, since non-US utilities have slightly higher yields.
XLU was up sharply on Monday, closing 1.4% higher, and continuing what appears to be a technical breakout from a downward price trend it has been battling since late 2022. Going back further, it is up only 9% total (not annualized) including dividends since the pandemic market top on February 19, 2020. So, it is fair to say that like the utilities bills we pay each month, XLU is "due."