Utility stocks were the prize inside investors’ Cracker Jack boxes in 2011. In a still-sluggish economy, this dull but durable sector went wild, with returns near 20% last year. And that stellar performance pummeled high-flying investments such as tech stocks and high-yield bond funds.
But as optimism abounds over a strengthening U.S. economy, the smart money has begun to flee the sector for more exciting investment opportunities that promise aggressive growth and sky-high yields. And let’s face it: That’s a solid strategy.
Why? Utility stocks are counter-cyclical, meaning their stable base of rate-paying customers provides a safe haven during a recession. That makes utility stocks perform better than consumer cyclicals such as retail, automotive or hospitality when the economy turns south. But with many economists predicting that U.S. gross domestic product will grow by 3% this year, the stage is set for investors to abandon their safe-haven utilities for higher-yielding plays.
Or is it? Well, that depends on whether you believe that the economic rebound is bulletproof, that Europe’s fiscal gloom and doom will not spread across the pond and that persistent problems such as a weak housing market and limited permanent hiring won’t put the brakes on the rebound.
Even if all those high hopes come true, there is still no political will in a presidential election year to tackle the massive U.S. budget deficit in any meaningful way. That’s the realpolitik of Washington: Given the choice between doing nothing or making hard decisions that produce real results, politicians of all persuasions would rather do nothing and campaign on the issue.
So it’s more likely than not that income investors in particular may find the safe haven of utility stocks looking a lot more attractive in the second half of the year than they do today. Since some individual stocks are overbought right now, a good way to play the sector in a more diversified manner is through exchange-traded funds (ETFs), which trade on an exchange, just like stocks.
Earlier this week, InvestorPlace looked at utility ETFs that hold Duke Energy.
Here are five utility ETFs to buy specifically for the dividends:
Utilities Select Sector SPDR Fund (NYSEARCA:XLU). This ETF tracks the Utilities Select Sector Index. Top holdings include Southern Company (NYSE:SO), Dominion Resources (NYSE:D), and Exelon (NYSE:EXC). With a market cap of $6.7 billion, the ETF is trading at around $34.40, 16% above its 52-week low last August. It has a one-year performance of 11.8% and a current dividend yield of nearly 4%. This fund has an attractively low expense ratio of 0.2 — far better than the sector average of 0.5. Like most SPDRs, XLU’s holdings have a lower annual turnover rate than many other funds — only 3.2% — compared with a sector average of nearly 22%.
iShares Dow Jones U.S. Utilities Sector Index Fund (NYSEARCA:IDU). This ETF seeks to match the performance of the Dow Jones U.S. Utilities Sector Index. Top holdings include SO, D, Duke Energy (NYSE:DUK), EXC and NextEra Energy (NYSE:NEE). With a market cap of $715 million, the ETF is trading at around $85, 17% above its 52-week low last August. It has a one-year performance of nearly 11% and a current dividend yield of 3.4%. While IDU and XLU are both heavily focused on electric-power companies and track the same index, IDU has a higher rate of annual turnover in its holdings — 8%. Its expense ratio of 0.47 is about the same as the industry average.
Rydex S&P Equal Weight Utilities ETF (NYSEARCA:RYU). This ETF aims to replicate the performance of the S&P Equal Weight Utilities Index. Holdings include CenturyLink (NYSE:CTL), CMS Energy (NYSE:CMS), and DTE Energy (NYSE:DTE). With a market cap of about $48 million, the ETF is trading around $53.50, 14% above its 52-week low last August. It has a one-year performance of 7% and a current dividend yield of 3.4%. RDU differs from IDU and XLU in a couple of key areas — weighting and holdings. The Rydex fund has an equal-weighting strategy in all of its holdings (about 2.5%), which include communications companies such as AT&T (NYSE:T) and natural gas and liquid natural gas companies such as ONEOK (NYSE:OKE) as well as power companies. Its expense ratio is 0.5%, and its annual holdings turnover rate is 15%.
PowerShares S&P SmallCap Utilities Portfolio (NYSEARCA:PSCU). This ETF aims to replicate the price and yield performance of the S&P SmallCap 600 Capped Utilities & Telecom Services Index. Top holdings include Piedmont Natural Gas (NYSE:PNY), New Jersey Resources (NYSE:NJR) and Southwest Gas (NYSE:SWX). With a market cap of $45.4 million, the ETF is trading at around $30.25, 17% above its 52-week low last August. It has a one-year performance of 10.5% and a current dividend yield of 3%. Unlike many ETFs, PSCU is focused on small-cap utilities (loosely defined as having market caps from $300 million to $2 billion). PSCU’s portfolio includes some small-cap utilities with stratospherically high P/Es, such as General Communication (NASDAQ:GNCMA), with a P/E of nearly 110, and Central Vermont Public Service (NYSE:CV), with a P/E of 80. Most investors are wary of high-P/E stocks, so the ETF is betting that these companies will find a way to wildly grow earnings in the coming year. PSCU’s annual holdings turnover rate is 8%, and its expense ratio is an attractive 0.29.
Ultra Utilities ProShares (NYSEARCA:UPW). This ETF seeks daily investment results that correspond to 200% of the Dow Jones U.S. Utilities Index’s daily performance. Its top holdings include SO, D, DUK, EXC, NEE and American Electric Power (NYSE:AEP). With a market cap of just over $19 million, the ETF is trading in the mid-$51 range, 36% above its 52-week low last August. It has a one-year return of 18.2% and a current dividend yield of close to 2%. UPW is an interesting variation on the ETF theme: It is a 2x leveraged equities fund, meaning it uses sophisticated financial instruments such as swaps to achieve twice the pop from small movements in the utility sector. Its annual holdings turnover is 5%, but its expense ratio is 0.95.
As of this writing, Susan J. Aluise did not hold a position in any of the investments named here.