Utility funds undergo transformation

Mutual funds

July 07, 1996|By NEWSDAY

It has been a roller-coaster ride for utility funds, long considered to be for conservative, defensive-minded investors.

In 1994, when interest rates rose, utility funds took a pounding. Last year, as rates fell, they made a major comeback, averaging a 27.35 percent gain for the year. This year, the funds took a hit early on as interest rates rose, but they have rebounded slightly as rates have stabilized.

Utility funds used to be considered "widows and orphans" funds because they paid attractive, stable dividends from regulated companies. But the stocks, and hence the funds' share prices, were tied to interest rates, and when rates rose, the stock prices fell.

Now utilities are going through some fundamental changes while trying to hold on to the stable investment position they have always had. There has been deregulation of the natural gas industry and the telecommunications industry, and a state-by-state deregulation of electric utilities.

And there has been diversification. Now the term "utility fund" might mask funds that hold large positions in uranium stocks, as the top-performing Lindner Utility Fund does, or oil companies or foreign telecommunications companies in emerging markets. Now you need to understand what you are getting. So, you might wonder, who are these funds for?

"They are still for income investors for a long-term hold," said Michael Trensky, a Value Line analyst. "You don't buy them for a quick buck like a tech or small-cap fund. You are going to get lower total returns than with economically sensitive funds." In the past five years, he pointed out, utility funds have averaged 11 percent returns, compared with the Standard & Poor's 500 index average of 16 percent.

So who are the funds looking for? "We still want the conservative, defensive-minded investor who wants preservation of capital more than anything else," said Linda Duessel, co-manager of The Federated Utilities Fund. "But they should also look for total return as well as dividends."

But Morningstar fund analyst Andrew Lohmeier said, "Utility funds are, more and more, total return funds. Some will get into strange sorts of things, like Lindner and uranium. They want to jazz up the funds. Lots of funds are buying telecommunications companies that provide service and equipment and are looking more to foreign markets for growth. Very few are for widows and orphans anymore."

But in the market, utility stocks are perceived as interest-rate plays, and when rates rose in February, fund shares dipped because "people dumped our stocks," said William Reaves, who manages the Strong American Utilities Fund. "The rates have settled down, and if the Treasury bond rates drop back again, there is room for surprising gains."

Reaves likes to keep oil companies in the fund as a hedge against inflation. When rates rise and utilities take a dive, oil companies do well and buoy the fund returns.

As do yields. Duessel said the average electric company stock yields about 6.5 percent. But she looks for companies in the top tier in quality, not just yield.

But as electric companies are allowed to sell their power at competitive prices, which may undercut local utilities, strong companies are repositioning so they can survive. "There are some companies whose destiny it is to be taken over by someone and little premium is going to be paid for them," Reaves said.

The other major utilities, the phone companies, have had their ups and downs. Many funds bought Baby Bells late last year and did well until the telecommunications bill deregulated the industry this winter. Then the companies took a dive. Reaves remains optimistic because "the telecommunications pie is very powerful, thank you very much, and as things are lining up, you are going to have companies with double-digit earnings."

For the year to date, utility funds are about breaking even overall, as deregulation and interest rate moves create uncertainty.

"Yes, things are happening," Reaves said, "but when a group is considered out of favor, then everyone worries about all the possible problems, and everything is trotted out."

Pub Date: 7/07/96

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