If you consider where to invest nowadays, what would more likely come to mind? Probably those fancy internet-technology giants, electric cars or spaceships. However, as the economy enters the recession stage, the opportunities shift to the industries we would typically not notice. We don’t think much about those organizations that stand behind the provision of our basic needs. Well, probably only when we get cut off from the grid for not paying bills, or get notified about the water not available due to leakage. During the current economic downturn, it’s time to see the Utility companies not only as the drainers of our monthly budget but also as an attractive source of investment even when the economy is cooling down.
Often, when we think of utilities, we see wires, pipes and meters. And we’re not far from the truth – the Utilities Sector companies provide the resources (electricity, gas, water, etc.) and create the infrastructure to deliver to our homes the basic amenities we crave for daily.
The most significant participants in the Utilities Sector are Generators who create the power, such as electrical plants and Network Operators who build the infrastructure to deliver the power to your home – wires, poles and transformers. As the energy market becomes more deregulated, Retail Energy Providers emerged, – these are the alternative, independent suppliers that buy energy directly from power generators and sell it to customers offering many energy-saving services and plans along.
The generators sell the resources (electricity, gas, water) to Network Operators or Retail Energy Providers. Network Operators sell access to their network (electricity grid, gas or water pipes) to customers. Retail Energy Providers provide the services to customers to improve the efficiency of energy consumption and compete with Network Operators in selling energy. (See the illustration below.)
Advantages in investing in utilities
In the recessionary and low interest-rates environment utility sector offers regular and robust dividends to its investors normally making Utilities obtain a status of “safe haven” for investors. That’s made possible by the nature of utility companies’ earnings: even during the recession households and businesses must still consume, although less, the services such as electricity, water, heat and telecommunication. It’s not surprising to see Utilities carrying significant debt levels on their balance sheet as their business requires costly infrastructure maintenance. Low-interest rates enable Utilities to ease their debt interest expenses, thereby increasing dividend yields.
Top 3 Utility sector ETFs
Given the points above, it makes sense to consider investing in the Utility sector during the gloomy economic times. So, what would be the best way to implement that? We can go for Exchange Traded Funds, Mutual funds or individual stocks. The choice typically depends on your financial goals, risk profile and personal inventory as an investor. Exchange-traded funds (ETFs) and Mutual funds are both considered a passive, diversified form of investment where ETFs usually have lower expense ratios (annual operational costs), more tax-efficient and give a chance to time the market by executing an order on ETF stock intraday. Mutual funds are managed by a professional fund manager, while ETF is a basket of securities that represent the sector and is traded like stocks. For an investor willing to take maximum control over his or her investing decisions without additional documentation requirements on the contrary to investing in Mutual funds, investing with ETFs would more likely to be appropriate. Investing in Utilities via ETFs versus individual stocks brings some distinct advantages too. The returns of the companies in the Utility sector are not very dispersed, meaning that on average utility companies have similar profit margins. The reason for that is the profit margins are heavily regulated by the government as the companies often have a monopoly on the amenities they provide. For instance, in a consumer goods sector, the principles under which the companies make profits vary significantly (say car distributors’ sales suffer when people don’t travel while household goods retailers experience the surge in sales as people stay at home and look closer into the household’s needs). The nature of the consumer demand and products provided can be significantly different, so the risks are.
There are three major Utilities Equities ETFs by their total assets: Utilities Select Sector SPDR Fund, Vanguard Utilities ETF and Fidelity MSCI Utilities Index ETF. The most significant holdings that belong to each of these ETFs are Nextera Energy Inc, Dominion Energy Inc and Duke Energy Corp.
Utilities Select Sector SPDR Fund (NYSE: XLU) being one of the most popular ETFs for investors considering getting the exposure to the utility sector, The ETF Totals $11,171.7 M under management and currently, the asset yields 3.51% annually, that far exceeds the yields on 10-year Treasuries or the S&P500.
Vanguard Utilities ETF (NYSE: VPU) is highlighted by consisting of companies that show promising strategies in dealing with the relevant issues such as environmental, governance and social while maintaining the dividend yield at 3.14% and the expense ratio at 0.10%.
Fidelity MSCI Utilities Index ETF (NYSE: FUTY) has the lowest expense ratio (0.08%) in the category while maintaining the annual yield at 3.45%.
|ETF Name||Total Assets||Annual yield||Expense ratio|
|Utilities Select Sector SPDR Fund||$11,171.7 M||3.51%||0.13%|
|Vanguard Utilities ETF||$3,785||3.14%||0.10%|
|Fidelity MSCI Utilities Index ETF||$810.0 M||3.45%||0.08%|
How to trade and how to invest in ETF
There are numerous ways to take advantage of market conditions using Utilities ETFs. Let’s take a look at a couple of them:
Dollar-cost Averaging – an investor would typically spend a predetermined dollar amount monthly to buy the asset. The good side of it is that you can get more shares when the ETF price is low and fewer shares when ETF price is high, thereby averaging your asset entry price. It also trains your financial discipline to set aside a certain amount for the monthly investment. (See an example of the execution on Utilities Select Sector SPDR Fund chart below)
It’d also be prudent to employ some trading principles in your investing idea. Trading focuses on minimizing risk while seeking for the biggest possible reward putting more emphasis on the market timing. Generally speaking, the trading approach is executed within the timeframe from several hours up to several months. Let’s say you have an investment idea in Vanguard Utilities ETF. But when do you get in? And probably even more importantly, when do you get out, in case you’re wrong? Technical analysis principles would come in handy when you need to build the plan of your investment idea.
Let’s see the example below.
In this example, we can see the channel made up of two parallel lines, the down band of the channel stands as support. An investor would buy NYSE: VPU at around $120 per share (see the circled area). The protective sell stop order would be below the support area (the parallel inclined grey line), so the risk of the position is limited roughly to $5 (the red rectangle).
The Bottom line
Concluding, whether the economy is upbeat or falling asleep, people will always need to consume the basic amenities, – that’s what the Utility sector takes care of daily. Overall, the Utility sector stands out as a shelter during the windy weather in the ocean of the financial markets, providing stable dividends even during the economic recession. Investing with ETF in utilities enables meaningful risk mitigation while keeping the potential dividend rewards in place. ETF instruments make investing relatively technically easy and more cost-efficient than other passive forms of investment. An investor can follow a variety of approaches to take advantage of the financial markets. Dollar-cost Averaging would enable you to get a better average entry price and the principles of the Technical analysis help to limit your risk and time your entry to maximize the profit potential. Regardless of an instrument, if in every investment decision, we focus on controlling the risk, it’s easier to turn the odds of investing success to our favor in the long run.