Finding Yield With Utilities

By Aaron Levitt | July 18, 2010 AAA

The potential for interest rates to stay at their extremely low levels for an extended period time is growing. Ten-year treasuries yield fewer than 3% again, and short term investments like the PIMCO Enhanced Short Maturity ETF (NYSE:MINT) are paying next to nothing. These low rates, combined with extreme uncertainty with relation to the health of the economy, has income investors still facing headwinds as they try to extract yield from their portfolios. As investors look for safety and yield, a traditional sector of the market might just be what they need.

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Powering Modern Living and Portfolios
The utility sector might offer the right combination of safety and dividends that income investors are looking for to get them through 2010. Offering a combination of benefits that could power portfolios, the sector has received a great deal of renewed interest over the few weeks. It's easy to see why. Even in times of duress, people need to heat and cool their homes. They need the water and electricity flowing. Utilities' stable cash flows and recession resistant nature makes them ideal candidates for investing in uncertain times.

These stable cash flows help throw off large distributions to shareholders. The dividend yield on the SPDR S&P 500 Trust (NYSE:SPY) is about 2%, with the utility sector yielding an average 4%. Investors can find individual utility stocks with larger payouts. For example, Southern (NYSE:SO) pays 5.2% and American Electric Power (NYSE:AEP) yields 4.8%. The sector also has history of rising distributions, which can help lower inflation risks. Larger dividend payments aside, the utility sector provides smoothed volatility and is less subjected to wild swings like the overall market. This, plus the potential for capital appreciation, should give investors what they need in an income stock.

Portfolio Energy
While investors can add a multitude of individual utilities to their portfolios, they may want to opt for an indexed basket approach. The regulatory market for each state is different, and recent bill from Senate Energy and Natural Resources Committee chairman Sen. Jeff Bingaman proposes a cap on greenhouse gas emissions from the sector. Some utilities have been preparing for this potential, others have not. Diversification through an exchange traded fund helps caution against any insecurity with regards to legislation.

The Utilities Select Sector SPDR ETF (NYSE:XLU) is the largest fund in the area, containing nearly 60% of all utility ETF assets. The fund makes a logical starting point for investment in the sector. The ETF follows 37 different utilities, currently yields 4.2% and charges a rock-bottom 0.21% in expenses. Not to be outdone, iShares has a similar product in the iShares Dow Jones US Utilities (NYSE:IDU), which yields slightly less at 3.9%.

Just as families in the United States need to power their homes, so do those in the rest of the world. The recent debt worries in Europe have caused some of its blue chip utilities to have even greater yields. The SPDR S&P International Utilities Sector (NYSE:IPU) includes such stalwarts as National Grid (NYSE:NGG) and renewable energy superstar Iberdrola (OTCBB:IBDRY). The ETF yields 3%.

Finally, for investors who want to gain their utility exposure through "alternative" means and still remain tied to the global growth story, the SPDR FTSE/Macquarie Global Infrastructure 100 (NYSE:GII) has nearly 90% of its holdings dedicated to utilities and independent power producers. The remaining pieces of the ETF include toll road operators and gas pipelines, businesses that function very similarly to power companies. The fund yields 4.4%.

The Bottom Line
With interest rates hovering near zero for the foreseeable future, and uncertainty about the health of the global economy being questioned, income investors are at an impasse. The need for higher income yields, but safe investments, can be found in the utility sector. Exchange-traded funds like the Vanguard Utilities ETF (NYSE:VPU) make it easy to add them to a portfolio. Look for the sector to provide safety and yield investors are craving. (For more, see Trust In Utilities.)

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