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3 High-Income ETFs for a Goldilocks World

As the closely followed Economic Policy Symposium kicked off Friday in Jackson Hole, Wyoming, most analysts expect no significant policy changes to emerge from the world’s central bankers at their annual retreat. But political uncertainty nonetheless looms large.

Don’t get spooked by the news headlines. Below, I highlight three exchange-traded funds (ETFs) that are income-generating safe havens.

The global economic recovery remains (fitfully) on track, but silver linings always come with dark clouds. As nervous investors try to relax on their August vacations, rising political risk intrudes.

The overriding factor that has fueled the Trump Rally since election day — Donald Trump’s aggressive insistence on enacting his populist agenda — is now undermining that rally. Trump has managed to alienate not just Democrats but also corporate chieftains and his fellow Republicans. Trump in recent days has threatened to push for a shutdown of the federal government if Congress doesn’t agree to fund his border wall. This combative stance is a gift for Democrats, a conundrum for Republicans, and a bane for investors.

Wall Street no longer likes what it’s seeing in Washington, DC and stocks in recent weeks have pulled back. Now that we’re in the dog days of August, it appears that the Trump rally is running on fumes.

But the principles of shrewd investing — gauging the madness of crowds to pinpoint hidden value — are especially relevant in uncertain times like these.

That’s why, more than ever, you should stick to high-quality investments that can withstand fickle political fortunes. The ETFs highlighted below are solid bets for investors who want high income as well as peace of mind.

Don’t fear the taper…

Part of the Federal Reserve’s mission is to keep inflation at a level that’s neutral for the economy. Inflation remains considerably below the Fed’s target range of 2% and in recent months has actually eased. Despite healthy employment numbers, the absence of strong wage inflation is another factor that’s encouraging the doves at the Fed.

These “Goldilocks” economic conditions (not too hot, not too cold) mean that the Fed won’t be too eager to raise rates, which helps account for the utility sector’s unexpectedly strong performance this year.

Utility investors fear rising interest rates, a dynamic that’s simple to understand: as rates rise, utilities must pay higher costs on their loans for the capital expenditures that provide their future lifeblood. Moreover, higher rates make utility stocks less attractive, from a risk basis, when compared to interest-pegged income alternatives.

However, let’s survey the investment landscape today: benchmark West Texas Intermediate crude still hovers below $50 per barrel, economic growth is sluggish at best, and wage gains have been meager. It all means that an outbreak of significant inflation is unlikely, which in turn means the Fed will maintain its go-slow approach. These in-between conditions are manna for utilities.

Wired for income…

For income investors building a retirement portfolio, high-dividend utility ETFs are timely choices that will pay off over the long haul. I examine the three most promising, in ascending order of risk:

Utilities Select Sector SPDR ETF (NYSE: XLU)

The largest utility ETF, Utilities Select Sector SPDR tracks the Utilities Select Sector index, which essentially mirrors the large utility stocks in the S&P 500. XLU has $7.53 billion in assets under management and currently has holdings in large (mostly electric) U.S. utilities. XLU’s five largest holdings are (in order of percentage of fund assets): NextEra Energy (NYSE: NEE), Duke Energy (NYSE: DUK), Dominion Resources (NYSE: D), Southern Company (NYSE: SO), and Exelon (NYSE: AEP).

XLU has racked up a year-to-date return of 11.29%. The expense ratio is low at 0.14% and the current annual dividend yield is 3.20%.

Vanguard Utilities ETF (NYSE: VPU)

With net assets of $3.35 billion, VPU has a more diverse base than XLU, encompassing several smaller utilities. More than half of VPU’s holdings are electric utilities; multi-utilities that provide more than one service (e.g., electric and gas) make up about a third, with the rest gas, water, and energy traders. VPU is ideal for investors who want a broader stake in the U.S. utility industry.

VPU has generated a YTD return of 11.35%; the expense ratio is low at 0.10%. VPU currently yields 3.13%.

Fidelity Select Utilities (NSDQ: FSUTX)

With net assets of $718.5 million, FSUTX is an actively managed fund that seeks capital appreciation for its investors by investing in the equities of growth-oriented North American-based utility companies. Turnover of holdings is relatively high. Current top three holdings in order of percentage: NextEra Energy, Sempra Energy (NYSE: SRE), and PG&E (NYSE: PCG).

FSUTX is less diversified in its holdings than our other two utility funds, which makes stability a concern if you’re risk averse. The expense ratio is 0.78% (still relatively low compared to the category average of 1.15%) and the current dividend yield is 2.06%. The fund has generated a YTD return of 16.41%.

 

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