Why Invest in Utilities ETFs?
Utilities ETFs are a valid option for income-seeking investors, especially in a low-interest rate environment. Learn about income investing with these utilities ETFs.
The utilities sector includes companies providing basic amenities. It is considered a defensive sector for its above-average yields. Utilities ETFs allow exposure to the utilities sector benefitting income-seeking investors with low expenses and diversification benefits.
What are Utilities Companies?
Utilities refer to basic, regulated public services like water, sewage services, electricity, dams, and natural gas. Businesses providing these amenities are profit-seeking private companies. They undertake most of their business activities in the public service landscape and that’s why the rates they charge are either regulated or contractually guaranteed. That may be why utilities companies are known to have reliable and stable income coupled with the ability to pay above-average dividend yields. Utility companies perform well during market downturns as demand for utility services tends to remain steady. As a result, investors typically treat utilities as long-term holdings for their income reliability, lower volatility, and lower correlation with the market. Additionally, they prefer them over low-dividend equities. For example, when the Fed tried to stimulate the economy after the financial crisis in 2008, they cut interest rates. This led investors to flock to utilities perceiving them as safer investments.
Utilities ETFs Benefits for the Investor
For income-seeking investors, adding utilities ETFs to their portfolio is one way to play the sector and benefit from its unique features: diversification, low expenses, and income. For instance, utilities ETFs invest in different asset classes, mainly equities and fixed income. Such a feature amplifies the diversification benefits of adding utilities ETFs to any given portfolio. As sector ETFs, utilities ETFs can add diversification by investing in a market area that the investors may lack in their portfolio. Moreover, utilities ETFs’ expense ratio tends to be lower than active mutual funds. In fact, the average utilities ETF costs approximately the same as the average ETF in Canada – 0.60% TER vs. 0.59% respectively. This provides investors with a relatively low-cost exposure to the sector. On the income level, utility companies are a viable defensive choice for investors during macroeconomic downturns while paying higher yields. This made utilities ETFs attractive to retail investors, especially those seeking income.
Actively and Passively Managed Utilities ETFs
On the management level, utilities ETFs are available in passive and active forms. Fund managers in actively managed ETFs can research and chose individual securities including electric companies, water utilities, gas companies, and energy traders. Alternatively, passively managed utilities ETFs hold a basket of securities that track a benchmark utilities index.
Utilities ETFs Available in Canada
There are 17 utilities ETFs currently listed and trading in Canada, according to the NEO ETF Screener. Together, they manage more than CAD$5 billion of assets while attracting CAD$870 million of investors’ money YTD. Out of these, CAD$2.9 billion (58%) are invested in passively managed ETFs while the remaining CAD$2.1 billion (42%) in passively managed ETFs.
BMO and iShares are behind the two top-performing utilities ETFs in 2022, the BMO Covered Call Utilities ETF (ZWU) and the iShares S&P/TSX Capped Utilities Index ETF (XUT).
Comparing the Top Performers: ZWU and XUT
The ZWU ETF and XUT ETF are in the same orbit and started trading in 2011 on the Toronto Stock Exchange. They both follow a dividend distribution where they distribute income generated to their shareholders.
It is important to note that the competition between these two ETFs is not as direct. One is replicating an index while the other is actively seeking companies in the utilities sector.
ZWU ETF: Active Approach
BMO decided to take the active approach, ZWU seeks to provide investors with long-term appreciation while exposing them to a portfolio of utilities companies generating income. It is actively managed and invests in an equally weighted portfolio of utilities, telecoms, and pipeline companies while mitigating downside risk using a covered call strategy. As of March 31st, this ETF invested in Utilities (55%), Communication Services (24.81%), and Energy (20.19%). Its 81 holdings include BMO Equal Weight Utilities Index ETF (5.82%), Rogers Communications Inc (5.23%), Pembina Pipeline Corp (5.12%), BC Inc (5.11%), TC Energy Corp (5.06%%).
XUT ETF: Passive Approach
Meanwhile, iShares' XUT seeks to replicate the S&P/TSX Capped Utilities Index. XUT invests primarily in equity securities issued by Canadian issuers participating in the utilities sector where individual constituents are capped at 25%. This ETF can be used to express a sector view, it is pure play on the utilities sectors. As of April 8th, the top 5 holdings are Fortis Inc (20.23%), Brookfield Infrastructure Partners (16.92%), Emera Inc (11.10%), Algonquin Power Utilities Corp (8.78%) and Hydro One Ltd (7.08%). XUT is geographically concentrated in Canada and has a less diversified asset base than ZWU, with its top 5 holdings constituting 64.11% of its total assets.
