When the stock market is hot, as it has been since October 1990, few domestic equity fund groups lag stock price indexes as badly as utility funds. When the market is down, few groups fare better.
Over a stretch as long as the last 10 years -- including market ups and downs -- two funds, Prudential Utility and Fidelity Select Utilities, were able to beat the 17.5 percent annual rate of total return of the Standard & Poor's 500 Index.
A third, Franklin Utilities, fell short. But it did exceed the 15.2 percent average return of all general equity funds, as calculated by Lipper Analytical Services.
Since well-run, diversified growth and growth-and-income funds are likely to be your most profitable fund investments over the long run, why consider a utility fund? And, why now?
For a couple of reasons, perhaps:
1. Because fully invested growth funds reflect the high level of stock prices, you might want to allocate part of your portfolio to a high-yield equity fund whose dividends should provide a cushion if there is a stock market correction. A utility fund can do that.
2. During this period of lower interest rates and stock yields, some utility funds continue to offer dividends of 5 percent to 6 percent, as well as the hope for increases in income distributions. (Remember, though, these are stock funds and involve market risk.)
Such considerations apparently have attracted many investors to put money into utility funds in the last year. And the prospect of managing that cash has led to new funds.
The number of utility funds tracked by Lipper rose from 15 to 25 in 1991, as the group's total net assets increased 53.8 percent to $10.4 billion -- due more to sales of shares than to total return.
With only a handful having performance records for more than five years -- the Franklin Fund dates all the way back to 1948 -- what do you look for in a utility fund?
Consistently good performance, to be sure. But also suitability of the investment objectives and underlying strategies.
Some funds aim to achieve high yields for shareholders who want income more than growth. Others strive for high total return, sacrificing some yield to seek greater capital appreciation.
Those offering high yields may be more sensitive to interest rate fluctuations. Thus they may move more in sympathy with the bond market and may be more likely to slip when long-term rates rise, as they've done moderately in recent weeks.
Some may reflect interest fluctuations not only because they own high-yield utility stocks but also because they own bonds -- as much as 40 per cent of assets in the case of Shearson Lehman Utilities.
All of the funds are sensitive to the risks associated with the utilities sectors generally and with individual companies.
These vary considerably, as stock prices indicate. To illustrate: in 1989, telephone stocks in S&P's utilities index had a total return of 57.4 percent and gas companies, 55.5 percent, well ahead of the electric companies' 33.2 percent. Last year, electric companies had a total return of 30.2 percent but the telephone companies were down to 7.5 percent and gas utilities had a negative 13.1 percent return.
"It was one of the widest divergences I've seen," says Gregory E. Johnson, co-manager of the Franklin fund.
Still not excited about the near-term prospects for phones and gas, utility fund managers remain heavily committed to electric stocks, if not as heavily as Mr. Johnson, who has 35 among 37 equity positions. Several have devoted up to about 25 percent of assets to phone and gas shares combined. (A different approach: Stratton Monthly Dividend Fund is more than 35 percent in non-utility stocks, mainly real estate investment trusts invested in nursing homes. The REITs contributed significantly to its 35 percent return last year.)
In screening electric companies for the three Fidelity funds that he manages, Jeffrey Ubben pursues different strategies. For the no-load Utilities Income Fund, he seeks stocks that pay 5 percent dividends and offer the opportunity for major increases. For the Select Electric Utilities and Utilities portfolios, which aim at capital appreciation, he can buy companies that suspended dividends because of financial problems and are "in a recovery mode."
Mr. Ubben also looks for utilities that have obtained rate increases and don't expect to reapply for several years. He does so on the assumption that they will work to cut costs -- "a nice way to grow earnings" -- and will pass along savings to shareholders.
Warren E. Spitz, manager of the Prudential fund, also emphasizes electric companies whose profits were squeezed when expansion costs exceeded expectations and could not
recovered through rate increases. To him, their projected ability to raise earnings and dividends matters more than their current yield, if any.