Sleepy Studs: Utilities ETFs Look to Extend Q3 Brightness

Even with all the talk about the Federal Reserve raising interest rates in September, something that obviously did not happen, the utilities sector shined bright during the third quarter.

Of the nine sector SPDR exchange traded funds, only the Utilities Select Sector SPDR XLU has traded higher over the past three months. XLU's 2 percent gain over that period is well ahead of the 0.3 percent loss posted by the Consumer Staples Select Sector SPDR XLP, the second-best SPDR over that period.

With third quarter earnings season about to start, investors may once again want to consider XLU and rival funds such as the Vanguard Utilities ETF VPU because utilities, a sector known for predictable but slow earnings growth, is expected to be home some of the best third quarter earnings among S&P 500 sectors.

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"The utilities sector was down 8.6% year to date through September, worse than the 6.7% for the S&P 500 index. However, in the third quarter, the sector's 4.4% increase was a stark contrast to the 6.9% decline for the broader market," said S&P Capital IQ in a new research note. "From a profit perspective, according to Capital IQ consensus estimates, the utilities sector is expected to post earnings growth of 0.9% for the third quarter of 2015 and 1.7% for all of 2015, both ahead of the S&P 500 index that is weighed down by energy and more multinational sectors such as consumer staples. The utilities sector is projected to increase EPS 7.0% in 2016, below the 10% for the S&P 500."

All the conjecture about the Fed boosting borrowing costs in September did not keep investors away from XLU. The ETF hauled in $881.4 million in new assets last quarter, one of the best inflow tallies among all sector ETFs.

Newest Option

There is a new option to consider among utilities ETFs, the actively managed Reaves Utilities ETF UTES, which debuted in late 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.

"XLU is the largest ETF offering exposure to the sector. It tracks the S&P 500 sector constituents and has 60% of assets in top-10 holdings. The ETF has a 0.15% expense ratio and trades with a $0.01 bid/ask spread," said S&P Capital IQ. "VPU is another sector alternative, though it has more exposure to small and mid-cap companies. The median market cap for VPU of $23 billion was below XLU's $27 billion. The Vanguard ETF is more diversified with top-10 holdings only 49% of assets."

As S&P Capital IQ reminds income investors, it is usually about dividends and high yields with utilities stocks and ETFs. The sector's five-year average payout ratio of 69 percent is more than double that of the S&P 1500, according to the research firm.