Utility Stock Funds? Better Look Again

While the Dow Jones industrial average sank more than 123 points Tuesday--adding to Monday’s 174-point decline--the Dow Jones utilities average soared to an all-time high.

And since April, utility stocks have surged nearly 12%, while the benchmark Standard & Poor’s 500 index of blue-chip stocks has fallen 0.5%.

Which means now’s a good time to start buying shares of a utilities sector fund, right?

Not necessarily.

Surprisingly, traditional gas and electric utility stocks--which comprise the Dow utilities average--represent a minority of the holdings in the typical utilities fund.

In many instances, a utility stock fund will invest more heavily in domestic and foreign telecommunications stocks than in gas and electric utilities, notes Amy Granzin, an analyst for fund tracker Morningstar Inc.

In recent months, few have complained, since the telecom sector, fueled by the boom in Internet stocks, has propped up many of these funds.

But in recent weeks, telecom stocks have sunk alongside other pricey “growth” stocks--those with high price-to-earnings ratios--on fears of rising interest rates.

Which may explain why, while the Dow utilities average rose 7.7% in the four weeks ending May 20, the typical utility stock fund was up less than half as much, according to Lipper Inc.

“Obviously, if one is going to hold a utility fund, there are several key questions to ask, including: ‘How is this fund allocated?’ ” said James Stack, editor of InvesTech, a market newsletter in Whitefish, Mont.

As of the start of this year, more than a third of the average utilities fund’s holdings were in domestic telecom names. And close to 20% were held in foreign shares, mostly global telecom stocks, Granzin said.

By comparison, electric utilities made up roughly 38% of the typical utility stock fund’s holdings. And gas companies made up a little more than 4%.

So how can you tell whether a utility fund is really a telecom fund in disguise?

* Look at its top 10 holdings. “If you see MCI WorldCom as a top holding, there’s a good chance that it’s not going to be a traditional utilities fund,” said Granzin.

In fact, some funds, such as Fidelity Utilities, recently held stakes of 15% or more in a single telecom stock.

* Look at the fund’s dividend payout. Utility stocks are considered conservative because of their high dividend yield, often above 3%. But the typical utility fund’s payout is a relatively meager 1.9%.

* Check its sector weightings. This information is available through fund tracking publications, such as Morningstar Mutual Funds.