Will Utilities Keep Shining?

The utility sector might seem dull compared to many other areas of the market. But utility stocks often have decent yields and low volatility, and they offer safe haven when markets are roiled.

For investors interested in capitalizing on increased demand for basic utilities, there are a number of ETFs that own utility stocks. Of the dozen or so utility ETFs available today, three have been around for a little more than eight years. These funds yield just less than 3%, providing a steady if not spectacular yield. A closer look at these three funds, which have low fees and some of the highest long-term returns, should help you choose the best one for your particular needs.

Comparing utility ETFs
Although the three funds each track different indexes of utility stocks, they include many of the same stocks. The Utilities Select Sector SPDR (AMEX: XLU  ) , for instance, tracks the Utilities Select Sector Index, which includes companies from the electric utility, multi-utility, independent power production, energy trading, and gas utility industries. That fund holds 31 stocks, with top holdings Exelon (NYSE: EXC  ) , Southern (NYSE: SO  ) , and FPL Group (NYSE: FPL  ) . The fund has returned 18.6% over the past five years.

The iShares DJ Utility Index (AMEX: IDU  ) tracks the Dow Jones U.S. Utilities Sector Index, which includes companies involved in electricity and gas, water, and multi-utilities. The iShares fund uses a representative sampling strategy to track the index. Top holdings include Exelon, Southern, and Dominion Resources (NYSE: D  ) . The fund has an average five-year return of 18%.

A slightly different model
Although the Utilities HOLDRs (UTH) trades like an ETF, it behaves a bit differently. HOLDRs are trusts and not registered investment companies, which means the underlying stocks included in the HOLDR do not change except for spinoffs, or mergers and acquisitions. The Bank of New York is the trustee.

When an issuer spins off a new security, an owner of a HOLDR receives that security in their brokerage account outside of their HOLDRS investment. The utility HOLDR has 18 companies in its portfolio, including Exelon, Entergy (NYSE: ETR  ) , and Southern. It clocks in with 14.5% performance over the past five years.

Fund prospects
Utility stocks have risen sharply in the past five years, which makes investors wonder whether they have much upside left. On one hand, utility companies have big plans to respond to a number of factors affecting them. With populations increasing, utilities will have to make large capital investments to increase capacity. In addition, greater demand for green-friendly energy, along with high oil prices, will push utilities to add non-petroleum-based production facilities. Those large capital expenditures could pressure stock prices in the short term.

On the other hand, utilities are fairly recession-proof. Because they usually pass price hikes on to consumers, they're insulated from the direct effects of rising energy prices. And although consumers feel the pinch from higher costs, most generally will try to keep the heat and lights on. That should give utilities an edge over discretionary consumer goods in difficult times.

Portfolio fit?
Solid earnings growth and stability can make utility ETFs attractive as a piece of an overall portfolio. So which one is best for you?

The Select SPDR and the iShares Utility funds are similar in performance, and both are well ahead of the HOLDRs. Although it is a tough choice between the two performance leaders, the SPDR drew me in with its lower expense ratio of 0.23%, versus 0.48% for the iShares fund.

In addition, with $2.3 billion in assets and an average of more than 5 million shares trading each day, the Select SPDR has the edge in liquidity. In contrast, the iShares fund has assets of around $830 million and average volume of just 65,000 shares.

Regardless which fund you decide is best for you, however, utility stocks are good for keeping your portfolio warm.

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