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There was a time when investors could lean on utility stocks — and mutual funds that focus on the sector — to weather rough markets. Electric, gas, and telephone companies were reliable. They grew profits slowly, but surely, retaining their value through thick and thin. Not only that, but they treated investors to a share of their earnings by paying out a relatively large dividend.
Of course, many utilities have experienced trouble of late. Enron tanked last year, taking billions of investor dollars with it. WorldCom’s accounting woes have tainted the telephone industry. And utility stock funds, as a group, have followed the leaders downward.
According to Morningstar Inc., the mutual fund research company in Chicago, the average utility fund sagged almost 21% in 2001. The top 10% of utility funds did better, however, finishing the year down 9.2%, beating out the Standard & Poor’s 500 index, which fell almost 12%. The top 10% of utility funds were off 4.4% as of the end of June 2002, fairing a lot better than the S&P 500, which has dropped almost 13.15% over the same period.
Why are a few funds outperforming the group by such a large margin? Well, in the early ’90s, utility funds went down two separate paths. At the time, the government was taking drastic steps to ease regulations in the energy and telephone service sectors. One faction of utility funds settled into a familiar niche — the staid, conservative, state-regulated companies that continued to offer rock solid dividends and stable profits. A second group of funds, though, went off to pursue the high-flying corporations that sought quick growth by expanding operations, and, in some cases, skewing financial results.
For much of the last decade, the buttoned-down group plodded along, while the funds angling for aggressively growing utilities soared. Come 2001, however, a dramatic change took place. California’s energy crisis tripped up many of the gas and electric companies. Investors also discovered that too many telecommunications operations had glutted the market with too much capacity, and prices in that business swooned. As a result, the go-go growth utilities and the funds that invested in them were sent reeling, while utility companies that had maintained a saner, more focused perspective were minimally affected. “Particularly this year, we’ve found that the best-performing funds have been the most conservative,” says Morningstar Mutual Fund Analyst Paul Herbert, who monitors utility funds.
Our advice? If you want to shelter a portion of your portfolio from a market avalanche, consider a fund that focuses on more traditional utilities. With that in mind, we screened Morningstar’s database of 99 utility funds in search of conservative offerings with solid yields. At the top of our list was the Franklin Utilities fund (FKUTX), a fund that returned an average 2.72% annually over the three-year period ending Aug. 31, 2002. By comparison, the S&P 500 slid 19.40% over the same stretch, while utility funds averaged a 22.58% fall. Our chart lists four more funds, each with a Morningstar rating of four or five stars.