Best and Worst Funds: Utilities Sector

The Utilities sector ranks eighth out of the ten major sectors as detailed in our sector roadmap. It gets my Dangerous rating, which, like my fund ratings, is based on aggre­ga­tion of stock rat­ings for each of 86 companies in the sector. The full series of my reports on the Best & Worst Sector and Style Funds is here.

Figure 1 does not present a pretty picture for Utility stocks, and it is worse for the funds. There is only one Attractive-or-better rated stock making up only 3% of the market cap of the sector. There are 30 Neutral-rated stocks making up 50% of the market cap of the sector. All of the 48 funds in the Utility sector are rated Dangerous-or-worse.

When funds are not rates as well as the stocks from which the fund manager can choose, the managers are not performing well. They are certainly not deserving of any management fees.

Investors are better off purchasing the single Attractive-rated stock than purchasing a fund that spreads their capital across a basket of Dangerous-or-worse-rated stocks.

Investors should sell funds in this sector because the cost of portfolio management (active or passive) is not justified. Investors can outperform by picking better stocks on their own while also avoiding the costs of putting money into a fund. The best sectors for finding funds and stocks are Technology and Consumer Staples. My series of Best & Worst Sector Funds reports on all sectors is here.

Figure 1: Utilities Sector Landscape For Funds & Stocks

Sources:   New Constructs, LLC and company filings

If you must take a position in the Utilities sector, know that all 48 funds are very different. Per Figure 2, the number of holding varies widely (from 23 to 85), which creates drastically different investment implications and ratings. Here is the full list of 48 funds.

How do investors pick the right fund out of the sea of choices that will deliver the best returns?

Figure 2: Funds with Most & Least Holdings – Top 5

Sources:   New Constructs, LLC and company filings

To iden­tify the best funds within a given cat­e­gory, investors need a predictive rating based on analy­sis of the under­ly­ing qual­ity of stocks in each fund. See Fig­ure 3.

Our predictive fund ratings are based on aggregating our stock ratings on each of the fund’s holdings and all of the fund’s expenses. Investors deserve forward-looking fund research that is comparable in quality to stock research.

Investors should not rely on backward-looking research of past performance for investment decisions.

Figure 3 shows the five best and worst-rated funds for the sector. Every fund allocates over 30% of their value to Dangerous-or-worse-rated funds. In addition, my ratings account for the  total annual cost of investing in a fund or ETF. My ratings (updated daily) on all funds in this sector are here.

The only Attractive-rated stock in the Utilities sector is Public Service Electric & Gas [s:  PEG], which gets my Very Attractive rating. It gets and Attractive rating because it has positive economic earnings, not just positive accounting earnings, and because it has a cheap valuation, a rarity among Utility stocks (and funds). Given the rabid search for dividend-paying stocks, too many Utility stocks are overbought. PEG is an exception. Its current stock price (~$30.34) implies the company’s profits will permanently decline by over 20%. The market is setting the bar low. The no-growth value of the stock is about $39. The fund that allocates the most (4.7%) to PEG is Dangerous-rated Fidelity Select Portfolios: Utilities Portfolio [s: FSUTX].

One of my least favorite Utilities stocks is NiSource Inc. [s: NI], which gets my Very Dangerous rating. The company’s ROIC is a dismal 2%, which inspires little hope of it ever achieving true economic profitability. Yet the valuation seems oblivious to this fact. The current stock price (~$22.73) implies the company will grow its after-tax cash flow (NOPAT) at 12% for over 10 years compounded annually. Has a utility company ever grown its cash flows over 10% for any extended period of time? I think the ratepayers (and the regulators) would demand a cut in prices before allowing a utility to be so profitable. The company’s historical growth rate is much lower than 12%. I also recommend investors avoid Flex-funds Trust: Utilities & Infrastructure Fund [s: FLRUX], which makes NI it largest holding and I rate as Dangerous.

Figure 3: Funds with the Best & Worst Ratings – Top 5

     * MF designates Mutual Funds and ETF designates Exchange-Traded Funds

Sources:   New Constructs, LLC and company filings

Figure 4 shows the rating landscape of all ETFs and mutual funds in the Utilities sector.

Our Sector Roadmap report ranks all sectors and highlights those that offer the best investments.

Figure 4: Separating the Best Funds From the Worst

Sources:   New Constructs, LLC and company filings

Figure 5 lists our Predictive Fund Rating for the 5 largest and most popular Utilities funds.

Figure 5: Five Largest Utilities Funds

     * MF designates Mutual Funds and ETF designates Exchange-Traded Funds

* Analysis uses the top-ranked class for each fund

Sources:   New Constructs, LLC and company filings

The full list of Utilities funds and our ratings on each fund is here.

Dis­clo­sure: I receive no com­pen­sa­tion to write about any spe­cific stock, sec­tor or theme.

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