Many investors prefer utility funds/ETFs when it comes to the generation of income but, as the past years have shown, they are anything but the perceived place of safety where money can be parked without worry.
The WSJ featured an article on the subject titled “A Classic Dividend Play.” Let’s listen in:
Utility stocks didn’t fully participate in last year’s market rebound and may remain laggards for some time, given the likelihood of an anemic economic recovery and higher interest rates. Considering that, the biggest appeal of utility-stock mutual funds and exchange-traded funds may continue to be what has been the sector’s main drawing point historically: high dividend yields over the long haul.
Last year, utility funds were the weakest performers among 21 U.S.-stock categories tracked by Morningstar Inc., returning 18% (including price change and dividends) in a year when the Standard & Poor’s 500-stock index returned over 26%. The only utility funds that greatly outperformed the sector average benefited from nontraditional holdings.
…
Of course, utility stocks have never been considered that exciting. Deregulation and the shooting star of energy-trading utilities such as Enron Corp. added some spice to the sector.
And utilities funds had some appeal as defensive positions in the market debacle of 2008, posting an average return of negative 34%, better than many other types of stock funds and the S&P; 500, which plunged 38%, according to Morningstar. But in general, utility stocks remain most attractive to conservative investors seeking a reliable income stream from high dividend yields.
As of late December, the median yield of the 26 utilities funds followed by Morningstar was 2.9%, outpacing the 1.2% yield for large-company “blend” funds and the 2.3% yield of the S&P; 500.
…
Investing in regulated utilities, however, isn’t without risk. Some analysts say the potential for higher interest rates and the looming prospect of cap-and-trade legislation aimed at curbing greenhouse-gas emissions may hurt the sector over the next few years.
“We’re a little concerned” about utilities funds’ exposure to the factors holding down regulated electrical utilities, says Tom Roseen, a research manager at Lipper Inc., which says U.S. electric utilities account for about 30% of the average U.S. utilities-fund portfolio.
Higher interest rates are of particular concern, says Don Linzer, managing director of Schneider Downs Wealth Management Advisors. Utilities tend to have a lot of debt because of construction requirements, so a rise in interest rates would increase those borrowing costs. And if bond yields rise, that increases the appeal to investors of bonds versus utilities stocks.
[Emphasis added]
I must be missing the point, because I am not sure how utilities can be considered a “defensive position.” Is it maybe because they lost “only” 34% in 2008 vs. the S&P;’s loss of 38%? Sure, that would make an investor feel much better…
All kidding aside, while utilities can be a great place to park your money in order to generate a consistent dividend, you still need to pay attention to the direction of the trend. One look at the chart of XLU makes this abundantly clear:
Even supposedly safe investments such as utilities took a steep dive in 2008, and for those who participated, it will take quite some time to make up the losses despite the 2009 gains.
Actually, from a trend tracking point of view, utility funds/ETFs are well suited since they tend to move in less erratic fashion compared to other sectors. If this type of investment appeals to you, pick your entry point once the long term trend line has been crossed to the upside.
Then work with a trailing sell stop so that will never participate in a disaster year like 2008. All the data you need are easily accessible in my weekly StatSheet.