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Blog Posts — January 31, 2020

Investors Turn to Utilities to Immunize Portfolios Against Coronavirus Volatility

by Diana R. Baechle, PhD

Investors flocked to US Utilities, a defensive sector that could help immunize portfolios against volatility caused by the growing coronavirus outbreak. Stocks around the globe fell last week, after WHO declared the coronavirus epidemic an international health emergency. Businesses were disrupted in China and internationally, amid broad efforts to contain the virus, with entire cities in China remaining in lockdown, Chinese factories shutting down, airlines cancelling flights, etc. Global investors are now concerned about the outbreak’s impact on both individual markets and the global economy overall.

Utility stocks have taken off this year, especially after mid-January, when the coronavirus first began to spread beyond China’s borders, and fears about the outbreak mounted internationally. It was an abrupt change from the prior quarter, when Utilities barely finished in the black, being one of the worst performing sectors in the Russell 1000 in Q4 2019. The strength of Utilities lies in their defensive nature; US Utilities are unlikely to be directly affected by the impact of the virus.

Utilities’ year-to-date cumulative return climbed to 7% by January 30, on par with that of the most successful sector in the Russell 1000—Information Technology.

Source: Axioma Portfolio Analytics

The magnitude of Utilities’ return was high. To put it in perspective, the second-best performer, Real Estate—also a defensive sector—posted less than half of Utilities’ gain over the same period, namely 2.6%. Materials and Energy, both of which are sensitive to China, were hit the hardest, incurring year-to-date losses of 4.0% and 8.5%, respectively. Since January 15, all sectors have fallen except for Info Tech, Real Estate and Utilities, with Info Tech boosted by strong earnings reports for major tech companies, while Real Estate and Utilities benefited from their defensive nature.

Utilities’ return in January was large even when compared with historical monthly returns for the sector. Utilities has not seen this level of return since June 2016, when the world was rattled by the UK’s vote to leave the European Union.

Source: Axioma Portfolio Analytics

*Note: Jan 2020 is the monthly return up to 01/30/2020.

One would expect Utilities to do well in a weak market because of their defensive nature. And we see that clearly, as Utilities outpaced the Russell 1000, reporting a year-to-date active return of 5%. More than 50% of Utilities’ active return was attributable to the sector’s negative exposure to Market Sensitivity (in other words, its low beta). Drilling down to the industry level, Electric Utilities turned in the best performance.

Factor-Based Performance Attribution

Source: Axioma Portfolio Analytics

All US sectors saw a decline in risk[1] since the end of 2019, except Utilities and Energy—the best and the worst performing sectors so far in 2020, respectively. However, Utilities remained the least volatile sector after Consumer Staples, while Energy the riskiest. The spread between Energy and Utility forecasted risk is now more than 10 percentage points.

Source: Axioma Portfolio Analytics

As markets continue to fret over the impact of the coronavirus on global growth, Utilities, especially Electric Utilities, have offered a safe haven. As we come off a year of extremely high equity returns, whether that flight to safety continues is likely to depend not only on how the virus spreads, but also on investors’ perceptions of the continuation of higher-than-average growth, continued low inflation and interest rates, and, of course, numerous other unknowns and uncertainties.

[1] Sector risk is calculated by creating a portfolio of all stocks in a particular sector in the Russell 1000. Weights, based on Russell 1000 weights, are then rescaled to add to 100%. The risk of each sector portfolio is then calculated using Axioma’s US4 short-horizon fundamental model.