As most portfolio managers know, building a broadly diversified portfolio has one key building block. Low or negatively correlated assets. Ideally, if each of these building blocks has low correlation to the others, one or more will be falling in value while the others are going up in value. This ideal scenario lends itself to arbitrage opportunities and the ability to buy assets when the market has placed them ‘on-sale’. With that said, have you considered diversifying a portion of your portfolio into the Utilities sector? If you want low correlated assets in your portfolio, I would suggest considering the Utilities sector. The utilities sector has maintained a very low correlation to the U.S. Stock Market over the last 19 years, at just 0.39. I wrote more in depth about this low correlation phenomena right here: Which Equity Asset Class has the Lowest Correlation to the U.S. Stock Market?
Utilities Sector Correlation to U.S. Markets January 1999 – December 2017
Source: Portfolio Visualizer
As you can see in the chart above, the correlation between the Utilities sector and the U.S. Stock Market is 0.39. While maintaining a very low correlation, the Utilities sector did not increase volatility nor subdue performance in a long-term equity portfolio. A 6.71% CAGR is not stupendous, but the Utilities sector has slightly outperformed the S&P 500 during this same 19-year period.
Up to now I’ve only shown the performance of the Utilities Select Sector SPDR® Fund. But, before I invest in a sector, I’d like to know which are the best performing funds in that sector. I have confined my research to U.S. Utilities sector ETFs that are 10 years old or older. Here are the ETFs I used in this comparison:
I compared each one of these funds head-to-head with each other using Portfolio Visualizer and found that the 3 ETFs that have performed the best were:
- Guggenheim S&P 500® Equal Weight Utilities ETF (RYU : $RYU)
- Vanguard Utilities ETF (VPU : $VPU)
- Utilities Select Sector Fund (XLU : $XLU)
We’ve already seen in the first chart that XLU has outperformed the S&P 500 during the last 19 years. But, let’s see how XLU compares with VPU and RYU:
RYU vs VPU vs XLU December 2006 – December 2017
Source: Portfolio Visualizer
As you can see from this chart, RYU does outperform both VPU and XLU, but only slightly. One negative I see with RYU is that it is more correlated to the overall U.S. Market than both VPU and XLU. Additionally, we could see RYU’s outperformance disappear in the future due to its higher expense ratio of 0.40% (VPU expense ratio = 0.10%, XLU expense ratio = 0.14%).
So, what is actually in these Utilities sector ETFs?
Source: Fund family websites
Please notice that RYU obviously has some communications sector companies in it. Also notable, RYU is an equal-weight ETF. Additionally, note that VPU & XLU have nearly the same holdings, although they are weighted slightly different. Next, let’s look at the objectives of each of these funds to get a better sense of why the holdings are as they are in the chart above.
- RYU: Seeks to replicate as closely as possible, before fees and expenses, the performance of the S&P 500® Equal Weight Telecommunication Services & Utilities Index. The family of S&P 500® Equal Weight Sector Indices includes an index from ten of the eleven Global Industry Classification Standard (GICS) sectors. Each index has the same constituents as its capitalization-weighted counterpart, but each company in the S&P 500® Equal Weight Sector Indices is equally weighted. To maintain composition, the S&P 500® Equal Weight Utilities Index rebalances quarterly.
- VPU: Seeks to track the performance of a benchmark index that measures the investment return of stocks in the utilities sector. Passively managed, using a full-replication strategy when possible and a sampling strategy if regulatory constraints dictate. Includes stocks of companies that distribute electricity, water, or gas, or that operate as independent power producers.
- XLU: The Utilities Select Sector SPDR® Fund seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Utilities Select Sector Index (the “Index”). The Index seeks to provide an effective representation of the Utilities sector of the S&P 500 Index. Seeks to provide precise exposure to companies from the electric utility, gas utility, multi-utility, and independent power producer and energy trader industries. Allows investors to take strategic or tactical positions at a more targeted level than traditional style based investing.
In this chart, I’ve distilled much of the pertinent data from these funds into one place for ease of comparison.
In conclusion, I believe investors who want to be invested in the Utilities sector would be wise to utilize any of these 3 funds. (RYU, VPU, RYU) When deciding, it may just boil down to whether your brokerage house offers commission-free trading on one of these securities.
Thank you for taking time to read this article.
Disclosure: We own shares of RYU and intend to accumulate more shares in the future. I’m not a registered investment adviser. Please perform your own due diligence before investing in any security mentioned in this article.