Deregulation Can Spell Opportunity for Utility Funds
This hasn’t been a great year for utility stock mutual funds. In fact, it hasn’t been a great 20 years, really.
Utility funds make up the biggest single U.S. specialty fund sector followed by fund-tracker Lipper Analytical Services, with 90 funds now holding $22.4 billion in assets. But given their record over much of the last two decades, one wonders what investors have seen in the funds.
The average utility fund’s total return over the last 20 years was just two-thirds what the average growth-and-income (i.e., blue-chip stock) fund returned. Looking over the last five years--a fairer time period to measure, with many more funds in existence--the average utility fund rose 77%, versus 96% for the growth-and-income category.
So far this year the score is utility funds up 2.2%, on average, growth-and-income funds up 9.4%.
Theoretically, the hefty dividends paid by electric, gas and telephone utilities over the last two decades should have handsomely compensated investors. That was, after all, the traditional lure of utilities: Higher dividends, lower volatility.
The sector did in fact perform better than the typical blue-chip stock fund in the 10 years ended Dec. 31, 1993. But since then, utilities’ troubles can be summed up in one word: Deregulation.
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As Congress and the states have, to varying degrees, removed regulatory shackles from the gas, electric and telecommunications industries, what were formerly level playing fields have turned into battlefields--with lots of victims.
That has forced restructurings and dividend cuts at many once rock-solid utilities. Hence, the sector’s turmoil in recent years.
But that deregulatory movement increasingly is producing investment opportunities as well. A merger wave among electric utilities last year has been followed by mergers among several big electric and natural gas utilities this year. Consolidation also is sweeping the telecom business.
In short, it’s now a stock-picker’s market in the utility business, as many fund managers hunt either for undervalued long-term survivors in the field or for takeover targets, or both. The old utility fund strategy--just buy and hold high dividend payers--is losing favor.
Maura Shaughnessy, manager of the MFS (Massachusetts Financial Services) Utilities fund in Boston, has steered her portfolio to a 7% gain this year, three times the sector average. “I’m basically just a stock-picker; I don’t focus on big group [bets] or on rotation” among utility sectors, she says.
This year she had owned a large stake in Portland General, the Oregon electric utility that natural gas pipeline giant Enron recently agreed to buy. Meanwhile, the gas business itself has been a winner for Shaughnessy, as surprising strength in gas prices, at least until recent days, has sharply boosted such pipeline stocks as PanEnergy, Williams Cos. and Sonat.
For the Invesco Utilities fund in Denver, shareholders’ 7.8% year-to-date gain is thanks to manager Jeff Morris’ big score with such stocks as electric and gas utility IES Industries, currently the subject of competing takeover bids; regional phone company Cincinnati Bell; and oil and gas utility Enserch, which plans to merge with Texas Utilities.
In St. Louis, Eric Ryback’s Lindner Utility fund may be one of the most eclectic utility portfolios of all: He likes such traditional names as gas distributors Questar and Equitable Resources, but the fund’s 15% rise this year also owes itself to gains in stocks such as Zenith Electronics and uranium producer Uranium Resources. Ryback can hold up to 25% of the fund in companies that are suppliers to utilities, such as Zenith with its cable TV signal boxes and Uranium Resources with its nuclear-plant fuel.
But are these utility fund managers skillful stock-pickers, or did they just get lucky this year? Maybe some of both.
The important point for utility-fund shareholders, and potential investors, to understand is that it will never again be business as usual for this sector. Not only will utility investors have to contend with the vagaries of market interest-rate changes--which still have a strong influence over utility stock values--but deregulation will significantly reward some firms and devastate others.
If you’ve owned a utility fund for many years, you should take a close look at it today; it may no longer resemble what you originally bought. If you were buying an electric utility portfolio, for example, you might be surprised to find that the fund today is more heavily invested in telecom stocks than electric companies. That may suit you just fine, depending on whether the fund manager has picked the right telecom stocks. If you don’t think you’re invested with a good stock-picker, all else is irrelevant.
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Low Power
Utility stock funds have badly lagged returns on growth- and- income stock funds- which tend to favor blue- chip issues- over every major period of the last 20 years. A look at average returns over four periods ended June 30, amd year- to- date- results:
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Avg.growth Avg.utility Period and income fund stock fund 20 years +1,246% +821% 10 years +206 +150 5 years +96 +77 1 year +22 +18 Year-to-date +9.4 +2.2
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* Through last Thursday
Source: Upper Analytical Services
