To minimize the impact of a hard landing, central banks in major economies continued to deliver jumbo-sized interest rate cuts near the tail-end of the year. Following several months of stalling progress, with interest rates remaining historically high, policymakers managed to jump to action and begin shifting gears on their fiscal monetary decisions.
The slower-than-anticipated reaction had seen investors seeking shelter with defensive, more cyclical, and recession-proof options that would provide them with near-term security. Attempting to navigate conditions has proven harder than expected, and reliance on traditional instruments has delivered below-average returns.
However, perhaps in a changing interest rate environment, there remain a few hidden gems that could provide partial near-term stability, while maximizing long-term performance and growth. Historically, utility companies have relied heavily on loaned capital to expand operations and build new infrastructure, which, in return, makes them heavily indebted companies.
Growing long-term earnings requires regulatory support, raising utility prices, and reducing operational costs, even during periods of inflationary pressure. However, should interest rates come down, the performance of utility companies tends to be powered by new capital infusion, slower expenditure, and lower levels of high-interest debt.
A safer option, especially in current conditions would be utility exchange-traded funds (ETFs), despite the plethora of utility companies there are to choose from. Utility ETFs provide security, balance, and long-term exposure across the sector.
U.S. Utility Sector
In 2024, the U.S. Federal Reserve delivered three separate interest rate cuts following months of stalling progress and hawkish monetary loosening. A jumbo rate cut of 0.50% kicked off the cooling cycle, followed by two separate cuts of 0.25%. Currently, interest rates are standing at a target range of 4.25%-4.50%.
Updated projections by the Federal Reserve suggest that the central bank will reduce interest rates by 0.50% of additional rate cuts in 2025. This estimate comes in lower compared to their projection of 1.0% from September 2024.
The S&P 500 Utilities Index managed to maintain robust performance throughout 2024. Slight outperformance during the opening months of the year delivered impressive results, with the index posting a 19.73% year-to-date (YTD) return, compared to the benchmark S&P 500 Index return of 23.84%.
Overall, sector volatility remained a key factor throughout the year, with rising costs of materials and labor impacting corporate performance. However, stabilization in market conditions nearing the end of the year helped subdue volatile conditions and further provided stability following the U.S. elections.
U.S. Utility ETFs
There were several funds that managed to keep themselves in the spotlight this year, delivering impressive growth and forward-looking projections.
Vanguard Utilities ETF
The usual suspect – Vanguard – remained a top pick for investors this year, delivering a 23.20% year-to-date return, above the industry benchmark index. This passively managed fund invests in a broad selection of electricity, water, gas, and independent power producers, and holds 70 stocks in its portfolio.
The fund tracks the performance of a benchmark index, which measures the investment return of the selected stocks in the utilities sector. Electric utilities (61.20%), multi-utilities (24.90%), and independent power producers (5.20%) make up the largest holdings in the fund portfolio. Renewable utilities (0.80%) make up the smallest percentage of fund diversification.
In total, VPU holds over $8.80 billion in assets, and a 5.2% earnings growth rate, making the fund one of the largest, and most competitive in the market. Fund performance is down 8.67% since December 1 through December 31, but remains nearly 20% higher than the same period of December 2023.
iShares U.S. Utilities ETF
Another big name in the sector, iShares U.S. Utilities ETF (IDU) posted impressive gains in 2024 despite having to navigate sector-wide challenges, including legacy infrastructure, inefficient use of employee skills, labor shortages, and rising material costs, among other things.
The fund delivered a 42.10% one-year market return, slightly below the benchmark total return of 42.67% for the same recorded period. On a year-to-date basis, IDU delivered a 23.90% return, higher than both the S&P Utilities and S&P 500 Index.
True to the nature of iShares, the fund is heavily exposed to U.S. electricity, gas, and water companies, to target access to domestic utility stocks. Top sectors in the iShares U.S. Utilities ETF include electric utilities (58.08%), multi-utilities (22.32%), environmental and facilities services (10.01%), and independent power producers and energy traders (3.87%).
Fidelity MSCI Utilities Index ETF
Generous performance throughout the later parts of 2024 helped the Fidelity MSCI Utilities Index ETF (FUTY) regain its foothold in the utility sector and among investors seeking security with short-term investments amid uncertain market conditions driven by high interest rates and sticky inflation.
FUTY delivered a total year-to-date performance of 17.87%, through December 31. The fund managed to maintain an upward position for much of the fourth quarter, before ending slightly lower near the end of the year. Still, considering the average price range of $48.35 – $48.91 per share, the fund remains an affordable option for broader portfolio diversification.
In total, the fund has over 71 holdings, with over half, or around 52% of the top holdings consisting of energy companies, with NextEra Energy (NEE) (11.61%), Southern Co (SO) (7.00%) and Duke Energy (DUK) (6.49%) making up the top three positions.
Overall, FUTY holds roughly $1.80 in total net assets, which makes it one of the smaller options among other competitors. Despite this, the fund delivered a 37.11% one-year market return, and a 10.48% return since its inception. FUTY is a consistent option for investors seeking stability, but increased utility exposure.
Canada Utility Sector
In June 2024, the Bank of Canada announced an interest rate cut of 0.25%, making them the first central bank among the G7 nations to begin cutting interest rates, following several months of interest rates setting at a peak of 5%.
Since then, the central bank has commenced a more aggressive campaign to reduce interest rates, cutting the target and bank rate an additional three times on separate occasions. By December, policymakers approved another rate cut, further reducing the overnight target rate to 3¼%, and bringing the bank rate down to 3½%.
Following December’s delivery, the bank has said that it remains optimistic about the forward-looking prospects of further rate reductions in 2025, and continuing its policy of balance sheet normalization.
Several key challenges await in 2025, one of which is President-elect Donald Trump’s proposed tariff on imports. Several key Canadian policymakers have already threatened to cut off energy exports to the U.S., which would include oil and natural gas.
The proposed tariffs of 25% on imports would not only hurt the Canadian utilities sector but could blow a major punch to American consumers, businesses, and manufacturers that rely on energy imports. Not only will Americans feel the impact, but Canadians might see their Toronto utility bill reaching a new high in the coming months.
Outside of political challenges, volatility in the market regarding material costs, labor costs, and inflation continues to be key factors utility providers are keeping a close eye on in the new year. While the sector has experienced firm stabilization in recent months, further inflationary pressures, which have moderated in recent months, could perhaps threaten long-term growth output.
Canadian Utility ETFs
The domestic utility sector has a handful of high-performing funds that provide investors necessary liquidity, exposure, and diversification.
Hamilton Utilities Yield Maximizer ETF
The Hamilton Utilities Yield Maximizer (UMAX) fund delivers a unique blend of exposure, which primarily includes investing in Canada’s largest pipeline, utilities, and railways companies.
In fact, sector allocation sees UMAX heavily weighted towards utilities (32.6%), and secondly, pipelines (25.1%). Industrials (22.1%) and communication services (20.1%) round up fund distributions.
In 2024, the fund managed to maintain its average benchmark yield of 13%, with a current annualized yield of 13.91%. Something that sets UMAX aside from its competitors is that it uses an options strategy, better known as covered calls.
This approach allows the fund to sell call options of up to 50% of the portfolio holdings. This means that the price of the options sold is usually equal to the market price of those underlying stocks.
For investors who rely on dividends, this approach allows the fund to generate additional income. In 2024, the fund fared well, with a year-to-date return of 10.86%, and a one-year return of 14.20%.
iShares S&P/TSX Capped Utilities Index ETF
Canadian investors looking for a similar blend to iShares U.S. Utilities ETF might be surprised to notice that the iShares S&P/TSX Capped Utilities Index ETF (XUT) holds a diverse range of domestic utility stocks, intending to replicate the performance of the S&P/TSX Capped Utilities Index.
XUT holds the majority of electric utilities (44.14%), followed by multi-utilities (25.02%) and renewable electricity (11.47%). Other sectors include independent power producers and energy traders (10.54%), gas utilities (8.31%), and a small portion dedicated to cash or derivatives (0.51%).
During 2024, the fund delivered a one-year return of 22.97%, which fell below the benchmark return of 23.77%. Importantly, despite the slower delivery, fund performance is up just over 8% year-to-date through December 31, and is 4.31% below its former peak recorded halfway through the fourth quarter of 2024.
BMO Equal Weight Utilities Index ETF
Another medium-risk fund, BMO Equal Weight Utilities Index ETF (ZUT) delivers an annualized distribution yield of 4.06% and holds a modest $506 million in net assets as of December 2024.
The fund follows a strategy that allows it to replicate the performance of the Solactive Equal Weight Canada Utilities Index net of expenses. ZUT invests in Constituent Securities of the Index and currently holds a similar proportion of assets as they are reflected in the underlying index. Based on current fund literature, ZUT is designed for growth-focused investors, seeking long-term exposure to Canadian utility stocks.
Top fund holdings include a handful of well-known domestic utility companies, including TransAlta Corporation (TA) (11.66%); Capital Power (CPX) (9.33%); Atco Canada (ACO) (7.26%); Emera (EMA) (7.12%) and Brookfield Infrastructure (BIP-U) (7.12%).
Other notable names include Canadian Utilities (CU) (6.88%); Fortis Inc (FTS) (6.88%) and Altagas (ALA) (6.60%). The high concentration of electricity and industries provides the fund with the blended exposure required to maintain sustainable growth and long-term distributions.
Closing Remarks
There are plenty of new developments up ahead for the utility sector. For one, changing monetary policies, and the reduction of historically high interest rates will bring utility growth back into the spotlight, and perhaps deliver more attractive distributions for investors.
Though it’s not clear how political conditions will influence the performance of the sector in the coming months, possible tariff changes, and price increases across the board could bring new headwinds for the sector, regardless of from which angle you may be looking at things.
Utilities provide a unique opportunity for investors, much of which lies in the importance of diversification these funds and companies will provide their portfolios. But more than this, they provide stability and a sense of near-term security amid volatile conditions and recessionary fears.
