Exchange traded funds that track utilities stocks have been among the best performing sector plays this year, but when looking through utilities ETF gains, investors might have noticed some slight differences.
For instance, the Guggenheim S&P Equal Weight Utilities ETF (NYSEArca: RYU) rose 13.2% year-to-date while the Utilities Select Sector SPDR (NYSEArca: XLU) increased 12.9%.
Unlike XLU, RYU includes a small allocation toward telecommunication services and follows an equal-weight methodology, writes Miriam Cross for Kiplinger.
The Guggenheim ETF has a 14.9% weight toward telecom stocks. Guggenheim argues that telecom stocks act more like utility stocks than the tech industry.
“The volatility, dividend yield and price-earnings ratio associated with telecom services are more closely aligned with the utility sector than with tech,” Guggenheim’s William Beldan said in the article.
Additionally, RYU follows an equal-weight indexing methodology where underlying holdings are more-or-less equally weighted. For example, Pepco Holdings (NYSE: POM) has a 3.6% weight in RYU, Frontier Communications (NasdaqGS: FTR) is 3.2% and Exelon Corporation (NYSE: EXC) is 3.1%. Last week, Exelon, the largest U.S. nuclear power provider and a top-10 holding in several of the largest utilities exchange traded funds, has agreed to purchase Pepco Holdings for $5.4 billion in cash. [Some ETF Ideas for the Exelon/Pepco Takeover]
By equally weighting the underlying holdings, RYU leans toward mid-cap names. Mid-cap stocks make up 45.8% of the ETF, followed by large-caps at 42.4% and mega-caps at 11.7%.
On the other hand, XLU, which tracks the S&P 500 utilities sector, only focuses on utilities companies, including electric utilities, multi-utilities, independent power producers & energy traders, and gas utilities. Additionally, the SPDR ETF follows a market capitalization-weighted methodology, which tilts toward large-caps at 66.1% of the ETF’s holdings, followed by mid-caps at 33.9% of the fund.
“Utilities companies have benefited from strong residential and commercial demand for electricity and have enjoyed cheap debt financing to fund capital projects,” according to Morningstar analyst Robert Goldsborough. “In addition, utilities companies benefit from a declining interest-rate environment, which can boost firms’ profitability because regulated rates of return are not frequently adjusted by regulators.”
The recent outperformance of the utilities sector has also been a result of a combination of increased heating demand due to an abnormally frigid winter and falling yields in benchmark 10-year Treasuries. [Yield-Generating Utilities ETFs Shine in a Murky Market]
For more information on the utilities sector, visit our utilities category.