Seeking Refuge In Utility ETFs

Ten-year Treasury yields have surged nearly 28 percent over the past six months, a move that helps explain why the Utilities Select Sector SPDR XLU is down 9 percent this year. Among the nine sector SPDR exchange traded funds, only the Energy Select Sector SPDR XLE has been worse this year.

That is a stark reversal of course from 2014 when XLU was the top-performing SPDR. However, with risk-off recently becoming the name of the game for investors, utilities stocks and ETFs are getting some of their groove back.

In what is turning out to be another turbulent day for U.S. stocks, three of the top 15 ETFs in terms of percentage gains are utilities funds – XLU, the Vanguard Utilities ETF VPU and the iShares US Utilities ETF IDU.

Some investors have been prepared for utilities ETFs to bounce back as inflows to the previously moribund funds have picked up this month. For example, investors have put $315 million in new capital to work in XLU this month. That after the largest utilities ETF lost more than $1 billion in the first six months of the year. In the first half of the year, investors also yanked more than $1.2 billion from IDU.

Ahead of utilities sector earnings, there has also been evidence of traders buying calls on some XLU constituents in anticipation of a rebound.

"The recent upside call activity in XLU is clearly capturing the upcoming quarterly earnings cycle in the sector, and when we look at the top holdings, we can see that these names all report quarterly results prior to August expiration: (DUK (8.74%), 8/6/15), (NEE (8.45%), 7/29/15), (D (7.70%), 8/5/15), SO (7.39%), 7/29/15), EXC (5.25%), 7/29/15)," according to a recent note from Street One Financial.

As that note indicates, three of XLU's top 10 holdings (a trio that combine for close to 20 percent of the ETF's weight) report earnings on Wednesday.

Falling Treasury yields serve another purpose for rate-sensitive fare such as utilities ETFs. While those falling yields mean higher prices, those lower yields also make the utilities sector's dividends more attractive. For example, XLU has a trailing 12-month dividend yield of 3.64 percent, or about 140 basis points above where 10-year Treasury yields currently reside.

Long-term investors looking to save a few bucks on fees can opt for VPU or the Fidelity MSCI Utilities Index ETF, both of which charge just 0.12 percent per year compared to XLU's 0.15 percent. However, XLU is the most heavily traded utilities ETF, has narrow spreads and has the most robust options market among utilities ETFs.