Rate Uncertainties Shake Utility Stocks Sector Still Considered Good Defense In Volatile Market

Utility funds were among the poorest-performing mutual funds in the first quarter, hit by the same surge in interest rates that briefly sent the stock market reeling.

Though the market recovered, the stocks of electric utilities did not, and analysts say fears of another rate increase should continue to depress the sector.

Utility funds, which typically have a third of their assets in electric utilities, finished the quarter virtually where they started, thanks to other holdings that acted as a bit of a buffer. Still, disappointed investors continued to pull money out of the funds as they have for much of the last year. In a sign of just how out of favor the category is, the Dreyfus Corp. annouced that it would liquidate its five-year-old Edison Electric Index Fund this month.

“This industry is changing rapidly, and lots of opportunities are opening up for electric utilities, but there’s no question about it - they still follow interest rates, and when rates go up, stock prices fall,” said Jane Collin, who follows power companies for the Standard & Poor’s Corp.

Utilities are particularly sensitive to changes in rates because they borrow heavily to finance their operations, and because their yields compete with bonds on yield.

Along with electric companies, utility funds sometimes hold positions in telephone companies, natural-gas producers and energy transmission companies.

The stocks of telephone companies have risen, spurred by the recent announcement SBC Communications Inc. would acquire the Pacific Telesis Group for $17 billion, in a merger of Baby Bells, but analysts aren’t expecting much from the rest of the utility sector this year.

In the long term, however, many analysts still see utilities in their usual role as safe havens, holding up when the broader market weakens.

“At some point, corporate earnings growth is going to diminish, and we think there will be a point of time out there when the flow of funds will become more defensive again,” said Nancy M. Messer, an analyst at the A.G. Edwards & Sons brokerage.

With their dividends now averaging 6 percent and their prices traditionally less volatile than those of most equities, power-company stocks appeal to risk-averse, income-hungry customers, much as bonds do.

But the rise in long-term rates of nearly three-quarters of a percentage point last quarter dealt a blow to both investments.

Many analysts expect the upward pressure on long-term rates, gauged by the 30-year Treasury bond yield, to continue.

David Jones, chief economist at Aubrey G. Lanston & Co., predicted a near-term hold in the range of 6.5 percent to 6.75 percent, with an advance to 6.75 percent to 7 percent by the end of the year.

Despite this outlook, many utility investors remain committed to the group. Kevin Rogers, a financial planner in Cherry Hill, N.J., said he had largely eliminated long-term bonds from his conservative accounts, but he was keeping a one-third weighting in utility funds.

“Utilities are one of the few areas where yields are high and there are capital gains to be had as well,” he said.

Utilities are a classic defense against market volatility, which Rogers said he expected would increase in 1996. He noted that stocks of power companies rallied when investors began to flee semiconductor issues last fall.

“When the hot hand starts to go cold, that money needs to look for a safe harbor, and utilities are always the beneficiaries,” he said.

That helped utility funds show average total returns of 27.7 percent last year, according to Morningstar, the fund-tracking company.

But returns this year for the funds have been clustered around zero.