In light of the lingering market uncertainty and record low Treasury payouts, yield hunters have zeroed in on the safe and decent payouts from utilities exchange traded funds, but investors should still remain cautious as the sector is beginning to look overcrowded.
“We do continue to advocate a dividend bias, but believe investors need to avoid overpaying for that income stream,” Russ Koesterich, Managing Director iShares Global Chief Investment Strategest, said in a research note. “In particular, we believe that investors should be very cautious on the U.S. utilities sector.”
Given the prevailing loose monetary policies around the globe and low yields on government debt, investors have become more creative in their search for yields. Consequently, many investors have paid up for income generating investments.
“We believe that investors have probably pushed this trend too far, with utilities now looking very overvalued,” Koesterich added. “Given that utilities are a slow-growing, regulated industry, utilities historically trade at a discount to the broader market; since 1995, the average discount has been roughly 25% of the S&P 500. However, today utilities are trading at more than an 8% premium, the largest premium since late 2007.”
Nevertheless, the utilities sector provides investors with a defensive position, as the sector has the lowest beta – only 0.5 – of any of the S&P economic sectors. Additionally, the sector offers yields of around 3.5%, whereas the yields on benchmark 10-year Treasury notes still hover around 1.5%. [Utilities ETFs Can be a Market ‘Tell’]
“Absent a major correction of the broader market – under which scenario utilities would probably outperform given their low beta – we believe utilities are likely to continue to trail the market, even in a slow growth environment,” Koesterich said.
Instead, investors may consider diversified funds with some exposure to U.S. utilities to spread out the risk:
- iShares High Dividend Equity ETF (NYSEArca: HDV): 2.83% yield.
- iShares Dow Jones EPAC Select Dividend ETF (NYSEArca: IDV): 5.3% yield.
- iShares Emerging Markets Dividend ETF (NYSEArca: DVYE): 6.21% 30-day SEC yield.
For more information on dividends, visit our dividend ETFs category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.