Utilities Investing Gets Growthy

Utilities funds. Filled with electric and water companies, right? Big on yield, low on total return? About as exciting as watching paint dry?

Maybe, sometimes. Many utilities funds take pride in being boring, because that's exactly what they're supposed to be. By investing in traditional utility stocks like electric, gas, and regional Bell telephone companies, they give investors exposure to industries that aren't huge on growth, but demand for their services is steady. Thus, these funds can serve conservative, income-oriented investors well, or act as hedges for more aggressive portfolios.

In recent years, however, several funds have put a much racier spin on utilities investing. Instead of keeping their portfolios heavily weighted with traditional utilities, these funds have gotten extra performance juice in the last few years from telecom, wireless, and communications-equipment stocks. These aren't your grandparents' utilities funds.

Funds Get a Telecom Jolt
The changing face of the telecommunications landscape, and the opportunity for growth that it offers, has prompted many utilities managers to put their focus squarely on that sector. The Internet's increased dominance in the last few years has led to new opportunities for telecom companies to provide all kinds of new services. And the breakup of telephone monopolies has led some former regional Bells to go on buying sprees in order to broaden their businesses. Case in point: After Bell Atlantic merged with GTE, it became Verizon Communications (VZ). In addition to local and long-distance phone services, Verizon's subsidiary businesses include cellular services, software, and computer maintenance.

As the Verizon example illustrates, telecom companies are dipping their fingers into lots of different pies these days. Consequently, defining what types of companies should be considered telephone utilities is getting harder all the time.

Some fund managers are responding to this dilemma by making their definitions as broad as possible. For example, Qualcomm (QCOM), a wireless-communication system maker, has popped up in portfolios like Evergreen Utility (EVUAX). Other funds like AIM Global Utilities  and Invesco Utilities (FSTUX) own networking-equipment stocks like Qwest Communications . AIM manager Claude Cody recognizes that these stocks aren't utility plays, but he includes them in the portfolio because they enable the services that utilities provide.

Of course, broadening the definition of what makes a utility stock to include these high-flying growth names has helped the performance of these funds, too. Many of these growth-heavy funds have dusted their more traditional, income-oriented peers in the last few years.

Some Still Strive for Stability
But great performance for growthy utility funds comes with a price: volatility. Some of these funds can hit bumps in the road when growth stocks tumble. For example, AIM Global Utilities fell more than 15% during March and April's Nasdaq volatility, far more than the average utility fund lost. Fidelity Select Utilities Growth (FSUTX), another growth-laden fund that has notched terrific performance in recent years, lost more than 12% during April and May.

With this in mind, it can be comforting to know there are still funds out there that still put their focus squarely on stability and traditional utilities. Such funds usually don't totally eschew the telecom sector; in fact, many keep sizable weightings in that area. But instead of letting their portfolios lean very heavily toward growth, they try to strike a balance between traditional, income-oriented utilities and telecom names.

The last few years haven't been kind to these funds. However, they still have their charms, namely stability and income. Even though providing a high yield isn't as much of a priority for many of these funds as it used to be, some of them still offer a decent payout. For example, Vanguard Utilities Income  concentrates only on stocks that pay dividends, so its portfolio leans toward electric and gas companies and away from telecom. Its long-term returns aren't much to write home about. But its 2.99% yield is higher than average (though it used to be higher; it has gradually come down as its managers have added a couple more telecom names lately). It's also less volatile than average. Putnam Utilities Growth & Income  is a similar fund. Again, returns have been lackluster for this telecom-light portfolio, but its yield is high and it hasn’t been too volatile. Owning a fund like one of these can be a valuable hedge against the swings of growth stocks. At a time when even value funds are landing on the growth side of the Morningstar style box, these funds can be good diversifiers.

Owners of these funds can boast about another perk this year: improved performance. Through July 31, the top-performing utility fund was Galaxy II Utility Index , a fund that seeks to replicate the performance of the electric- and gas-heavy S&P Utilities Index. Second on the performance list was American Gas Index (GASFX), which focuses on natural-gas distribution and transmission companies. Both of these funds have gained much from the energy sector's great run this year, and the sense that energy rate hikes are over has given some strength to other traditional utilities. Deregulation in these more staid sectors has also helped; firms like Enron  and Dynegy , which distribute power, have performed quite well recently.

The Upshot
So, which way should you turn for your best utility bet? It depends on the role that one of these funds will play in your portfolio. The returns of many growth-laden funds may look tempting, but if you want a portfolio hedge, one of the more conservative funds may be for you.

And if you are looking for a portfolio with some more oomph, you may want to consider a telecommunications sector fund. If you're looking for straight exposure to the telecom and/or networking and infrastructure sectors, you might be happier with a specialty-communications fund such as T. Rowe Price Media & Telecommunications (PRMTX) or Fidelity Select Telecommunications (FSTCX).

There are also a few funds out there that have produced great results over the years and won't force you to choose between these two camps. MFS Utilities (MMUFX) has one of the best records in the group and is pretty well diversified across various utility subsectors. AXP Utilities Income (INUTX) is less growthy than MFS, but both its returns and its yield are above average.