Try This Buy Ranked Utility ETF to Protect Your Portfolio

Zacks

2014 has so far been event driven. Record chills in the U.S. plagued the stock markets as the year unfolded with a pack of downbeat U.S. economic indicators. As spring set in and investors seemed comforted by some assuring data, the standoff between Russia and the West on the Ukrainian issue again rendered a blow to the stock market.  

The much-awaited and much-talked about gradual unwinding of QE stimulus was already in place. The persistent concerns about a possible slowdown in China, which is the world’s second largest economy, a relatively weak Japanese economy and deflationary worries in Europe added to the woes. All these suddenly raised the appeal for defensive stock investing.

Among a handful of defensive sectors, utilities held up quite well this year with SPDR Utilities Select Sector ETF (XLU) breezing past SPDR S&P 500 ETF (SPY). Normally, the utility sector is loved by risk-averse investors thanks to its regulated nature of operations and steady return to shareholders. Though it lacks the ability to skyrocket in boom times, the sector comes across as a safe bet in a rocky environment (read: 3 Utility ETFs Surviving the Market Turmoil).

However, no roses are without thorns. Even the utility sector has some shortcomings. As utilities stocks require huge infrastructure, which creates a massive debt burden and the resultant interest obligation on these companies, these stocks can perform poorly in a rising rate environment (read: The Comprehensive Guide to Utility ETFs).

With the U.S. economy fast approaching an era which will be devoid of quantitative easing, a rising rate issue will be looming large. Thus, it would be prudent to pick a potential ETF winner from the infrastructure pack that is likely see huge demand, be less vulnerable to rate issues, and strike a nice balance between value and growth stocks as well as large and small caps.

Demand-wise, companies involved in energy infrastructure should do well ahead as the global economy has been on an uptrend since the middle of last year boosting the energy requirement. Thus, to pick an energy infrastructure ETF, investors can look at the Zacks ETF Rank and find the top ETFs in the sector.

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class (Read: Zacks ETF Rank Guide). Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks ETF Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the utility space, we have taken a closer look at the top ranked GRID. This ETF has a Zacks ETF Rank of 2 or ‘Buy’ rating (see the full list of top ranked ETFs) and is detailed below:

First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund (GRID)

This fund offers exposure across the grid and electric energy infrastructure sector. For a slightly more ‘active’ choice in the infrastructure world, investors should consider GRID for quality exposure.

It looks to have an enhanced exposure on the NASDAQ OMX Clean Edge Smart Grid Infrastructure Index. Though it is an unpopular choice with AUM of less than $20 million, there are some features in the ETF which makes it a distinguished play in the broader utility ETF space.

GRID has as much as 66% exposure in industrials followed by technology (17%) and utilities (15%), setting it apart from utility or industrial pure plays. Reduced focus on utilities makes the fund less susceptible to rising rate risk. From style and capitalization perspectives, GRID is well diversified. Small, mid and large caps account for almost equal share of the portfolio.

Unlike pure utilities that are normally prone to value stocks, GRID puts a decent level of capital on the growth stocks (by about 40%). However, a cautious stance is also well represented in the portfolio with about 37% focus in value stocks and 23% share dedicated to blend stocks.

There is a twist in the geographic division as well. The U.S. accounts for more than half of the portfolio while international stocks comprise the rest, with Europe making up 45% of the portfolio followed by Asia-Pacific (4%).

With Europe on the growth path, though rather slow, the fund is likely get some impetus from this regional exposure. Also, interest rates in Europe are at the rock bottom level with no possibility of increases in the near term. This will also do good to the rate-sensitive slices of the fund.

GRID consists of 38 stocks. The fund has little bit of concentration risk with the top five holdings accounting for more than 8.0%. Red Electrica Corporacion S.A. (8.40%), Quanta Services, Inc. (8.39%) and Schneider Electric S.A. (8.19%) round out the top three holdings of the fund (read: Deutsche Bank Launches Muni Bond, Utility ETFs).

For this unique exposure, the fund charges 70 basis points in annual fees which is slightly costly in the utility ETF space. The fund gained about 7.22% in the YTD time frame in contrast to 12.32% gain seen in the biggest fund in the space – XLU and SPY’s advancement of 1.36%. We currently give GRID a Zacks ETF Rank of 2 or ‘Buy’ rating along with a medium risk outlook.

Bottom Line

Overall, the global economy is picking up. While the pace is not same across the board, the dark era of recession is over. As a result, infrastructural spending should see a lift from now. Moreover, be it safety or be it risk whatever be the market sentiment, GRID’s uniqueness in portfolio composition should earn it some decent returns and possibly a place in your portfolio too.

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