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.

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