The Utility of Investing in Utilities

The Utility of Investing in Utilities

investing in utilitiesThe secular bear market that began in 2000 has seen many investors scratching their heads over where to allocate their investable funds. Stocks have lived up to the secular bear moniker by fluctuating wildly but managing little real price progress over the past decade. In the meantime, bonds have extended a 30-plus year bull run that has seen nominal interest rates hug the zero bound and real rates dip into negative territory.

So stocks haven’t looked great unless you’re a skilled trader and bonds seem to have run their course. Now many are talking about the economic slowdown continuing and perhaps gathering steam. To top it all off, China – a key global economic engine – seems to have blown a gasket of late. Witness the decline of the Shanghai Composite Index, down about 34% since its April 2011 peak and around 18% since its February 2012 peak.

Many investors have turned to stalwart dividend-paying stocks to ward off market motion sickness over the past dozen years. After all, it’s easier to sit through those scary declines if you’ve got some nice distributions coming in right? It’s not a bad strategy, although one could easily argue that that boat is already pretty full. Having said that, I’d like to take a look at a particular type of dividend-paying stock today. Investing in utilities might be one way for investors to take on a little less volatility while allowing them to cling to some pretty steady yields.

Utility Utility

Utility can refer to a public service providing essentials like energy and communications. It also means “the state of being useful, profitable, or beneficial.” In this challenging market climate, it seems that utility companies can really live up to their name, serving a unique function in your portfolio during a time of economic uncertainty. Regardless of whether the global economy heads into recession, the European debt crisis escalates or politicians send us over the fiscal cliff, we will need utilities to provide basic infrastructure and services. (Incidentally, if the economy rebounds and the European debt problem is perceived to be under control, we’ll probably need even more energy to fuel the recovery.)

That’s not to say that another global economic crisis wouldn’t send utility stock prices lower along with all the others, but that they may not get clobbered quite as soundly as, say, commodity stocks. During the 2008 financial crisis, the TSX Composite Index fell a little over 50% from June of 2008 to March of 2009. From June 2008 to its nadir in November of 2009, the TSX Capped Utilities Index fell 37.6%. Commodities, as measured by the CRB Index, fell by about 58% during that timeframe.

The percentages listed above refer only to price movements. That is, they don’t include dividends. Some of the decline in the TSX Composite would have been cushioned by dividend distributions – more so for utilities and less so for commodities, depending on what you owned and when you owned it. So utilities aren’t immune to market volatility, but they are somewhat resistant to it.

How to Buy Utilities

If you own an index fund or ETF that tracks the TSX Index, you likely already have some exposure to utilities. The XIU (iShares S&P/TSX Index Fund), for example, includes some utilities. At 0.90% utilities compared to 33% financials, however, you may want to boost your utility exposure a little.

Here are a few other Canadian ETFs that include utilities:

  • XDV: Dow Jones Canada Select Dividend Index Fund has a 6.34% weighting in utilities with a 12-month trailing yield of 3.85% and an MER of .55%. Note that this ETF also has a huge weighting in financials to the tune of 51.55%.
  • CDZ: S&P/TSX Canadian Dividend Aristocrats Index Fund has a 10.66% weighting in utilities with a 12-month trailing yield of 3.34% and an MER of .67%. This ETF has a 21% weighting in financial services.
  • XEI: S&P/TSX Equity Income Index Fund has a 6.73% weighting in utilities with a 12-month trailing yield of 4.65% and an MER of .62%. This ETF has a 30% weighting in financials.

Of course, if you want a pure play on Canadian utilities, you’ll want to take a look at XUT (S&P/TSX Capped Utilities Index Fund), with a 12-month trailing yield of 4.14% and an MER of .62%. Alternatively, you have the option of stock-picking. You could choose to invest in a selection of Canadian utility companies. Here are a few of the XUT component companies, with their current yields:

  • Fortis (FTS): 3.67%
  • Emera (EMA): 3.91%
  • Canadian Utilities (CU): 2.64%
  • Transalta (TA): 8.25%
  • Atco (ACO.X): 1.74%

(Note: All of the data above was current as of early September, 2012.)

There’s no magic pill or silver bullet that can protect your portfolio from the vagaries of a secular bear market. Utilities are no exception. They are just another tool at your disposal to use as you see fit.

Have you considered employing utilities to boost yield and reduce volatility in your portfolio? How do you use them?

Written by Kim Petch

4 Responses to The Utility of Investing in Utilities

  1. I’m not an investor yet (lack of knowledge and information overload have been the two main factors stopping me) but the idea of investing in utilities is very interesting. As you mentioned, the need for utilities doesn’t go away regardless of the market, so it does seem like that’s a more secure route than others. You’ve piqued my interest, I’m going to definitely do some more research on this!

  2. Now that’s one hell of an interesting topic. The flip side is that the potential for longer-term capital appreciation is limited with utilities. The growth opportunities for most companies in the sector is limited, and this is reflected in their stock price performance. One benefit of this, of course, is that with fewer opportunities to invest for future growth, the companies have more cash on hand to pay out dividends. So you know either way its undoubtedly beneficial. You just have to cautious that’s it.
    Jennifer Goldblum

    • I agree Jennifer. Utilities perform a specific function in your portfolio: relative safety and decent yield. For the growth portion, I like to look at ETFs that track the Nasdaq 100. I think XQQ fits the bill for Canadians, but it’s quite new and still thinly traded. If you don’t need/want Canadian dollar hedging, buying the Q’s in the States is easy.

      Of course, there are lots of other ways to add some growth to your portfolio too.

      Thanks for contributing!

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