The philosopher Nietzsche developed the concept of “eternal recurrence,” or that our lives will repeat infinitely. A look at the utilities sector might bear out the truth of this. Electric utilities were once the sexy technology stocks of the investment world preceding the 1929 stock market crash. They then evolved into boring, dividend-paying, “orphan-and-widow” stocks for decades. And now they’re hot once again.
Utilities have had a torrid rally for the past three months through June 5. A combination of more subdued inflation and the hope that the AI revolution and migration to electric vehicles will spur more electricity usage has powered the 12 ETFs that fall in Morningstar’s Utilities fund category.
AI & EVs Driving Electricity Usage
Demand for Nvidia’s chips for AI applications seems unlimited, and the stock is up more than 100% for the year and a staggering 50% annualized on a 15-year basis. Also, sales of electric vehicles have gone from 54,000 in 2015 to nearly 1.1 million in 2023, according to data from Edmunds, while zero-emissions car sales must be 100% in nine states, including California, by 2035.
On average, the utilities ETFs are up 12.5%, with the category’s big Kahuna, the $14 billion Utilities Select Sector SPDR ETF (XLU ), up 15.1% through June 5. Overall, the 12 ETFs have $24 billion in assets, with the second-largest fund, the Vanguard Utilities ETF (VPU ), claiming $6.6 billion of the total.
To put those returns in perspective, the funds are up 9.8% on average for the year, while XLU is up 13.7%. So they were down for the year until they began their run three months ago.
Interest Rates Impact Utilities
The funds suffered a 19% drawdown, on average, from the middle of 2022 to late 2023, after posting gains of more than 15% in 2021. The reason for that rise-and-fall was interest rates dropping to nearly nothing in 2021, and then rising with inflation in 2022.
Investors piled into the sector, using it and REITs as bond proxies when no yield was available in the bond market. That pushed prices up, with XLU, for example, posting a 17.7% gain in 2021. Then when bond yield became available, investors began to flee. XLU posted a 1.4% gain in 2022 and a 7.2% loss in 2023 when the S&P 500 was up 18%.
For the three-year period through June 5, the 12 funds have averaged a 3.8% annualized return. However, the category (including mutual funds) has become more volatile. The standard deviation of the average fund for the three-year period through May 2023 is 17.17%. For the 10-year period, it’s 14.5%.
Leading Utilities ETFs
Through all the turmoil, the ETFs with the best records for the three-year period are the Virtus Reaves Utilities ETF (UTES ) and the Invesco S&P 500 Equal Weight Utilities ETF (RSPU ), which have posted 11.2% and 6.97% annualized returns, respectively. They are very different products.
The Virtus fund is actively managed, while the Invesco fund tracks an equal-weighted index. Virtus’ UTES has 17.49% of its assets in NextEra Energy, parent of Florida Power & Light, compared to 14.6% for XLU, which tracks the S&P 500 Utilities Index.
Also, the Virtus fund’s second-largest holding is Vistra Corp, which serves 20 states including delivering energy to one-third of Texas residents. By contrast, Southern Company, which provides power to 9 million customers primarily in Georgia, Alabama, and Mississippi, is cap-weighted XLU’s second-largest position. Southern Company is only the Virtus fund’s 19th-largest holding.
The Invesco fund is based on the the S&P 500 Equal Weight Utilities Plus Index, and is rebalanced quarterly. It holds the stocks in the utilities sector of the S&P 500 Index.
RSPU currently has 31 holdings, and none of them occupy more than 4% of its assets, and none of them less than 2.9% of its assets. NRG Energy, which has 6 million customers primarily in Texas, is its top holding, occupying just under 4% of assets. Position sizes will reflect how stocks have moved after the most recent rebalance.
Whichever fund they choose, investors making a bet on utilities will have to become accustomed to the fact that utilities may not function as boring “orphan-and-widow” stocks as they have for many decades.
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