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The Institutional Investor: Still Hot on Utility Stocks?

Michael R. Yogg, who manages Putnam's Global Utilities Fund, explains what investors want from the sector.

Fortnightly Magazine - July 2006

there a level where interest rates would have to be where you’d move more of your money into fixed income investments over utility stocks? Is this an urban legend?

Yogg: An investor has to look at things from a number of different vantage points, and that is certainly one of the ways. A lot of the return from electric utility stocks comes from the yield, so if the yield on electric utility bonds exceeds the stock yield by more than the growth rate, then you have to consider the bonds. After all, bonds are safer.

So, on the question of interest rates, utility bond yields especially have a big impact on utility stock yields (and how utility stock yields adjust through stock-price changes.) So is that an important factor? Yes. On the other hand, the whole energy area is a very dynamic, rapidly changing environment, and there are lots of ways to invest that offer a lot more return and somewhat more risk than bonds. So bond yields are a big factor, but they are not everything.

Fortnightly: What is the size of the portfolio that you manage in the utility sector?

Yogg: First of all, we have the utility funds that are basically industry-sector funds. We have a mutual fund that is $525 million and a variable annuity product, which is a clone of the mutual fund, and which is $230 million, so slightly over $750 million between the two of them. Putnam-wide we have about 3 percent in utilities; that would be between $5.5 and $6 billion. I manage the utility funds and advise on the rest.

Fortnightly: Of your investments that you have on the electric side, what would have to happen for you to substantially increase your holdings?

Yogg: We would substantially increase if the entire industry went to a market-based system and if prices, at wholesale and retail, reflected market conditions, and the true value of the product. We would definitely want to be investing if stocks stayed at these levels, but they would not.

Fortnightly: Of your investments that you have on the electric side, what would have to happen for you to substantially decrease your holdings?

Yogg: Although there are fully regulated utilities that we favor and have full positions in, such as PG&E and Wisconsin Energy, if the entire industry turned back toward regulation, we would see that as a negative. There are places like California where the regulatory story is exciting; but for most of the country and the world, the regulatory story alone is not exciting enough to support the valuation of the stocks currently.

Fortnightly: What if regulated utility stocks had a lower valuation?

Yogg: At a lower valuation, a totally regulated industry would be a safer investment, that is, if dividend yield plus growth were substantially better than the prospective total return from bonds. It would be a safe investment and a diversifier for most portfolios, but not necessarily something to overweight versus the market.

Fortnightly: What is it about wholesale markets that you find attractive?

Yogg: The stock price