By Alex Veiga
AP Business Writer
Funds that hold utilities stocks have been top performers this year as investors sought shelter from a turbulent stock market.
The sector has traditionally been seen as a more attractive investment at times of heightened market volatility. And their steady returns and high dividends also make utilities an appealing bet, especially when interest rates are low.
The sector is up 13.3 percent this year and 12.1 percent from a year ago. In contrast, the Standard & Poor's 500 index is up only 0.3 percent this year, and remains off 2 percent from a year ago.
That's helped drive money into mutual funds and exchange-traded funds invested in utility stocks. They attracted $4.6 billion in net investment in the first three months of the year, according to Morningstar.
It's also made utilities shares among the most expensive stocks, based on their price-to-earnings ratio. So what are the prospects for further gains in utilities funds?
Douglas Simmons, who manages the Fidelity Select Utilities Portfolio (FSUTX), says that the combination of low long-term interest rates and signs of global economic weakness bode well for utilities funds.
His fund, which is comprised primarily of power and gas utilities, is up 11.5 percent this year and is essentially flat versus a year ago.
Simmons spoke with the AP about where utilities stocks are headed. Answers have been edited for length and clarity:
Q: What are the factors that have driven the run-up in utilities this year?
A: The three biggest factors that drive the space are interest rates, dollar strength and natural gas prices. And when I say interest rates, I'm talking about long-term interest rates, so the 10- and 20-year bond yields.
The market was really expecting interest rates to move higher with the advent of tightening by the Federal Reserve, and long rates actually fell, making income products like utilities more attractive.
The second thing is the market really went through a recession scare, largely in February, and so you had that big drop in the S&P. That was caused because investors were scared that potentially the U.S. economy could maybe be going into recession.
Those fears have subsided some, but that fear factor of recession and what may happen in the future, and even just heightened market volatility, both of those can drive utilities higher.
Q: The sector's performance this year is a turnaround from 2015, when expectations of a Fed rate hike weighed on the sector for much of the year. What's your outlook for interest rates and their impact on utilities?
A: Now we see the data that the U.S. and the global economy are maybe losing steam. My view is that long-term interest rates are probably relatively stable and in the slow band, which would bode well for the sector.
Q: Consensus seems to be that utility stocks are expensive. Is this a good time to buy into utilities funds?
A: It's a tough question to answer. Valuations tend to be on the higher side and that's a reflection of the defensive positioning within the market.
Right now utilities are trading at roughly around a 7 percent premium to the S&P on 2017 earnings, but they have gone as high as 15 or 16 percent premium to the S&P.
They're not cheap, but they're not overly expensive compared to where they've traded on a relative basis in the past.
Q: Do they have room to run from here?
A: It really comes down to what we expect from the broader market moving forward. From a rate perspective, I think long-term interest rates are going to be relatively stable, which is supportive for the group. It really comes down, if you look farther out, do you think that essentially there's a stronger economic recovery than what we're seeing it right now?
The sector is really probably attractive to your more risk-averse investors. Because if you have a more constructive view on the U.S. and global economy, you're probably going to eschew utilities for more pro-cyclical investments.
Published: Wed, May 11, 2016
