“For income investors, utilities’ dividend yield premium to interest rates has been attractive the past few years. But that premium is closing,” said Morningstar. “Since the 10-year U.S. Treasury rate climbed to 2.4% from 2.1% in late 2017, utilities’ 3.4% dividend yield looks less attractive. However, the 100-basis-point premium remains historically attractive and should cushion the sector’s sensitivity to future rate increases.”
XLU yields about 3.3% on a trailing 12-month, making it and rival utilities ETFs popular alternatives to lower-yielding bond funds. The sector, one of the smallest sector allocations in the S&P 500, is also one of the least volatile. Additionally, tax reform should not hamper the sector.
“The new U.S. tax regime shouldn’t affect utilities much,” said Morningstar. “Utilities with unregulated businesses should benefit, but regulated utilities will simply pass tax savings to customers through lower energy bills. Lower rates could provide headroom for utilities to accelerate capital investment, leading to earnings growth. Renewable energy incentives will remain, but falling wind and solar costs are more important to the industry’s health.”
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