Utilities for Unfixed Income
Monday, September 28, 2020
Utilities offer attractive "unfixed" income—high dividend yields, with prospects for growth.
The spread between the utility sector dividend yield versus 10-year Treasury yield remains in the 99th percentile relative to the past 25 years. Why do we view today’s environment as a unique valuation opportunity in utilities?
With renewed volatility in the markets, it may be a good time to think about an allocation to utilities.
What may come as a surprise to investors is that the traditionally-defensive utilities sector has significantly lagged S&P 500 Index year-to-date*. Utilities have underperformed by over -11% as a handful of mega-cap stocks have driven the broad market higher.
As of August 31, 2020
Source: Bloomberg; S&P; Miller/Howard Research & Analysis
We view today’s environment as a unique valuation opportunity in utilities.
The dividend yield for utilities stocks relative to the US 10-year Treasury yield peaked on March 23, 2020 during the COVID-19 market panic. The spread remains near historic highs, even six months later. Today’s spread between the utility sector dividend yield versus 10-year Treasury yield remains in the 99th percentile relative to the past 25 years.
As of August 31, 2020
Source: Federal Reserve Bank of St. Louis
This is largely driven by one half of the equation: the 10-year Treasury is near historic lows. To frame it from an income-perspective, a client with $1 million in savings invested in the 10-year Treasury can expect an annual income of roughly $7,000.** Looking at the Miller/Howard Utilities Plus portfolio, with a current dividend yield of 3.6%, that same $1 million could hypothetically produce an annual income of $36,000 in year one.***
Utilities are, traditionally, a more stable source of income for bond investors who are tired of meager income. With a high current yield—5-times the 10-year Treasury yield—and a strong track record of income growth, utilities can be a powerful alternative to fixed income.***
Sources: Bloomberg, S&P 500 Utilities Index, S&P 500 Index, Federal Reserve Bank of St. Louis, Miller/Howard Research & Analysis
* As of September 21, 2020
** Source: Federal Reserve Bank of St. Louis Economic Research - 10-Year Treasury Constant Maturity Rate (DGS10), as of August 31, 2020
*** Based on the Miller/Howard Utilities Plus portfolio dividend yield as of August 31, 2020
Adam Fackler, CFA, focuses on infrastructure companies including utilities, telecommunications, and midstream energy/master limited partnerships (MLPs). Prior to joining Miller/Howard in 2016, Adam spent 10 years in equity research, including five years at Rodman & Redshaw, KLR Group, and MLV & Co. where he covered exploration & production companies and MLPs. Adam holds a BS in Business Administration with a minor in Economics from Bucknell University.