Exchange traded funds versatile, not volatile
D ear Mr. Berko: I wanted to buy a utility stock, but my broker recommended an exchange traded fund traded on the stock exchange. He claims that they are better than buying 300 or 600 shares of a utility stock.
Please give me your thoughts on these and tell me if you like them. And if I don't buy an exchange traded utility fund, what specific utility do you like? I want to own a utility that has good growth potential and a decent dividend with dividend increases. I have $16,000 to invest.
C.C. Kankakee
Dear C.C.: An exchange traded fund, like a traditional mutual fund, is an investment company that pools investors' money using professional managers to invest in specific objective sectors like: oil stocks, foreign stocks, income or growth stocks, etc.
But unlike a mutual fund, ETFs issue only a fixed number of shares and trade on the New York or American stock exchanges. Therefore, ETF shares are bought and sold just like common stock.
I like ETFs because they're less volatile than the individual issues and their diversified portfolios can provide safer capital gains potential than an individual common stock.
There are ETFs for every season and every reason. Some own municipal bonds; some own corporate bonds; some own preferred stock, mid-cap stocks, small-cap stocks and large-cap stocks. Other ETFs own emerging market stocks, REITs issues, oil shares, natural gas and utility stocks. Then there are ETFs that invest only in retail, biotech, regional banks, technology, health care, energy, insurance, homebuilders, semiconductors, aerospace, dividend growth and other sectors. And in the main, their expense ratios are often half of traditional mutual funds.
There are three utility ETFs that you may wish to consider. Utilities Select Power (XLU -- $28.92), the portfolio of which includes electric utility, multi-utility, energy-trading, independent power production and gas utility stocks. Among the 31 stocks in its portfolio, Exelon, Southern and FPL Group are the largest holdings. In the past five years, XLU has returned 18.6 percent and the current dividend yields a sweet 4.52 percent.
Then there's iShares DJ Utility Index (IDU -- $69.88) that tracks the Dow Jones Utility Index and includes electricity, gas, water and multi-utilities issues. Exelon, Southern, Dominion Resources are IDU's top holdings. In the past five years, this ETF has returned 18 percent and in the dividend yields 3.97 percent.
Finally, there's a slightly different model called Utilities Holders Trust (UTH -- $92.42), which trades like an ETF but behaves a bit differently. UTH is a trust and not a registered investment company like IDU or XLU. This means that the stocks in its portfolio never change except for mergers, acquisitions or spin-offs. If an issue is spun off, the shareholder receives his share of that utility in his brokerage account. There are 18 utility stocks in the UTH portfolio including Southern, Exelon and Entergy. During the past five years, UTH has returned 14.5 percent and its dividend yields about 3 percent.
A single utility issue that has the Street's favor is Edison International (EIX -- $32.06), which is on track, according to Value Line, to be a $50 or $60 stock in the coming five years. EIX serves 5 million customers in a 49,726.2-square-mile area of Southern California, excluding L.A. and San Francisco. Its diverse business model should, in the next five years, grow revenues by 22 percent to $17.2 billion, help earning grow 36 percent to $4.25 a share and improve the dividend by 20 percent to $1.50.
Frankly, I'd consider covering all the bases and split your $16,000 evenly among EIX common, XLU, IDU and UTC. And remember to reinvest all your dividends.
Address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or e-mail him at mjberko@yahoo.com.
