8/26/2014 3:45 PM ET|
3 dividend-rich ETFs for volatile markets
With their steady, high yields and low correlation to the S&P 500, utilities stocks can help light up your portfolio.
If you are looking for portfolio ballast in these turbulent times, utilities could provide it.
Many impatient investors dismiss utilities as stodgy, slow-growth and exceedingly vulnerable to the inevitable rise in interest rates that will happen at some point. But lately — and particularly this year — utilities have offered effective counterbalance to the market's volatility.
At the start of this year, for example, the general market headed downhill while utilities clip-clopped higher. Later on, of course, the market rebounded and set new highs, outstripping the utilities. On June 30, the utilities topped out on fears of onerous new federal regulations on coal and slowing electricity use.
Utilities sank more than 9 percent before recovering earlier this month. Even with that rally, however, utilities are still about 6 percent below their early-summer peak. Whether that's a buying opportunity is a crystal-ball question we will happily duck.
Though price performance usually isn't utilities' strong suit, they are now showing about twice the gain of the broad market this year. In addition, their steadying influence on portfolio returns is especially attractive now as geopolitical developments keep stock investors guessing.
Index-based ETFs and mutual funds are clearly the way to play the utilities stability card, if for no other reason than they are well diversified among companies in the sector. There are 10 utility-sector ETFs open for business, but three have captured 94 percent of the nearly $10 billion in assets under management.
The biggest and oldest is the Utilities Select SPDR (XLU), which has $6.1 billion. A distant second is the Vanguard Utilities ETF (VPU) at $1.8 billion. The iShares U.S. Utilities ETF (IDU) brings up the rear with $1.1 billion. Here is how the three funds stack up on other metrics:
Number of stocks
Median market cap of holdings
2014 performance (through Aug. 8)
*based on underlying index
Though the three differ in the number of stocks they hold and the average size of those stocks, their performance is similar in both the short- and long-term. That means all three have comparable exposures to the sector, which helps ease your decision making process when choosing an ETF for your portfolio.
Overlap is the primary reason: The top 10 holdings of all three ETFs are almost identical, with one fund holding one different stock in the 10th slot.
Another piece of information might sway your decision: management fees. Vanguard unsurprisingly is the lowest at 0.14 percent, followed closely by the Select SPDR at 0.16 percent. The iShares ETF is an outlier at 0.46 percent.
All three can contribute diversification benefits to your portfolio. As Modern Portfolio Theory demonstrated, assembling low-correlated assets is a prescription for getting the best return for the least amount of risk.
Utilities have become even less correlated with the broader market over the past two years. In 2013, the correlation between these three ETFs and the SPDR S&P 500 ETF (SPY) ranged from about 65 to 69 percent. Last year, that figure dropped to just 32.8 percent for XLU, while VPU's correlation was the highest at 37.6 percent.
These are low correlations by any standard, including historically. Over the past 16 years, the correlation of the Utilities Select SPDR and the SPDR S&P 500 on a monthly basis is 88.5 percent.
So, the present is a rare opportunity to add some low-correlated assets to your stock portfolio -- and to get paid a handsome yield for doing so.
You will have to keep an eye on conditions to see when they begin to revert to "normal." For now, though, utilities could help you turn out the lights and get some sleep.
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