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MUTUAL FUNDS / RUSS WILES

Utilities' Beating Points Up Common Risk

May 30, 1994|RUSS WILES | RUSS WILES, a financial writer for the Arizona Republic, specializes in mutual funds

Utility funds are suffering through one of their worst stretches since the 1970s, but the pain hasn't been evenly distributed.

Portfolios filled mostly with electric stocks, once synonymous with widows-and-orphans safety, have borne the brunt of the decline, while other utility investments, namely the telephone stocks, have held up better.

The whole episode underscores the importance of knowing what a particular fund holds, as the stereotypes once associated with utility funds crumble. It also points up the dangers of risking too much on any one industry, even one perceived to be stable.

A lot of people who sank money into utility funds between 1991 and 1993, when the group's combined assets swelled from $11.4 billion to $30.3 billion, probably expected fairly low volatility and generous dividend yields. And the funds, anchored by their electric holdings, had mostly delivered them.

But electric stocks have gone into a tailspin over the past eight months. Some utility funds with a heavy focus in this area are down 15% to 20%, including dividend income, over that stretch. And all of a sudden, critics are talking about long-lasting structural changes in the business.

It's possible utility funds, like bond portfolios, simply took a beating from the sudden reversal in interest rates that started last fall. If so, stable long-term rates could allow the shares to recover lost ground. Electric utility stocks trade much like bonds because of the large dividends they pay.

But a full-fledged rebound might be harder to achieve because of new worries surrounding deregulation. Some feel increased competition in the utility business will crimp earnings for years to come.

The 1992 Energy Policy Act created a competitive market for wholesale power, one that big industrial users are increasingly trying to exploit, says Charles B. Carlson, editor of Dow Theory Forecasts, an investment newsletter based in Hammond, Ind.

These customers are demanding larger discounts. Downsizing offers a bargaining chip, as companies threatening to close plants might drive a harder bargain with the local electric company for lower rates on the ones that remain open.

Another threatening aspect is "retail wheeling," which would give any power generators access to a utility's transmission network, for a fee. Customers could then buy electricity from entities other than their local utility. Though not yet widespread, it could wreak havoc by making local demand hard to predict, Carlson says.

Of course, lower-cost utilities and those with excess capacity could benefit from deregulation, so the outlook wouldn't be universally bleak. The telecommunications business provides an example of a deregulated industry that has thrived with competition.

So for investors, the relevant question is whether the bad news associated with deregulation is already reflected in the lower prices for electric stocks. Some advisers think so.

Utility "stocks have been the victim of bad press due to the growing competition in the industry," says Fund Profit Alert, a Cincinnati newsletter.

"We expect that this well-publicized growing competition has been more than factored into current utility share prices."

As positives, energy costs and utility borrowing expenses remain under control, the latter helped by the refinancing of debt at low interest rates. Also, some observers believe that deregulation in the electricity business could be less disruptive than in other industries.

And for contrarian investors willing to take some chances, the 5% to 6% yields available on some utility funds are certainly tempting, though it's worth noting that dividends could be cut in the face of deregulatory pressures.

For some of the more widely diversified utility portfolios, the recent ride has been much less bumpy. While nearly all utility funds have lost ground in 1994, the telecommunications-driven portfolios haven't dropped as much, and a few funds with heavier foreign exposure are showing gains.

With the proliferation of fax transmissions, cellular phones, computer transmissions over phone lines and other high-tech applications, the domestic telephone industry is seen as a long-term growth business.

The telephone industry is also viewed as a growth business abroad, especially in developing economies, where basic communications services are still in great demand--hence the global reach of many telecommunications funds.

Even the third utility leg, natural gas shares, could offer good potential. Carlson predicts that these companies, which have already gone through their own bout of deregulation, will outperform electric stocks.

Warren Spitz, manager of the $4-billion Prudential Utilities Fund, the largest fund in the group, has boosted his natural gas stake to 30% of assets, compared to 5% for other utility funds.

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