Three exchange-traded funds holding utility stocks are available from three different ETF companies.
Two of the three have management expense ratios of 0.61 per cent, which is unconscionably expensive, and a third has just moved to a lower but still significant cost. ETFs right have a reputation as the go-to investment for cost-conscious investors and advisers. But there are glaring exceptions, as utility ETFs show.
The two high-fee funds are the BMO Equal Weight Utilities Index ETF (ZUT-T), with assets of $500-million and 14 total holdings; and the iShares S&P/TSX Capped Utilities Index ETF (XUT-T). with assets of $379-million and 15 holdings.
A third fund, the Global X Canadian Utility Services High Dividend Index ETF (UTIL-T), will on March 4 reduce its current MER of 0.61 per cent to an estimated 0.32 per cent. UTIL has assets of $18.6-million and 12 holdings.
The number of holdings in these funds is significant because it suggests a level of complexity in managing the portfolio. Somehow, broad market Canadian equity ETFs with 200-plus holdings can have MERs as low as 0.04 to 0.06 per cent, but a concentrated portfolio of utility stocks costs much more to manage.
The high cost of utility ETFs is an exploitation of conservative investors who prefer the diversification of a basket of utility shares to picking their own stocks. As it happens, utility stocks are of particular interest now for their defensive attributes. If a U.S.-Canada trade war starts and the Canadian stock market suffers, utilities could reasonably be expected to fall less than the broader market.
Falling interest rates would be another plus for utility stocks in a trade war. Expect the Bank of Canada to cut its overnight rate to support a struggling economy. Falling rates make the dividends from utility stocks look extra attractive. The yield for XUT, for example, was around 3.9 per cent recently based on the most recent distribution. ZUT was at 4.2 per cent, while UTIL was at 4.9 per cent. With a lower MER, holders of these funds would receive even more income.
While the basic mission and fees are similar for these three ETFs, they do differ in portfolio construction. XUT tracks the S&P/TSX Capped Utilities Index ETF, which weights stocks according to their market capitalization. Market cap is shares outstanding multiplied by share price. ZUT tracks the Solactive Equal Weight Canada Utilities Index, which the same weighting on each position in its portfolio. UTIL has worked higher yielding stocks like Telus Corp. (T-T) and Enbridge Inc. (ENB-T) into its portfolio of more or less equally weighted stocks.
BMO used to have an MER of 0.6 per cent on its BMO Equal Weight Banks Index ETF (ZEB-T), but then lowered the fee to a more reasonable 0.28 per cent. It’s time for a similar price cut on utility ETFs.