Heading into 2017, there was some concern about the ability of the utilities sector and the related exchange traded funds to deliver for investors against the backdrop of multiple interest rate increases by the Federal Reserve.
Give the First Trust Utilities AlphaDEX Fund (NYSEArca: FXU), a smart beta spin on utilities, some credit. FXU is up nearly 4% year-to-date and hit an all-time on Thursday.
Like the other AlphaDEX funds, FXU is “based “on growth factors including three, six and 12-month price appreciation, sales to price and one year sales growth, and, separately, on value factors including book value to price, cash flow to price and return on assets,” according to First Trust.
Utilities stocks and ETFs are extremely sensitive to changes in interest rates. Still, some investors see opportunity with rate-sensitive assets such as FXU and real estate ETFs, noting that 10-year yields are overbought and sentiment against the likes of FXU is at bearish extremes, which could create opportunity from the long side with the utilities sector.
Last last year, utilities ETFs languished on the basis that fixed-income instruments more attractive on a relative basis, and bond-like equities, like utilities, less enticing. Consequently, utilities may remain flat or underperform other segments of the equities market once rates start ticking higher.
No sector is as negatively correlated to rising interest rates as utilities, meaning the longer the Fed resists raising interest rates, the longer high-yielding utilities stocks and ETFs remain compelling destinations for yield-starved investors.
Home to 38 stocks, FXU has $1.48 billion in assets under management. The ETF’s holdings have a median market value of $14.1 billion.
FactSet projects the utilities sector is expected to experience earnings growth of 4.4% in 2016. Consequently, analysts warned that the lofty prices may not be supported by robust earnings growth. Investors can tap the potential potency of earnings growth via FXU’s methodology at an earnings multiple that implies a slight discount to the broader utilities sector.
For more information on defensive ETFs, visit our defensive ETF category.