Today we are going to take a look at the Utilities Select Sector SPDR Fund (NYSE: XLU – $38.01) that tracks the index by the same name. With assets of $5.5 billion under management, this is one of the largest U.S. equity funds as well as one of the oldest. The low-cost ETF is diversified by holdings with these top ten stocks repressing about 57.5% of the total U.S. based companies comprising the index:
The index is also diversified within the broad utilities sector as follows:
Historically, interest rates have had a major impact on utility companies, which tend to outperform other equity sectors in declining/low-rate environments, which we have seen over the past several years. With this in mind and the prospect of higher interest rates once the Federal Reserve starts to wind down its bond buying program, it is unlikely that this ETF will outperform the market. Morningstar’s equity analysts have looked at decades of historical data and concluded that even if interest rates rise to 4% (currently under 3% as indicated by the ten-year note), investors still could see solid, if unspectacular, absolute returns from utility companies. However, outperformance would not be likely. For outperformance to take place, rates would need to decline or at least flatten, which is not on the horizon given the latest assessment from the Fed. On the plus side, the long-term effects of interest rates to utility company performance has not been highly correlated, and the dividends for these companies have compensated conservative income investors well with a steady and reliable stream of payouts. With XLU’s latest distribution, the annualized dividend yield is currently 3.97%. Since entering thebuttonwoodproject portfolio, the ETF is up 18.8%, not including the annual dividend. For now, I will maintain the position in the income list with an allocation of no more than 6% of the total portfolio.