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ETF Specialist

Rising Valuations Driving Down the Yield of This Utilities ETF

The utilities sector has historically been an income oasis, but demand from income-hungry investors is sending yields lower.

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 Utilities Select Sector SPDR ETF (XLU) is an appealing option for investors who want broad exposure to defensive, high-yielding U.S. utilities companies. This low-cost exchange-traded fund contains only mid- and large-cap U.S. utilities firms, as it only holds those utilities stocks that are constituents of the S&P 500. That means it owns the more-stable stocks among the steady-Eddie utilities cohort. The fund follows a market-cap-weighted index, which means that larger companies tend to hold more sway. Over time, that has resulted in mixed performance. During periods when large- and mid-cap names outperform smaller-cap ones, this fund does better than an equal-weighted option, while during periods when small- and mid-cap names tend to outperform larger utilities names, an equal-weight utilities ETF would perform better.

This fund's holdings include regulated utilities, diversified utilities, and unregulated power generators. Many utilities firms are known for their reliability and income generation. This ETF is suitable as a satellite holding for a diversified equity portfolio, given that the utilities sector makes up only about 3% of the S&P 500. The fund also can serve as a tactical bet on low interest rates and long-term growth in electricity demand.

Ben Johnson has a position in the following securities mentioned above: EXC. Find out about Morningstar’s editorial policies.