Utility Stocks See The Light

Mutual funds that specialize in utility stocks likely will finish among the top-performing categories for 1997.

One reason is a virtually free lunch for electric utility investors, thanks to Wall Street financial engineers who have come up with an ingenious way to pass a major chunk of the utilities’ business risk from their investors to the public at large - with little complaint so far from the public.

Of late, the Lipper Analytics index of utility funds was running ahead of widely popular small-company funds and on a par with the far more risky biotechnology funds, and at roughly two-thirds of the significant gain of the Standard & Poor’s 500-stock index.

The utility-fund performance represents a major turnaround from 1996, when they returned under 9 percent, which was less than half the 22 percent total return for the S&P 500. Lower interest rates and a switch by many investors this fall from growth stocks to less risky vehicles such as fixed-income and utility investments explain much of the gain.

Mark Luftig, portfolio manager for W.H. Reaves & Co. in New York and co-manager of the Strong American Utilities Fund, says electric-utility stocks’ story has distinct features:

Aggressive cost-cutting in advance of greater competition for residential and commercial users.

A reduction in shares outstanding and share price premiums resulting from a continuation of mergers in the industry.

But another development is at work - one that’s also generating new securities for utility-bond investors and, at the same time, assisting in the transition to deregulation and competitive pricing for customers.

In November, several California utilities marketed a new form of debt securities known by the euphemism “rate-reduction bonds.” They represent a shift of responsibility onto the public for resolving the high costs of electric utilities’ investments in nuclear power plants and other big-ticket projects.

Industry critics, especially those of nuclear power utilities, believe owners of utility stocks and bonds should take the hit to write off stranded costs. But it’s hard to argue with a financial mechanism that promises lower utility rates, competitive pricing and service, higher utility stock prices and a new generation of bonds.