The Dow Jones Utilities Average returned 30.7 percent in 2014, its fattest gain since 2000. The S&P 500 Telecommunication Services Index, however, generated a total return of only 3 percent.
And after a torrid start to the year, the plummeting price of crude oil and natural gas liquids (NGL) took the starch out of the Alerian MLP Index, which closed the year with a 4.8 percent gain.
Thus far in 2015, the Alerian MLP Index has sunk another 3.6 percent, while the Dow Jones Utilities Average has climbed by 1.4 percent.
Shares of regulated utilities have started the year strong for the same reasons they finished 2014 with their best fourth-quarter return since 2014: Income-seeking investors continue to rotate into the sector to limit their exposure to falling oil prices.
This perceived safety seemingly outweighs the Dow Jones Utilities Average’s paltry 3.1 percent yield. By comparison, the Alerian MLP Index offers a current return of 6.1 percent and the S&P 500 Telecommunication Services Index yields 5 percent.
Despite the growing popularity of exchange-traded funds (ETF), sector rotation will only take you so far.
Consider that the six master limited partnerships (MLP) in our model Portfolios last year generated an average total return of 26.2 percent, easily trouncing the 4.8 percent return posted by the Alerian MLP Index and popular ETFs that track this index.
Bottom Line: Buying individual stocks selectively improves your chances of outperforming, especially in a late-stage bull market where the number of stocks leading the rally continues to narrow.
The ETF world does include innovative offerings that individual investors can use to pursue strategies that traditionally have been the province of professionals.
Last fall, for example, we booked a 15.3 percent gain over four weeks in ProShares Ultra Utilities (NYSE: UPW) as part of a short-term trade to capitalize on seasonal strength for utility stocks. This specialty ETF gave moves two percentage points for every single-point move in the Dow Jones Utilities Average.
And Conservative Income Portfolio holding iShares Utilities Bond (NYSE: AMPS) provides easy exposure to a diversified portfolio of mostly near- to intermediate-term bonds issued by essential-services companies—an asset class that’s difficult for individual investors to access.
However, the diversified exposure to a specific sector, industry or theme that’s such a selling point for ETFs effectively locks in underperformance because their underlying portfolios usually include the best and worst stocks that fall into that category.
Picking a sector-focused or thematic ETF may be easy, but selecting individual stocks can be more rewarding—with some homework and luck.
But investors shouldn’t stick their heads in the sand and ignore the rise of ETFs; the popularity of these investment vehicles helps to exaggerate price swings to the upside and downside.
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