How To Protect A Portfolio In Utilities

Includes: D, IDU, NEE, SPXU, SRE, XLU
by: Fred Piard

Sectors are some of the factors that may influence the choice of going to cash, hedging, or doing nothing when entering a bear market. My previous articles of this series gave examples for consumer staples, industrials, healthcare, energy, materials, consumer discretionary and financials (last episode here). This one will focus on the S&P 500 Utilities sector.

For each sector in the S&P 500 universe, I defined a fundamental ranking process. My Utilities Ranking uses three fundamental ratios, among them the sales growth for the last five years. For the next part, I will use a strategy consisting of a 4-week rotation of the ten stocks of highest rank. It represents about one third of the reference set: there are currently 31 utility companies in the S&P 500 index. This is not one of my investing strategies, but a model portfolio using common sense and simple fundamental factors. I find it more relevant than using a market cap-based fund like XLU, IDU or VPU.

I have performed three 15-year simulations (1/1/1999-1/9/2014): without protection ("NP"), with market timing ("MT") and timed hedged ("TH"). The portfolio is rebalanced every four weeks. The timing indicator is the same for market timing and timed hedging. It is defined by a bearish signal when the S&P 500 current year EPS estimate falls below its own value three months ago, and a bullish signal when it rises above this value. The hedge is an S&P 500 short position in a 1:1 ratio with the portfolio value (it might be a long position in SH).

The next table shows simulation results. Dividends are included, transaction costs are 0.1%. A 2% annualized carry cost is applied for temporary hedging positions.

S&P500 Strategies




























Timed hedging is modeled here in a margin account, and margin costs are included. However, it can be executed without a margin account, by selling 25% of the portfolio and buying SPXU. A previous article here shows that hedging is possible with leveraged ETFs without fearing their systematic decay. In reality, the decay of leveraged ETFs is not so systematic (read here).

In this example, the highest total return is for the time-hedged version, but the volatility and drawdown are still high. The simple market-timing (going out of the market) gives the best risk-adjusted performance (Sortino ratio). Here is the equity curve of the "MT" strategy (in red) compared with SPY (in blue):

This is a dynamic portfolio. On average, one stock changes every four weeks. The three highest market capitalizations among current holdings are:



Capital (M$)



Div. Yield

D Dominion Resources Inc. 37,467.14 Multi-Utilities 30.19 3.39%
NEE NextEra Energy Inc. 36,530.45 Electric Utilities 17.89 3.07%
SRE Sempra Energy 21,911.20 Multi-Utilities 22.06 2.79%

*Trailing 12 months, extraordinary items included.

As a conclusion, for at least 15 years a simple market timing was the best of these three tactics to maximize the risk-adjusted performance of a model portfolio in utilities. The next article of the series will be on the Technology sector. If you don't want to miss it, click on "Follow."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.