Consider This ETF for a Better Investment in Utilities - ETF News And Commentary

Zacks Investment Research
Posted: Jun 10, 2013 4:15 PM

As talk of the Fed tapering bond purchases hit the market, pretty much every asset class sold off. However, the bulk of the pain was in higher yielding corners of the market like REITs and utilities.

These sectors were crushed as investors began to take another look at bonds, while others cashed in some of their big winners in these once-hot industries. The scale of the sell-off, which saw losses of over 7% in just a week’s time, has probably frightened off many investors from the space, at least in the near term with this significant level of volatility (see REIT ETFs Crushed: Time to Panic?).

Still, it is worth noting that the damage in the utility market hasn’t been uniform in the least, and that there have definitely been some relative winners. In particular, investors could look to the small cap space, and the PowerShares S&P Smallcap Utilities ETF (PSCU) for a better utility ETF play at this time.

Why Small Caps?

In this recent sell-off, small cap utilities have managed to avoid the brunt of the bearish wave. Instead, investors were laser-focused on the large cap corner of the utility space, driving names in this corner far lower.

While part of the reason may be due to some downgrades in a few big names in the utility market, it is also worth noting that small caps have been beating out their large cap counterparts for much of the past year. In fact, the small cap-centric PSCU has beaten XLU and VPU by several hundred basis points over the last twelve months, although the space has broadly underperformed the S&P 500.

In other words, PSCU and its small cap stock brethren, have managed to fly under the radar despite their impressive performances in a pretty hot (until recently) sector. This is despite being a high yielder—the fund pays out roughly 3.8%-- that has clearly benefited from the trend towards big payout stocks earlier in the year (read Utilities ETF Slump on Downgrades).  

Given this outperformance, some investors who are still looking to get in on the utility space may want to consider PSCU instead of the other names in the space. It appears to be better positioned than its large cap counterparts, while it still pays out a solid yield, suggesting that some investors may want to take a closer inspection of this often overlooked fund.

PSCU in Focus

PSCU tracks the S&P SmallCap 600 Capped Utilities and Telecom Services Index, a benchmark of about 22 companies. The ETF charges a pretty low 29 basis points for its exposure, focusing on U.S. companies.

In terms of industries, there is a nice breakdown with natural gas taking up about 40%, electric utilities taking up a quarter of the fund, and then telecom rounding out the top three at roughly 15% of assets. Unsurprisingly, this utility focus leads to a value tilt, as just 18% of the stocks in the fund aren’t classified as value securities.

While the ETF is a high yielder and a relative outperformer, investors should note that the product isn’t exactly popular as just $30 million is invested in the fund. This produces low trading volumes, and while the fund can be relatively easily traded, make sure to watch out for wider bid ask spreads here (see Three Biggest Mistakes of ETF Investing).

A few extra basis points in costs hasn’t really mattered when you look at the performance though, as PSCU has outperformed its large cap competitors by a pretty healthy clip as of late. PSCU has lost about 1.8% in the last one month, compared to much heavier 5% (and more) losses for the ultra-popular names in the space, XLU and VPU.

Bottom Line

Yes, there has been a significant amount of pain in the utility ETF space lately, but most of it has been contained to large caps. Small caps could still be a decent value in the space, and they have proven to be more resilient to big sell offs as well (read Small Cap Value ETF Investing 101).

So if you still are looking for some high yielding sectors and you don’t mind the volatility of small caps, PSCU could be a great pick. The ETF has a Zacks ETF Rank of 2 (Buy) and we are looking for this relative outperformance to continue later this year as well, especially if investor scorn remains on the large cap corner of the utility ETF market.

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PWRSH-SP SC UTL (PSCU): ETF Research Reports
VIPERS-UTIL (VPU): ETF Research Reports
SPDR-UTIL SELS (XLU): ETF Research Reports
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