Seeking Alpha re-ran this morning's post and a reader left a good question on the SA version. He asked whether international utilities, specifically captured via WisdomTree International Utilities (DBU), are better for reducing correlation than a broader foreign product.
Well the numbers are in and the reader is correct. According to PortfolioScience.com iShares EAFE (EFA) has a 0.84 correlation to the S&P 500 while DBU has 0.56 correlation. I would note that DBU, although dividend weighted hasn't actually paid much of a dividend which is frustrating.
Regardless of the dividend DBU (which I own for a few clients) has done well, has outperformed both EFA and SPY and does have a low correlation.
The biggest risk, IMO anyway, would be if interest rates which are generally low start to go up. A rule of thumb is that rates moving up are bad for utilities as fixed income (talking further out on the curve) competes for some of the money that goes into utilities.
I think higher rates further out on the curve would be a positive for equities as that might signal a return to normal but it sets up utilities to, at a minimum, lag a little.
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7 comments:
I have found that utilities are a great diversification tool. It doesn't matter whether you use XLU or DBU or JXI. There's something about the "localized" nature of utilities and their return streams that makes them less correlated to the S&P 500 than almost all other sectors on an ongoing basis.
While utils only make up about 3.6% of the S&P 500, I personally overweight them (up to maybe 5-7%) in both my personal accounts and in client accounts. The sector correlation to the market is generally in the .5 to .7 range (as opposed to the .8 to .9 of most other sectors.) Of course, there are drawbacks to being overweight utilities (as Roger has mentioned in this post and others) but I have found that they serve me well for dampening volatility.
Incidently, this article Unique Diversification Benefits of Utilities is an excellent expose' on the topic. It's written by Geoff Considine who has done great work with his Quantext Portfolio Planning tool. (I am a user and have no affiliation with Geoff)
I think we have seen the last of rate cuts and the next move will be higher. Inflation is a big problem worldwide. The Fed will not let this get out of hand.
Banker
Jeff Howard, thanks for the link to Geoff C.'s paper on utilities. I've read his website, but it was good to be reminded that utilities are in deed an alternate( no correlated to SPY) investment class. Sometimes you lose sight of the forest from the trees. I own DUK and will look for an entry point on Excelon over the hike in rates.
Roger, thanks for maintaining an interesting and diversified blog. I am curious, why do you listen to CNBC? Doesn't sound like you get much content from what you hear.
Sam
Sam
re CNBC, well maybe they'll have me back on, bah hahahahahaha
they will report news faster than I will naturally find it on my own. also, as an example, I have never owned GM but when the GM news was the biggest thing it was important to know what's going on but also not waste time reading about a stock i am unlikely to ever own.
lastly they have plenty of very smart guests come one. sometimes they ask the right questions and sometimes they don't. when they do ask they right question it becomes a learning opportunity.
Roger,
Regarding the sparse dividends in DBU...how new a product is it? Given that it seems that most foreign firms pay annually, or, at best, semi-annually, maybe there haven't been enough divvies paid yet to make a difference? Just a thought.
jan
Jan, i have touched on this many times and it was lazy not to do so here.
If you own 100 shares of a stock on ex-date you will get 100 shares worth of dividend on the pay date.
If, in between ex date and pay date you buy another 500 shares you still only get the dividend for 100 shares.
So these funds have to pay 100 shares worth of dividend over 600 shares held.
at the start of 2007 DBU was $27 million in assets. at year end it was $92 million. as long as the fund keeps growing this should persist.
Historically Utilities have been used as a source of generating extra income in a portfolio. They usually have low or negative beta's and trade very much like a preferred stock/bond. Yet over the last several years many utilities have traded like energy companies through the age of Enron mostly because of the deregulation. XLU has provided the masses with a safe heaven to park cash very much due to the low interest rate environment. Things seem to be signaling a change as US interest rates are at or close to a bottom and will probably reverse course in the future. Many utilities are sporting lofty price multiples and should pull back in the event of a slowing economy. The XLU chart alone is signaling a very bearish tone. It might be fine to have some exposure for the yield but I would rather be underweight the sector going forward. Having said that I have always been fond of DUK and EXC (even though they gobbled up one of my favorites Peco Energy) but right now I am more attracted to the holdings of PIO in a similar but related field.
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