Utility exchange-traded funds (ETFs) are funds whose portfolios have exposure to utility companies that are regulated. The companies that a typical utility ETF is exposed to in this particular sector are those that supply, for example, water, electricity, natural gas and other daily utilities. This type of ETF can be vulnerable to changes in regulation, and its performance is linked to that of the securities it holds.
In a basic sense, the fund purchases securities from companies in the utilities sector based on a specific criteria. Then it turns around and sell shares to individual investors and/or institutions, and the proceeds can be funneled to buy more utility companies securities. Generally, a utility ETF also uses a certain utility sector index as a performance benchmark. Moreover, the ETF can be traded on a stock exchange the same way as equities, and it yields dividends.
Commonly, a utility ETF does not experience the same volatility as the general stock market because of its nature. It is a defensive investment, which means that it will continue issuing dividends irrespective of the business cycle. This is because even in a recession, when most sectors are hurting, consumers still need water, electricity and other utilities. A utility ETF can, therefore, be an attractive investment in a downturn, but when the economy is prospering, there are other investments that can possibly offer better yields.
Infrastructure businesses, also referred to as utilities, are normally subject to changes in government regulation. The performance of a utility ETF investment will be influenced by regulation that directly affects utility companies. This is because the performance of a utility ETF is mainly tied to that of the companies that the ETF has in its portfolio. This also means that if the utilities sector is doing well, then the ETF should normally do well.
Investors can further diversify their portfolios by investing in ETFs that reach other utilities markets on a global scale. Investors who can bear the extra risk for a chance of higher yield can even access utility ETFs that are leveraged. There are also what are called inverse ETFs, which allow investors to use particular hedging strategies. An inverse ETF, as the name suggests, will move in the opposite direction of the index that it tracks. That is, if the index rises, the ETF will fall, and if the index declines, the ETF will appreciate.