Utilities companies have been on fire this year, outperforming the broader S&P 500 index as investors shifted toward safety and sought attractive yields. Among the sector options, one actively managed utilities exchange traded fund stands out.
The Reaves Utilities ETF (NasdaqGM: UTES) has been the best performing utilities sector-related ETF of 2016, rising 19.7% year-to-date. In contrast, the widely observed Utilities Select Sector SPDR (NYSEArca: XLU) gained 17.8% so far this year while the broader S&P 500 Index advanced 8.5%.
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UTES is an actively managed fund that tracks the utility sector, which includes utilities companies that are involved with products, services or equipment for the generation or distribution of electricity, gas or water.
[related_stories]The Reaves Asset Management team implements a value-based, bottom-up stock selection approach in picking utilities securities. The sub-advisor selects those that are attractive based on the potential for growth of income and capital appreciation over time.
Specifically, the sub-advisor will target utilities that exhibit conservative capital structures, solid balance sheets, history of potential for growing earnings and raising dividends, positive catalysts that may unlock value or lower-than-market levels of volatility, correlation or similar characteristics.
Through its investment style, UTES has a bigger tilt toward mid- and small-cap utilities. UTES includes 53.3% large-caps, 40.0% mid-caps and 6.7% small-caps. In comparison, XLU has 75.4% large-caps and 24.6% mid-caps.
“It is easier to turn the wheel in small- and mid-cap companies,” John Bartlett, portfolio manager and electric utility analyst at Reaves Asset Management and co-portfolio manager of the Reaves Utilities ETF (NasdaqGM: UTES), told ETF Trends in a call.
Bartlett explained that smaller companies may drive a little more growth and are apt to be acquired by larger companies. Over the past 12 to 18 months there has been a lot of merger and acquisition activity, notably among smaller companies, the analyst added.
The utilities sector has been among the best performing investments this year after investors plunged into the defensive play in search of yield and safety in an environment of historically low yields, slow growth and geopolitical uncertainty.
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“Utilities are a bond substitute and are correlated to what is going on in the Treasury market,” Bartlett said.
The utilities play has weakened in recent weeks as the safety play dissipated with the broader equities market pushing toward new highs. The recent pullback gave the sector a breather after utilities surged into overbought territory in early July. Over the past month, UTES fell 2.4% and XLU declined 4.9%. Now, Bartlett argued that after the pullback, utilities look attractively priced to debt securities.
“For someone with a low fixed-income coupon, add something like utilities that do better than bonds,” Bartlett added.
For instance, UTES’s portfolio shows a 2.3% dividend yield, whereas yields on the benchmark 10-year Treasury note is hovering around 1.56%.
For more information on the utilities sector, visit our utilities category.