Last year at this time, I theorized that Utility Stocks "UTES" might be a better investment than TIPS (inflation-linked bonds). It's time for an update.

(Disclosure: I have a small investment position in utility stocks.)

Since 10/8/10 … when I posted the idea: TIP (tip etf): Total return (coupons reinvested): 7.75%VPU (vanguard UTE etf): 10.85%SPY (S&P etf): 5.72%AGG (Total bond market etf): 4.20%

Source: Bloomberg.

So as James Brown would say: "I feel good."

What's surprising to me is that UTES beat both the AGG and the SPY! I would be very surprised if the UTES continue to beat both the AGG and the SPY over the next 12 months, but I would not be surprised if they continue to beat the TIPS. Contrary opinions are always welcome. But my inclination is to continue to sit on my hands — because most of the time that's the right investment decision. AND it's cheaper than wearing mittens.

From that email exchange:

I thank the speclisters who kindly pointed out (offlist):

1) During the 1930's depression, utility stocks held their dividends… And people who paid their bills saw higher rates to compensate for the people who did not pay their bills.

2) The TIPS will return par at maturity — there is no similar guarantee for utility stocks.

3) Because TIPS are currently trading at a premium to par, outright deflation can be injurious to their returns.

4) Utilities are taxed as corporations — and are also subject to the risks of cap&trade etc. However, the state rate-setting boards may/may-not compensate for the increased costs of cap&trade with rate hikes.

The daily and weekly statistical correlations between utes and tips are quite poor. But as the attached chart shows, they do seem to move in the same directions.

Perhaps foolishly, I'm least worried about technological innovation — because the primary motivation for investing in a regulated utility is that they set rates based on a statutory ROE….


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