Utility companies are expected to provide fairly stable performance, without too much downside risk. Utilities are also typically expected to provide lower average returns than the broader market. In the last decade, however, utilities have out-performed the broader stock market as investors have become increasingly risk-averse and worried about the prospects for sectors that depend largely on robust economic growth in order to meet their earnings targets.Performance
The Folio Investing Utility Folio, designed to track the Dow Jones Utilities index, was launched in April 2000 and has delivered a return of 7.9% per year over its lifetime (through August 20, 2012), as compared to 1.4% per year for the S&P500 (including reinvested dividends) over this same period. Utilities have vastly out-performed the S&P500 over this 12.4-year period. The Utility Folio performs essentially identically to the iShares Dow Jones U.S. Utilities ETF, as it should, given that they are both designed to follow the same index (see chart below). The expense ratio for the ETF is 0.47%, so we would expect the Folio to slightly out-perform because Folios have no explicit expense ratio. The chart below does not account for any brokerage expense of buying the ETF or of maintaining a brokerage account at Folio Investing. The chart does reflect the funded performance of the Utility Folio, capturing bid-ask spread and other factors.
iShares Dow Jones U.S. Utility ETF (NYSEARCA:IDU) vs. Utility Folio (8/31/2009-8/20/2012)
One of the very attractive features of utilities is that they tend to be far less impacted by sudden shifts in the market. From July 20, 2011 through August 20, 2011, the S&P500 lost 15%, including dividends (see chart below). The Utility Folio lost 3.9%.
S&P500 vs. Utility ETF (7/20/2011-8/20/2011)
The market recognizes that the expected earnings from utilities are simply less impacted by economic bad news than the broader market. For this reason, utilities tend to be less affected during broad sell-offs.Industry Overview: A Unique Industry Providing a Crucial Product
Utility companies deliver electricity, natural gas, and other commodities to residential customers and to businesses. An unusual feature of the utility industry is the level of regulation. Your local utility must get approval from the public utility commission before they can raise the price that they charge for the products and services that they provide. Another unusual feature of utilities is the limitation in transportation for electricity. If one state has a shortage of a commodity (and therefore high prices) and another has an excess (and lower prices), the commodity will be shipped from the state with low prices to the one with high prices, thereby equalizing the prices between the two states. With electricity, in particular, it may not be possible to transport (technically to transmit) the power to regions where there is a shortage of electricity. Transmission lines and related infrastructure constrain the ability to move electricity. So, for example, if there is a heat wave in the Mid West and the South East is unusually cool in the summer, it may not be possible to use idle generators in the South East to provide electricity to the Mid West. A third unusual feature of utilities is that demand for electricity is not very responsive to price. For many commodities consumers respond to an increase in price by buying less (and vice versa).The Holdings in the Utility Folio
The Utility Folio consists of the same stocks that make up the Dow Jones Utility Average (DJUA).
|American Elec Pwr Inc||AEP||6.83%|
|Centerpoint Energy Inc Com||CNP||3.49%|
|Dominion Resources Inc.||D||9.07%|
|Duke Energy Corp New Com||DUK||3.72%|
|Consolidated Edison Inc||ED||10.35%|
|Nextera Energy Inc||NEE||10.82%|
|Public Svc Enterprise Group||PEG||5.42%|
|Williams Cos Inc Del||WMB||5.46%|
[Note: The holdings are re-evaluated and updated (as needed) on a quarterly basis.]Commentary: The Narrative for Utilities
Utilities are an attractive asset class for many types of investors. For those who want to limit the risk in their equity holdings and for those who are seeking income, utilities are particularly of interest. Utilities are represented in market capitalization weighted indexes such as the S&P500. Being overweight utilities (e.g. beyond the weight in the broad stock indexes) has several effects on a portfolio. First, adding more utilities tends to create a 'value' tilt to the portfolio because utilities tend to have higher dividend yields and lower price-to-book ratios than the broader market. Second, utilities tend to be less impacted by market declines than many other sectors, as well as gaining less during market rallies. Finally, if the economy follows an anemic growth trajectory, utilities have good potential to provide something of a safe-haven given that demand for electricity, in particular, is fairly consistent in both good times and bad.Related Links:
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