Utilities stocks hit hard by surge in interest rates in first quarter

Mutual funds

April 07, 1996|By NEW YORK TIMES NEWS SERVICE

Utility funds were among the poorest-performing mutual funds in the first quarter, hit by the same surge in interest rates that briefly sent the stock market reeling.

Though the market recovered, the stocks of electric utilities did not, and analysts say fears of another rate increase should continue to depress the sector.

Utility funds, which typically have a third of their assets in electric utilities, finished the quarter virtually where they started, thanks to other holdings that acted as a bit of a buffer. Still, disappointed investors continued to pull money out of the funds as they have for much of the last year. In a sign of just how out of favor the category is, the Dreyfus Corp. announced that it would liquidate its 5-year-old Edison Electric Index Fund this month.

"This industry is changing rapidly, and lots of opportunities are opening up for electric utilities, but there's no question about it -- they still follow interest rates, and when rates go up, stock prices fall," said Jane Collin, who follows power companies for the Standard & Poor's Corp.

Utilities are particularly sensitive to changes in rates because they borrow heavily to finance their operations, and because their yields compete with bonds on yield.

Along with electric companies, utility funds sometimes hold positions in telephone companies, natural-gas producers and energy transmission companies.

The stocks of telephone companies have risen, spurred by the announcement last week that SBC Communications Inc. would acquire the Pacific Telesis Group for $17 billion, in a merger of Baby Bells, but analysts aren't expecting much from the rest of the utility sector this year.

In the long term, however, many analysts still see utilities in their usual role as safe havens, holding up when the broader market weakens.

"At some point, corporate earnings growth is going to diminish, and we think there will be a point of time out there when the flow of funds will become more defensive again," said Nancy M. Messer, an analyst at the A. G. Edwards & Sons brokerage in St. Louis.

With their dividends now averaging 6 percent and their prices traditionally less volatile than those of most equities, power-company stocks appeal to risk-averse, income-hungry customers, much as bonds do.

But the rise in long-term rates of nearly three-quarters of a percentage point last quarter dealt a blow to both investments.

Many analysts expect the upward pressure on long-term rates, gauged by the 30-year Treasury bond yield, to continue.

"My guess is we'll hold in this general range, of 6.5 percent to 6.75 percent," said David M. Jones, chief economist at Aubrey G. Lanston & Co., "but I think they'll drift slightly higher by the end of the year, to the 6.75 percent to 7 percent range."

Despite this outlook, many utility investors remain committed to the group. Kevin Rogers, a branch manager in Cherry Hill, N.J., for Linsco/Private Ledger, a financial-planning firm, said that he had largely eliminated long-term bonds from his conservative accounts, but that he was keeping a one-third weighting in utility funds.

"A conservative account is somebody looking for income and keeping their principal in pace with inflation," Mr. Rogers said, "and utilities are one of the few areas where yields are high and there are capital gains to be had as well."

Utilities are a classic defense against market volatility, which Mr. Rogers said he expected would increase this year. He noted that stocks of power companies rallied when investors began to flee semiconductor issues last fall.

"When the hot hand starts to go cold, that money needs to look for a safe harbor, and utilities are always the beneficiaries," he said.

That helped utility funds show average total returns of 27.7 percent last year, according to Morningstar, the fund-tracking company in Chicago. But that only lifted annualized returns to a mere 8 percent for the three years that ended on Feb. 29.

Though utility funds try to distinguish themselves from one another, their returns in the first quarter were largely the same, clustered around zero.

The Franklin Global Utilities Fund gained 1.81 percent because more than half its $180 million in assets was deployed outside the United States and only 37 percent was committed to electric companies. The Smith Barney Utilities B fund, with nearly 90 percent of its $1.8 billion in assets invested in electric utilities, lost 3.60 percent in the quarter.

An exception was the Lindner Utility Fund, which advanced 10.97 percent. Lindner's broad definition of utilities includes energy and mining companies, which prospered.

At the end of February, those two groups accounted for 36 percent of the fund's assets, roughly the same portion allocated to conventional utilities, with the balance among other industries.

Other utility funds are heavily weighted in telephone company stocks. Several of these funds rose in value last week after SBC made its bid for Pacific Telesis.

Fidelity Select Utilities Growth and the Fidelity Utilities, which both have large telephone holdings, gained about 2 percent each on the day the deal was announced.

Investors who want the high-return potential of stocks but are apprehensive about market gyrations can hedge some of the risk by diversifying with government debt, reminds Neuberger & Berman, the New York investment manager.

According to a study by Neuberger & Berman for the 35 years ended in 1995, a portfolio divided evenly between one-month Treasury bills and the Standard & Poor's 500 index of stocks has provided 81 percent of the return of the S&P with only half the volatility. Putting 60 percent in stocks and 40 percent in Treasury bills provided 85 percent of stock-market returns, with 60 percent of the volatility.

Pub Date: 4/07/96

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.