This is the final chapter in a series of nine articles comparing popular S&P 500 stocks with exchange-traded fund alternatives. Picking a single stock from all nine sectors, we then went to work finding ETFs that held the stock in their top 10 holdings.
We’ve uncovered funds of all sizes and descriptions, but the one thing that is abundantly clear after completing this process is that investors don’t have to settle for plain vanilla ETFs that track the major indexes. New products are available practically every day. Do your homework, remembering that every fund is different.
Utilities are the final sector in this series. Duke Energy (NYSE:DUK) happens to be the stock with the highest average daily volume — 12.74 million — and the third-largest by market capitalization, at $28.3 billion, behind only Southern Company (NYSE:SO) at $39.1 billion and Dominion Resources at $28.8 billion. Given that 34 businesses make up the components of the utilities sector — all with market caps greater than $1 billion — it was a little surprising to find only nine ETFs with Duke Energy in their top 10 holdings. It’s especially puzzling when you consider that the utilities sector returned 10.9% in 2011, the second-highest sector behind only health care at 13.2%. Nonetheless, we’ve got plenty to work with.
The first thing many investors look at when considering ETFs is the expense ratio, which is the percentage of the assets the fund company charges for managing your money. While it’s definitely an important consideration, in this exercise, it’s more important that we identify ETF options that are heavily weighted in Duke Energy. After all, we’re seeking an alternative to buying Duke Energy’s shares. Therefore, at least by weighting, the Utilities Select Sector SPDR (NYSEARCA:XLU) is our first choice.
The fund has total net assets of $7.2 billion, invested among 35 stocks with a weighted average market cap of $18.5 billion. Its dividend yield, which is very important to anyone considering an investment in the utilities sector, is 3.95% — 19 basis points lower than the index it follows. Duke Energy represents 6.18% of the portfolio and is its third-largest holding behind its two peers mentioned previously.
In terms of composition, the fund is heavily weighted in large-caps, which represent 75% of the portfolio, with the remaining 25% invested in mid-caps. Over 50% of the fund’s assets are allocated to electric utilities. Its performance over the long term, when compared with the S&P 500, has been excellent. Over the past decade, through January 23, the XLU managed an annual return of 6.24% — 267 basis points better than the S&P 500. In recent years, however, it has lagged the index, trailing by 798 basis points annually over a three-year period. Generally, though, it has been a good, conservative investment with a reasonable expense ratio of 0.20%.
Now, we’ll look at something more esoteric: PowerShares Global Nuclear Energy Portfolio (NYSEARCA:PKN), which is based on the WNA Nuclear Energy Index. According to Invesco’s literature, the index tracks the overall performance of global companies involved in the nuclear energy industry. It is rebalanced quarterly.
The fund has just $16.2 million in total net assets that are invested in 63 stocks. Of the utilities in the fund, Duke Energy has the highest weighting, at 2.99%. PKN has 38.6% of its assets in its top 10 holdings — Duke Energy being one of them — compared with 54.7% for XLU. Having a lower concentration is not necessarily a bad thing, but if you believe in the concept of investing in your best ideas, this fund spreads out its bets more than you might.
Income investors might want to consider that PKN’s SEC 30-day yield is only 1.36%. Its three-year annualized return, through January 23, is 7.07% — about 37% of the S&P 500’s 19.06%. With only a three-year track record for both the fund and the index, there’s plenty of time for it to outshine the S&P 500. Unfortunately, given its annual expense ratio of 0.75%, I’m not sure how many people are going to take the chance, especially when the XLU is a much cheaper alternative.
The final two ETFs were selected because they both have the lowest expense ratio of the nine funds, at 0.19%, and both also have Duke Energy weighted above 5%, with 45% to 46% of their assets in their top 10 holdings. The first is the Vanguard Utilities ETF (NYSEARCA:VPU), with $1.3 billion in total net assets invested in 84 stocks.
The second is the Focus Morningstar Utilities Index ETF (NYSEARCA:FUI), with total net assets of $6.8 million invested among 71 stocks. There is very little separating these two funds in terms of market-cap composition, turnover ratio, yield, etc. If you’re the type that likes to go with a proven commodity, the Vanguard fund probably is more suitable. However, if you prefer the rising star, FocusShares should be on your radar.
The bottom line: In the first article of this series, I pointed out that a 32-stock portfolio eliminates 96% of the company risk of owning just one stock. It’s for this reason that it makes sense to explore ETF alternatives to stocks you would like to own. Unless you have the funds to own 32 separate stocks, owning several ETFs can help you accomplish the same thing.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.