Over the last 12 months, XLU had a positive correlation both with Vanguard Total Stock Market ETF (VTI) (0.55) and Vanguard Total Bond Market ETF (BND) (0.21). There are two interesting observations here. First, as I originally argued in my sector analysis article a couple of years ago, utilities have a surprisingly low correlation with the broad equities market. For a group of US stocks to persistently demonstrate a correlation coefficient below 0.6 with all other stocks is a remarkable feature. Second, XLU has a positive correlation with the bond market, which is untypical for an equities ETF. For instance, VTI demonstrated a correlation of -0.31 with BND. So it is clear that utilities stocks stand somewhere in the middle between equities and bonds.
Individual holdings
To dig a bit deeper, I have extended the analysis to the individual holdings level. XLU has 31 holdings, top 10 of which account for 60% of the fund’s assets. The table below contains correlation coefficients between top 10 holdings in XLU with VTI, BND and XLU itself.
It is interesting to see that all 10 largest components of XLU have positive correlations with both broad stock and bond markets. Correlation coefficients with VTI fall into a narrow range of 0.44-0.56 and are a bit more diverse for BND – 0.08-0.26. Not surprisingly, the result similar when aggregated at the ETF level as well.
Conclusion
Factor and correlation analyses of XLU performance over the last 12 months reveal that US utilities sector stocks act as a combination of stocks and bonds. The ETF and all of its top holdings demonstrate positive albeit reduced correlation with both broad US stock and fixed income markets. Therefore, I would argue that an investor may want to classify XLU as hybrid security for their portfolio analysis purposes. Without overcomplicating it with statistics, a 50/50 attribution to stocks and bonds would probably be a more prudent approach than simply assigning the full investment to the equities basket. Last Friday was a good proof of that.