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Interest Rates Short-Circuit Utility Funds

Three days of intense selling knocked 409.59 points off the Dow Jones Industrial Average. This blow-up was sparked by rising interest rates. For the week ending Thursday, June 7, the yield on the generic 10-year U.S. government bond rose 24 basis points to 5.13% -- its highest level in almost a year.

The expectation of interest rates continuing their climb hurt stocks across all sectors. Looking at unleveraged funds only, energy funds were down by as much as 3.8% for the five trading days between May 31 and June 7.

The worst-performing health care funds lost as much as 3.9%, while financial funds lost 4.3% and precious metals were pounded down 5.3%. When the market is dropping, even holdings of socially responsible funds get tossed out the window. These funds lost as much as 4.3%.

Not to be outdone, the utility sector, renown for its interest rate sensitivity, offered up an example of one unleveraged fund being chopped down by 9.35%. On average, the utility funds we track lost an amazing 5.10%, when you exclude inverse funds that short the sector.

The 200% leverage of the Ultra Utilities ProShares (UPW) crushed the fund by 12.86%, while the 150% leveraged of (UTPSX)ProFunds Utilites UltraSector ProFund (UTPSX) slashed off 9.75%. Both funds follow the Dow Jones U.S. Utilities Index.

Investors tend to hold utility stocks for their good yields. But with higher risk-free rates, these stocks can become comparatively less attractive. In the past five trading days, members of the Dow Jones U.S. Utilities Index sank substantially.

Even in the absence of individual adverse news, Exelon (EXC) was down 10.36%, AES Corp. (AES) fell 10.20%, and Constellation Energy Group (CEG) lost 9.18%.


10-Year Yield at Highest Level Since July 2006
Click here for larger image.
Source: Bloomberg

The worst performing stocks held by (MFD)Macquarie/First Trust Global Infrastructure/Utilities Dividend & Income Fund (MFD) were Pennon Group, off 7.32%, Red Electrica de Espana off 5.17%, and Kelda Group PLC off 5.14%.

Being a closed-end fund that does not have to trade at its net asset value, this fund fell further than its holdings, dropping 9.35%. It also shows that rising rates are not just a U.S. phenomenon.

Worst-Performing Utility Funds*
Fund Ticker Rating Fund Type 1-Week Total Return
Ultra Utilities ProShares UPW U ETF -12.86%
ProFunds Utilities UltraSector Profund UTPSX A- Open-End -9.75%
Macquarie/FT Gbl Infra/Utilities Divi & Inc Fund MFD B Closed-End -9.35%
Fidelity Advisor Utilities Fund FAUFX A+ Open-End -6.89%
Fidelity Select Utilities Growth Portfolio FSUTX A+ Open-End -6.89%
Cohen & Steers Select Utility Fund Inc UTF B+ Closed-End -6.83%
Utilities Select Sector SPDR Fund XLU A+ ETF -6.79%
Vanguard Utilities ETF VPU A+ ETF -6.63%
iShares Dow Jones US Utilities Sec Index Fund IDU A+ ETF -6.61%
Utilities HOLDRs Trust UTH A ETF -6.60%
* May 31-June 7
U=Unrated
Source: Bloomberg

Even with an unbelievable one week return of 14.04%, the UltraShort Utilites ProShares (SDP) is still down 10.72% since it was launched Feb. 1. If interest rates continue to rise, this 200% negatively leveraged fund has a good shot at breaking even.

Also, not to be believed is the 0.10% positive return of the First Trust Utilities AlphaDEX Fund (FXU). This illiquid fund didn't trade on June 6 or June 7, nor did it last week on May 31 or June 1. So, the 0.10% figure represents the gain from $19.76 on May 30 to $19.78 on June 5. Over the comparable week, the fund's holdings averaged a loss of 5.44% -- with only three holdings rising while 51 declined.

Best-Performing Utility Funds*
Fund Ticker Rating Fund Type 1-Week Total Return
UltraShort Utilities ProShares SDP U ETF 14.04%
First Trust Utilities AlphaDEX Fund FXU U ETF 0.10%
DTF Tax-Free Income Inc DTF D Closed-End -0.14%
Gabelli Utility Trust GUT C+ Closed-End -2.10%
First Investors Value Fund FIUTX B- Open-End -2.23%
Evergreen Utilities and High Income Fund ERH B Closed-End -2.52%
Duff & Phelps Utility and Corporate Bond Trust DUC E Closed-End -2.54%
RiverSource Dividend Opportunity Fund INUTX A+ Open-End -2.55%
First Trust ISE Water Index Fund FIW U ETF -2.57%
PowerShares Water Resources Portfolio PHO C- ETF -2.78%
* May 31-June 7
U=Unrated
Source: Bloomberg

Friday morning, the yield on the 10-year U.S. government bond continued its climb, peaking at 5.242%. This attracted bond investors whose buying drove the yield down to as low as 5.101% and alleviated some of the pressure on stocks. It remains to be seen whether the resurgence in stocks on Friday was a dead-cat bounce or a phoenix rising from the ashes.

Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by TheStreet.com, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.

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