Utilities stocks and exchange-traded funds faced plenty of challenges last year as the Federal Reserve set the stage for its first interest rate increase in nearly a decade. With the central bank poised to raise borrowing costs several times this year, investors should approach the utilities sector and its ETFs with caution.

“The utilities sector experienced a challenging 2015, with its performance the third-worst of the 10 S&P 1500 sectors. But in the early days of 2016, the sector's relative safety has offered appeal. Based on a recent review by SNL Financial of upside to sell-side analyst target prices, a number of these companies could have a strong bounce back in 2016,” said S&P Capital IQ in a new research note.

XLU And VPU

Last year, the Utilities SPDR (ETF) (NYSE: XLU), the largest utilities ETF, and the Vanguard Utilities ETF (NYSE: VPU), the second-largest utilities ETF, each lost 3.9 percent.

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XLU focuses on large-cap utilities names, such as Duke Energy Corp (NYSE: DUK) and Southern Co (NYSE: SO), while VPU mixes in mid- and small-cap utilities in its lineup.

PSCU

Speaking of small-cap utilities, the PowerShares S&P SmllCp Utlts Pfo (NASDAQ: PSCU) was last year's best-performing utilities ETF, with a gain of nearly 6 percent.

“S&P Capital IQ Investment Policy Committee recommends investors have less exposure to the utilities sector relative to the S&P 500 index due to concerns that these ‘bond proxies‘ will suffer as interest rates move higher. Yet there are some undervalued stocks, according to our research. For example, Christopher Muir, utilities equity analyst for S&P Capital IQ, has a strong buy recommendation on Excelon Corporation (NYSE: EXC) based on P/E-growth analysis and supported by an above-average dividend yield,” said S&P Capital IQ.

Excelon is XLU's seventh-largest holding at a weight of 4.8 percent.

UTES

Another ETF to consider is the Reaves Utilities ETF (NASDAQ: UTES). UTES, the first actively managed utilities ETF, debuted in September.

Reaves Asset Management, which has over $2 billion in assets under management, "relies on both qualitative processes (management interviews, field research, macro factor analysis) and quantitative processes (modeling, valuation, technicals) to inform investment decisions," according to the firm.

UTES is up 1.4 percent since coming to market. UTES offers another advantage for investors over other actively managed funds: daily disclosure of its holdings. Some issuers of actively managed products, including some wanting to wear the exchange-traded label, are maintaining an old Wall Street mentality, refusing to disclose their holdings on a daily basis.