Meet 2013’s Best Utility ETF

In a year that has favored increased risk appetite and one that has seen the S&P 500 gain over 27%, it is not surprising that the stodgy utilities sector.

Combine an overt bull market with the spike in Treasury yields, induced by talk of the Federal Reserve trimming its asset-buying program, and it is easy to understand why utilities exchange traded funds have been laggards. The Utilities Select Sector SPDR (NYSArca: XLU) and the Vanguard Utilities ETF (NYSEArca: VPU) are up an average of 11.9% this year. [What Utilities ETFs are Saying About Rising Rates]

A more tactical approach to the utilities sector delivered bigger gains for investors this year with the First Trust ISE Water Index Fund (NYSEArca: FIW). FIW, which is six and a half years old and home to $185.6 million in assets under management, is up more than 22% this year. That still lags the S&P 500, but it is a performance that is superior to those of traditional utilities ETFs. [Utilities ETFs Stung by Rising Rates]

Part of the reason the cap-weighted FIW has outpaced larger utilities ETFs is that the First Trust offering is not a pure utilities fund. At just under 21%, utilities are just FIW’s second-largest sector weight behind a 66.3% allocation to industrial stocks. The allocation to industrials helps explain FIW’s durability as rates have risen because that sector historically performs well as rates rise on the premise that higher rates are indicative of a stronger economy.

Since there is no such thing as a free lunch on Wall Street, there are trade-offs for those opting for FIW over a fund like XLY of VPU. For example, utilities are thought as dividend destinations, but FIW’s 0.52% 30-day SEC yield pales in comparison to the 3.91% offered by XLU.