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January 02, 2003 at 07:00 PM
Dec. 23, 2002 — Consider it official: these are not your father’s utility funds.
Once, utility funds were regarded as the safe havens of the mutual fund world: great investments for widows and orphans, and a perfect way for a nervous neophyte to dip his toe into stock investing. However, thanks to deregulation, those days are gone. Through the first eleven months of 2002, utility funds as a group sank 23.4%, lagging most kinds of growth funds, with the exception of the extremely volatile technology and telecom sectors, according to Standard & Poor’s. The Dow Jones Utilities Average is now hovering near its lowest level in 14 years.
That trend prompted Vanguard Group to request and obtain shareholder approval for renaming and redefining the mandate of Vanguard Utilities Income Fund (VGSUX). Going forward, the fund will be transformed into Vanguard Dividend Growth Fund, which may invest in utilities, but will be free to seek out stable income wherever it can be found. The goal, Vanguard officials say, is to avoid confusion among investors over the nature of the fund.
“The original intent behind the utilities fund was to offer a high level of current income, and reliable income,” says Joe Vernon, senior investment analyst at Vanguard’s Portfolio Review division. “For the most part, utility stocks were highly-regulated, stable entities characterized by lower volatility and strong cash flow. And investors still think of them that way.”
Instead, by the late 1990s, Vanguard’s fund — like many other utility funds — was full of companies that fell far short of providing those characteristics, although they still qualified as utility stocks. Deregulation in both the power industry and in telecommunications meant that utilities faced a more competitive environment, and a host of new entrants. Power generation and power distribution businesses were separated by bankers; with power generation companies rapidly accelerating their spending, said one investment banker who helped raise capital for the sector. The spending was even more dramatic among telecom service companies, where the proliferating number of competitors raised capital and spent at a dizzying rate in order to gain market share. The consequences weren’t surprising: by 2001, both industries were facing serious overcapacity and a crunch on profitability.
“You had a tremendous number of factors creating a much more volatile market and business environment for companies that were only just getting used to being deregulated,” says Judy Sarayan, manager of Eaton Vance Utilities Fund (EVTMX). “All of a sudden, they’re having to grapple with the impact of sudden exposure to free markets and volatile pricing.”
Investors’ conceptions about the nature of utility companies doesn’t match the changing realities that the industry finds itself in.
Two years ago, the Colonial Funds complex (which are now part of Columbia Management Co), polled its stockholders and discovered that the majority considered utility funds as a safe, low-risk investment, said Scott Schermerhorn, a portfolio manager at Columbia. “We’ve been studying what to do with the fund as a result of that,” he says. “Deregulation transformed the nature of the utilities business and raised the component of risk.” As such, both investors and financial advisors need to educate themselves about the swift changes that have impacted the utility industry.
