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If the best offence is a good defence, then an allocation to the utilities sector may be a good fit for many investors these days.
Relative to growth stocks like technology, companies involved in providing electricity, natural gas, telecommunications and energy via pipelines have largely been a sleepy corner of the equities markets over the past decade.
Still, utilities are a perennially popular choice among many investors because they offer a combination of low price volatility and high yields, especially when compared to fixed income.
“For stable, high income, this is an area investors should be looking at,” says Mike Dragosits, portfolio manager at Oakville, Ont.-based Harvest Portfolios Group Inc. “It’s a great defensive asset in times of high volatility, particularly during selloffs as the sector has stable revenue drivers that are often unaffected.”
After all, utilities provide services and commodities the economy requires in bull or bear markets alike, says Simon Harry, senior investment advisor and portfolio manager at Wellington-Altus Private Wealth Inc. in Toronto.
“They’re services people can’t go without,” he says. “Utility companies often have long-term government contracts and huge barriers to entry, giving them a competitive advantage in the markets they serve.”
For Canadian investors, names like Fortis Inc. FTS-T, a provider of gas and electricity, and pipeline company Enbridge Inc. ENB-T are stalwarts of portfolios. And that’s true not just for conservative investors who are attracted to yields that outpace what would be found in fixed income significantly.
Mr. Harry says that utilities’ mix of income and relatively steady share prices are often ideal for growth-oriented investors as a defensive allocation to mitigate downside volatility.
“Utilities are great in that they can ground the portfolio,” he says.
Get the right diversification
One challenge for all investors is ensuring an allocation to the sector isn’t heavily concentrated in a few companies, says Adam Hennick, investment advisor with Hennick Wealth Management at Research Capital Corp. in Toronto.
He notes that utility companies have been resilient throughout the pandemic, citing Enbridge as a perfect example. Its share price is only slightly off its pre-COVID-19 level.
“But one issue I have with Canadian utilities is that there are just a few of them, so it can be a crowded trade,” Mr. Hennick says.
Investors are also missing out on opportunities in the U.S. and elsewhere. That’s where exchange-traded funds (ETFs) can help, offering diversified exposure at a low fee cost for advisors’ clients and do-it-yourself investors.
“That diversification can give you exposure to companies you might otherwise not be looking at, and it can also help you in terms of downside risk,” Mr. Harry says.
As an example, Harvest Equal Weight Global Utilities Income ETF HUTL-T holds 30 of the world’s largest utilities firms, from telecommunications infrastructure to pipeline companies.
“We start with a list of global 400 companies,” says Mr. Dragosits, one of the ETF’s managers. “We isolate the top half of the highest dividend yielders, excluding the top 10 percentile, which are often junk yield names with struggling business models or nearing dividend cuts.”
From that list, the Harvest team then selects the 30 largest companies by market cap, and ends up with a portfolio of strong performing global utilities, providing an average dividend yield of about 4.8 per cent (as of Dec. 31, 2021). That compares to less than 2 per cent for 10-year government bonds.
What’s more, the Harvest ETF enhances its income component with a covered-call strategy that boosts the current portfolio yield to about 7 per cent.
“It’s a pretty handy feature to have in an ETF,” Mr. Harry says. “You’re adding a strategic layer to your portfolio with professional management that’s very challenging to do on your own.”
Mr. Dragosits says the strategy to generate additional income can mute the ETF’s upside when its underlying assets’ prices rise significantly. Yet, in slow-growing, flat or even down markets, the covered-call strategy allows the fund to provide steady, high income, often outpacing peer funds.
Do rising interest rates matter?
The covered-call approach is potentially beneficial in a rising interest rate environment, which can cause headwinds for utilities, Mr. Dragosits says.
Then again, he says even the expected rate tightening among central banks may not have much impact. “There have been a lot of studies, but it’s pretty inconclusive,” he says.
Mr. Dragosits points to a S&P Global Market Intelligence Report that found the relationship between utilities performance and interest rates to be more complicated than a simple negative correlation.
“Generally, a rising interest rate environment can challenge the relative performance of utilities versus the broad market, but you can still see positive returns in the sector,” Mr. Dragosits says.
Even if rising interest rates affect pricing negatively, investors who want to allocate capital to utilities are presented effectively with an opportunity to buy low into a defensive asset – one that’s likely to rebound and continue to pay steady income.
“No matter what happens, strong utilities companies have stable business models that are often monopolistic and designed to pay out high dividends,” Mr. Dragosits says.
Advertising feature produced by Globe Content Studio with Harvest Portfolios Group. The Globe’s editorial department was not involved.